Why Signing a Letter of Intent (Pretty Much) Obligates You to Go Through with the Deal

by admin

keyboard In any merger, the parties might sign a document called a Letter of Intent or Memo of Understanding or something. What is it? And what is it used for?

What is it?

Basically, it’s the agreement in principle.  It’s a document that say the parties have agreed in principle to go forward with the merger.  The document might spell out some of the basics of the deal, such as price and form of payment (stock, cash, debt, etc.).

Is it legally binding?

It’s usually not legally binding.   If both parties intend the LOI or MOU to be binding, specific language to such effect should be stated in the document.  In fact, the document is not even necessary to a deal.    Still, it might be useful to have an LOI or MOU.

First, the document represents the basic terms of the deal memorialized on paper.  As negotiations continue, one party might go back on its word and claim that it never agreed to a certain deal point.  If the terms of the LOI indicate that the other party did in fact agree to that deal point, then any debate on this is nipped in the bud.

Second–and this is a more principled reason why it’s useful to have an LOI–the document represents a moral commitment of both parties.  A principled party to the merger will honor its word and commit to the basic terms of the LOI.

What should be covered?

The following is a general checklist of things to be covered in the LOI if they are known at the time of signing.  Your counsel may have a different list based on the specifics of your merger:

  • The form of the transaction (is it a stock purchase, a merger, an asset purchase, etc.?)
  • What the seller gets (cash, stock, debt, etc.)
  • Treatment of options, warrants, and convertible securities of the seller
  • Special contracts with key officers, directors, and employees of the seller, such as employment contracts, stock options, etc.
  • Major provisions, such as escrow or pledge, that have a significant protective effect for one or more parties.
  • Any conditions that must be met prior to consummation

What startups should understand about the LOI or MOU

Often, a potential buyer of a startup really wants the company.  Otherwise, the buyer wouldn’t be interested in purchasing your startup.  This pre-LOI time is when  you have the most leverage as an entrepreneur.  Not only can  you negotiate with the most strength for the purchase price, but you can also sound off on other matters which may be of concern to you (like a noncompete agreement).  After you sign the LOI, you will likely see your leverage drop dramatically.

As an entrepreneur, you will find it difficult to negotiate for significant concessions from the buyer.  You will also be put on the spot to go through with the deal.  Once the LOI is signed, everyone will know.  You will tell your employees and suppliers.  Your competition will find out.  Other potential buyers will also find out.  If the deal doesn’t go through, people will suspect that something  is really wrong with your company.




(photo courtesy of: http://flic.kr/p/5X3tDq)

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