Many founders have no idea what a letter of intent is, whether or not they should get one, and its role in M&A. So much goes into a startup acquisition, it can be daunting gathering all your financials, valuations, and everything else needed, nevermind just running your daily operations.
The letter of intent can be from 2 to 10 pages long, and it will show all of the key terms of the acquisition agreement when receiving an offer for your company.
What is a letter of intent?
When you, the startup’s founder and board, and the acquirer reach an agreement in principle, the purchaser will prepare a letter of intent (LOI). The LOI is a formal document that will outline everything that you have agreed upon, including the structure of the deal, management arrangements, and the length of due diligence. The LOI is not legally binding, so adjustments and edits can be made by the acquirer.
The Main Purpose of an LOI
The letter of intent is the legal groundwork for acquiring a startup. The LOI is entirely negotiable, and it is no surprise to the potential acquirer if founders reject it. Nevertheless, letters of intent should leave a good impression on the company’s founder.
The negotiating process can be shortened by minimizing misunderstandings further down the acquisition process, saving time and money. For example, if an agreement can’t be made during the LOI phase, the acquirer won’t invest in the lengthy purchase agreement. The seller won’t time themselves up.
Only serious buyers will spend time investigating a startup by analyzing all of the company information, such as financials, valuations, management and competition. They will get tax advice and consult with attorneys who will assist in drafting the purchase agreements. Getting to the LOI stage with acquirers and proceeding into due diligence can lead to a successful acquisition.
How to Write a Letter of Intent
Two essential provisions are included in the letter of intent: confidentiality and exclusivity. So naturally, buyers want to ensure you aren’t talking to other parties for a certain amount of time, and potentially wasting their time. Confidentiality swings both ways, but most importantly, for the buyer, since the startup shares highly sensitive information.
What do acquirers put into a letter of intent?
Buyers will write an LOI following all legal principles and will define their expectations.
- It’ll start with an introduction. The buyer will summarize the contents of the letter of intent and state that it is not legally binding. They will acknowledge you, the founders and shareholders of the startup, and all parties involved in the acquisition.
- Mergers are more complicated than acquisitions, but both will require legal professionals to word it appropriately. It should include the purchase price, payment dates, amounts and potential installments.
- Consider purchase price adjustments and determine if it is a debt-free deal with all working capital calculations and expenses.
- The buyer will add a due diligence timeline and negotiation.
- Exclusivity for the potential acquirer and the length of time the exclusivity will last.
- As part of the due diligence process, the LOI will list the management and employees who will remain part of the team.
- There may be third-party companies with which the startup is in business whose consent is required for contracts to get carried over after the acquisition.
- Non-disclosure agreements for both parties.
- If employees have equity in the startup, the LOI should state how they will get treated.
- All non-compete agreements should get indicated.
- When the acquisition agreement can be terminated
- How both parties will handle disputes.