When selling or buying a company, a letter of intent (LOI) is anatural, important step in advancing the transaction. LOIs outline key deal terms but are for the most part nonbinding. More often than not LOIs dance around critical issues that, once surfaced, complicate and sometimes derail a transaction. In my last column, we explored using investment bankers in a deal; there are actually more differences of opinions around how to handle LOIs. So here’s my roadmap of why and how to use LOIs:

• Not a step in the dating process: I’ve never liked, from either the buyer’s or seller’s perspective, to use LOIs as a way to push forward a deal that hasn’t gelled – is it a good fit? Are we in the ballpark on valuation and payment terms? Do they have the financing to close? Has enough diligence been done to know the company’s drivers and risks? The more indefinite these elements, the less likely the terms in the LOI will stick.
• Effect on other suitors: Apart from confidentiality, the one binding provision is a “no shop” – precluding the seller from continuing to talk with other suitors; if you’re a suitor and get the Heisman when an LOI is signed with someone else, the odds of you reengaging if that other deal busts is low (or you certainly know your price just went down). If there are multiple potential buyers, an LOI should only be entered into when you have a high level of confidence that the deal will close.
• Kicking the Can: Even if you have the right buyer and seller, there is a temptation to pass by key points in the deal (earn-out terms, purchase price adjustment triggers, working capital thresholds, indemnity levels, tax structure…), to leave them to negotiate later; I’ve never been a fan of pushing key issues (whether deal terms or diligence issues) to negotiate later; I can’t recall seeing a deal improve with last minute revelations.
• Keep timelines tight: the LOI should lay out expected timelines, the most obvious of which is the anticipated closing date; but equally important are timelines to see a first draft of the definitive purchase agreement, when that agreement must be executed (assuming that closing will be later than such execution); when diligence will be completed; if there is a financing contingency (buyer’s confirmation of ability to close), when that contingency is lifted.
• Confidentiality: It’s certainly a given that the buyer will agree to keep what it learns confidential; but what does that really mean, particularly if the buyer is a competitor or knowledge of customers or other trade secrets could compromise the seller if the deal busts? Diligencing the buyer’s track record of doing deals, talking to the CEOs of other targets acquired, timing when the buyer is given access to customers – and scripting how such access will happen – or disclosure of other critical information (the later the better), are all ways to manage this risk.

There is a tendency to hurry up and get an LOI signed, to not push too hard (from either side), to perhaps wave off a tricky issue or avoid a disagreement. I’ve rarely seen these behaviors work well (from either side) in hindsight. As fragile as everyone thinks this stage is, it’s foundational – and the time should be taken to get the terms and ground rules right.

With more than 30 years’ experience in law and business, Newt Fowler, a partner in Womble Bond Dickinson’s business practice, advises many investors, entrepreneurs and technology companies, guiding them through all aspects of business planning, financing transactions, technology commercialization and M&A. He’s the past board chair of TEDCO and serves on the Board of the Economic Alliance of Greater Baltimore. Newt can be reached at newt.fowler@wbd-us.com.