If you’re in the process of acquiring a manufacturing business, you’ll be expected to submit a formal letter of intent — or LOI — to the seller. So what exactly is this, and what critical elements should it contain?
The Purpose of a Letter of Intent (LOI)
A letter of intent is written after you’ve performed sufficient groundwork to want to proceed with further due diligence prior to an acquisition. It’s generally considered to be non-binding, but it does outline in broad strokes what a final purchase agreement could look like, including the form of consideration and purchase price. It clarifies and sets forth all negotiations up to that point and provides the seller of the business with a clear overview of what you’re prepared to offer.
Include a Cover Letter
It’s important to include a cover letter with your letter of intent. This should appeal to the emotional side of the seller. Be complimentary about what the seller has achieved with his or her business, and communicate your respect for his or hard work.
NDAs and Non-Solicitation Provisions
As Investopedia reports, many letters of intent contain non-disclosure agreements — or NDAs. These specify which aspects of the deal must be kept confidential and which — if any — may be shared. They also usually include non-solicitation provisions to ensure neither party may poach the other’s employees, as well as non-competition clauses that prohibit the buyer from using information gleaned from the seller to further his or her competitive positioning. The NDA, non-solicitation provision and non-compete agreement are referred to as covenants and are binding, even though the rest of the letter of intent is not.
Critical Elements
According to The Balance Small Business, a letter of intent should include the following sections:
- Introduction: This includes the purpose of the letter of intent, the date when it becomes effective and any definitions of terms that are necessary.
- Identification of parties: The buyer and seller are clearly defined. In addition, a full description of the business that will be bought should be included.
- Transaction and timing: This describes in general terms the nature and structure of the acquisition, as well as a suggested purchase price. It can also include deadlines for completion of certain steps, although it’s best to allow for some flexibility so they can be changed if the seller and buyer both agree.
- Contingencies: This section describes what parts of the process must occur before a next step can be taken. Oftentimes, a letter of intent for a business acquisition will state that the buyer must secure financing and the due diligence process must be completed.
- Due diligence: In this section, the buyer describes what actions he or she will take during the due diligence process — such as requesting financial documents, reviewing employment contracts and assessing the value of specific business assets.
- Signatures: Both parties should sign the letter of intent, date it and have their signatures notarized.
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Other Elements
There are also other elements that can be included in a letter of intent. These can address among other things:
- Details about escrow: How long the escrow should last and to which assets it pertains.
- Exclusivity: At this point in the negotiations, you might want exclusivity. That should be specified here, along with how long the exclusivity will last and under which conditions the seller is permitted to terminate it earlier than agreed.
- Employee-held equity and options: If these exist, will they be terminated or assumed by the buyer?
- Key contracts: Whether or not any third-party consents will be needed for important contracts.
- Employees: The manner in which the seller’s employees will be treated. Will they be hired or will their contracts be subject to change?
- Indemnification agreement: Any indemnification obligations of the buyer for the employees, directors, officers and stockholders are listed here.
- Prohibited actions: If the seller isn’t allowed to perform certain actions during the negotiations, they should be described here.
- Termination conditions: Should either party wish to terminate the transaction agreement, it can only occur under the conditions described in this section.
- Disputes: In the event any disputes arise, they should be resolved in the jurisdiction and according to the terms outlined here.
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Exactly what you include in a letter of intent depends on the details of the deal, but in general the more comprehensive it is, the smoother the transaction can progress, since many key issues will have been stipulated.
Sample Letter of Intent
Although every letter of intent is different, it can help to gain an impression of what one looks like. You can find a sample letter of intent to purchase a business here.
Understand the Value of a Letter of Intent
When buying a manufacturing business, it’s important to understand the value of a letter of intent. Even though it’s not binding, it lays a good foundation for the ensuing transaction and serves as a guide for what you need to complete and by when.
At the same time, it also brings potential discussion points to light early on in the negotiations so you and the seller can work on finding satisfactory resolutions. For these reasons, you’re best advised to consult a business broker with experience in the acquisition of manufacturing businesses when writing a letter of intent.