George P. Shenas

Letter of Intent in Business Acquisitions

Typically during the early stages of a negotiation between a buyer and seller involving the purchase and sale of a privately held company the parties enter into a letter of intent. The letter of intent often contains the following terms of the transaction: the price to be paid, the form of payment, a description of the assets to be transferred and the liabilities to be assumed, a description of the form of the transaction, an obligation imposed on the seller to carry on its business in the ordinary course, a confidentiality provision, an obligation imposed on the seller to deal exclusively with the buyer in connection with the sale of the business, a statement regarding the responsibility for expenses, and a termination provision.

Letters of intent have the advantage of clarifying the key terms of a transaction and flushing out potential "deal breakers" before the parties invest a substantial amount of time and expense in negotiating other terms of the transaction and preparing the purchase agreement and related disclosure schedules. The letter of intent may also assist counsel in drafting those provisions of the purchase agreement which are covered by the letter of intent. In a customary transaction involving a privately held company, one of the key terms a buyer should include in a letter of intent is a detailed provision requiring the seller to negotiate only with the buyer during a specified time period. Such a provision, generally referred to as "no shop" clause, ensures that the seller will turn away other potential acquirers during the term of the "no shop" clause and will conduct negotiations exclusively with the buyer. The "no shop" clause protects the buyer from expending substantial resources on a negotiation with a seller who is simultaneously conducting negotiations with other potential acquirers.

After the buyer and seller execute a letter of intent which includes a "no shop" provision, the buyer's negotiating leverage typically increases substantially over that of the seller because the seller is obligated to turn away other potential buyers. For this reason, the buyer is well advised to use general and non-detailed language in all other provisions of the letter of intent (except the "no shop" clause which should be narrowly drafted). By using general language in the other provisions of the letter of intent, the buyer will have maximum flexibility in negotiating the other terms of the transaction during a period of time in which the buyer's negotiating leverage has increased relative to that of the seller. For instance, in describing the transaction the buyer may want to include a statement in the letter of intent which says "the buyer will acquire the business" rather than a more specific statement which describes the structure of the transaction and the payment terms.

Because the seller tends to lose negotiating power following the execution of a letter of intent containing a "no shop" clause, the seller typically should press for a comprehensive and detailed letter of intent which locks up the key provisions of the transaction. The seller may also consider including a time line in the letter of intent which sets out the dates on which certain activities relating to the transaction must occur (e.g., the date on which the first draft of the purchase agreement will be delivered by the buyer to the seller, the date on which the buyer will have completed its due diligence investigation, etc.). In the event that these "milestones" are not met, the seller should be able to terminate the "no shop" clause and pursue other buyers. Because the seller's negotiating leverage tends to continue to decline during the course of the "no shop" term, the seller should attempt to compress any time table set forth in the letter of intent.