Mergers and acquisitions

Most merger and acquisition deals
(M&A) start with a letter of
intent, with one party (usually the buyer) submitting its proposal to the
other, to lie down the foundation of the
transaction. Letters of intent are generally short and informal, and, accordingly,
often are drafted and negotiated directly
by the principals to the transaction.
However, parties would be well-served
to consult their lawyers prior to executing the letter.

“All too often, clients give up significant negotiating leverage by signing a
letter of intent without running it by
their lawyer,” says Julio C. Esquivel, a
partner at Shumaker, Loop & Kendrick

“These miscalculations can often complicate and prolong negotiations and
sometimes lead to the failure of the
transaction or even to litigation.”

Smart Business talked to Esquivel
about the importance of the letter of
intent and how it can most effectively be
used in M&A transactions.

What is the purpose of the letter of intent?

The letter of intent memorializes the
preliminary agreement of the principals
and in that fashion allows them to take
their negotiations to the next level. It
does so by not only summarizing the
parameters of the proposed transaction,
such as price and closing conditions, but
also by setting forth certain safeguards
that promote continued dialogue such as
nondisclosure and no-shop provisions.

Additionally, letters of intent may
allow the parties to begin the process of
obtaining governmental and other third-party approvals necessary to close the

What is the most common mistake that parties make when it comes to the letter of

Often, having reached a handshake
agreement, the parties want to maintain
the momentum of their negotiations, so they rush to sign the letter of intent.
This is especially true when one of the
parties is eager to publicly announce
the agreement. But even though the letter may be meant to be preliminary, the
words in that letter can have a profound
impact on the subsequent negotiations,
providing one party with a psychological — if not legal — advantage over the

For example, sellers often sign letters
of intent that contemplate an asset sale
without fully appreciating the tax implications of such a structure. Later, having
conceded that point in the letter of
intent, it becomes very difficult to convince the buyer to restructure the deal.

Are letters of intent generally nonbinding?

They can be drafted to be either binding or nonbinding, but most commonly
are a combination of the two, with some
provisions being purely a reflection of
the parties’ preliminary intentions and
others having the weight of contract. It
is critical that the letter specify which
provisions are intended to be binding
and which are not; otherwise, the parties
may find themselves litigating this issue.

Which provisions are typically binding?

Typical binding provisions include confidentiality and other limitations on a
party’s ability to publicly disclose the
negotiations, as well as the standstill or
no-shop provision, which is a provision
that limits the seller’s ability to solicit or
accept competing offers for a certain
period of time. This allows the buyer
time to complete its due diligence and to
negotiate the definitive documentation
without fear that the seller may simultaneously be negotiating with others.

What about the purchase price?

The purchase price in the letter of
intent is typically nonbinding. Yet, for
the reasons already mentioned, and
because it is usually the key term to the
deal, particular attention should be paid
when drafting this provision.

In an all-cash deal, drafting the purchase price should be straightforward.
However, when the circumstances merit
it — for example, when the purchase
price is complicated by the existence of
an earnout, holdback or equity kicker —
the parties should carefully consider
how much additional detail should be
included so as to avoid later disputes.
Should the letter include the strike price,
vesting schedule and termination date
for any warrants to be paid at closing?
Additionally, should the parties specify
whether the earnout will be calculated
before or after interest and taxes or
based on generally accepted accounting
principles (GAAP)?

Legal counsel can assist clients in identifying these and other significant issues that
may need to be addressed in the letter of
intent and can ensure that the letter meets
the client’s objectives. For these reasons,
parties should discuss their objectives with
their counsel prior to signing a letter of

JULIO C. ESQUIVEL is a partner at Shumaker, Loop & Kendrick
LLP in Tampa. Reach him at [email protected] or (813)