As a business owner, you know the value that mergers and acquisitions can bring. With the potential to accelerate growth through entry into new markets, talent acquisition, and access to greater resources, formulating a successful M&A can set the stage for future growth.
Yet despite $2 trillion in global acquisitions, most M&As will fail for one reason or another. Successful deals depend on treading carefully through every step. In 2024, the Letter of Intent (LOI) remains as relevant as ever.
But what is an M&A LOI, and how can they benefit your deal?
What is included in a Letter of Intent?
Your LOI primarily demonstrates intent. As UK M&A volume trends downward, according to the latest statistics, businesses seeking deals must take care in a volatile market.
An LOI signals that you are interested in a deal, but it also includes price, conditions, contingencies, terms and more information. What should be included if you have reached the stage where you’re preparing to issue an LOI?
Every deal is unique, but all LOIs will contain similar points, including:
Deal Structure – How will a potential deal be structured? For example, will you be purchasing stocks?
Terms – Spell out the conditions that must be met to close the deal, including acceptable payment forms and projected closing dates.
Exclusivity – Practically all buyers will request a period of exclusivity, whereby the seller removes the business from the market and ceases talks with other third parties.
Break–Up Fees – Some LOIs may include break-up fees. If a deal falls through after the agreement, a fee may be charged to the buyer. The most common break-up fee in the UK is 3%.
Due Diligence – The LOI comes directly before the due diligence process, meaning it’s common to spell out the rules of engagement and what the buyer expects to be disclosed.
Confidentiality – Non-disclosure agreements are also a common contingency within LOIs. However, it’s common to spell out these agreements in LOIs.
Approvals – In the event either party requires approval from a third party, such as a board, agency, or investor, to greenlight a deal, an LOI will list them.
As always, it’s vital to secure the services of a qualified solicitor to go over any LOI to guarantee no stone has been left unturned. Take your time, and don’t skimp on the details; it could cause confusion, misunderstandings and arguments later.
Short form vs long form LOIs
Should you opt for a short or long-form LOI? Each has its pros and cons.
Firstly, long-form details go into far greater detail. They’ll contain plenty of legal and business terms, as well as going into the nuts and bolts of a proposed deal. In business circles, these are used to achieve a “meeting of the minds”.
Some of the reasons companies opt for the longer version of an LOI include:
· Pinpoint and discuss potential deal-breakers early.
· Resolve major issues early to save time and money.
· Insurmountable issues can be identified early, ensuring that neither party wastes their time on a deal that’s going nowhere.
On the other hand, with UK deal volumes declining by 21% in H1 2023 and the traditional principle that time kills deals, long-form letters may halt a deal’s momentum. This can be caused by jumping into contentious issues too early.
If you’re concerned about this, you may want to opt for a short-form LOI. These letters typically only contain a few key terms and the price. These are quicker to negotiate but have the disadvantage of postponing discussion of important issues.
In a global market that has already declined by 4% in H1 2023, some managing directors may want to hammer out the details early at the expense of time in a depressed market.
Who would use a Letter of Intent?
A Letter of Intent is essential for any major M&A transaction. The buyer’s side typically provides them, and it’s up to the seller to either accept the LOI or renegotiate it.
No legal requirement obligates either party to produce an LOI as part of an M&A deal, but their role means that forgoing one can put buyers and sellers at a distinct disadvantage.
Are Letters of Intent necessary in business acquisitions?
The obvious question is, “If an LOI isn’t legally binding, why waste the time making one?”
Truthfully, the LOI is one of the most pivotal documents in any transaction. In many ways, it eclipses the importance of the final purchasing agreement. It outlines the expectations and red lines for buyers, and sellers can also clarify their position before proceeding to the due diligence stage.
Not having an LOI means there is a greater chance that you will spend months on due diligence, and then the deal will fall through due to a failure to agree on prices and terms.
Who benefits from a Letter of Intent in an M&A?
A Letter of Intent is beneficial for both parties in an M&A.
A formal LOI enables the buyer to access core details about the seller’s business that could make or break their deal. Additionally, an LOI enables them to take advantage of an exclusivity clause, meaning a competitor cannot steal the deal from under them.
Ultimately, LOIs help inform buyers that they are investing in the right business for them, alongside triggering the due diligence process.
On the other hand, sellers can protect their business by insisting that an LOI is brought to the table. After all, if a buyer cannot agree with some basic ground rules and limitations within an LOI, it’s a sign of a lack of interest.
Furthermore, the terms of the LOI will usually be brought through to the final purchase agreement in some form.
Why are Letters of Intent so important?
LOIs benefit both the buyer and the seller. It’s not uncommon for LOIs to undergo multiple drafts and rounds of negotiations before both parties can agree on a framework for the upcoming due diligence process and a potential final deal.
But why else are LOIs such a keystone for a successful M&A deal?
- They test the commitment of both sides.
- Providing a moral obligation to negotiate in good faith.
- Sets an initial starting point for negotiations.
- Offers a period of exclusivity to the buyer.
- Clarification of details of various key terms that will form part of future negotiations.
- Outlines the deal’s structure.
- Provides information on any financing.
- Offers detailed expectations and conditions that must be satisfied before a deal can proceed.
In other words, LOIs crystallise interest and lay the foundation for negotiations. It’s also a chance for either side to back out before they invest time and money in an in-depth due diligence process.At Hilton Smythe, we understand the value of LOIs in successful M&A deals, which is why we have worked with countless businesses in drafting and interpreting them. To learn more about how our M&A Consultancy team can help you with your LOIs, speak to us today.