So What's Binding You?

This is the first in a series of articles dealing with the legal aspects of the buying and selling of a business. The focus of these articles will be on privately held companies, ones that do not offer their shares to the public.

Commonly, the first step in the legal process associated with the buying or selling of a business is the preparation of a Letter of Intent (“LOI”). The purpose of an LOI is to reduce to writing the essential terms of the proposed transaction. Attempts to negotiate the purchase and sale of a business through the presentation and revision of fully drafted agreements of purchase and sale is impractical, costly and time consuming.

It is of value to clarify the basic terms of a transaction as early as possible in the process. Notwithstanding that a proposed vendor and purchaser may have had numerous preliminary discussions regarding a proposed transaction, the lines of communication may not always be clear and many matters which had been discussed can be misunderstood and viewed completely different by the parties. Using an LOI to flush out the core elements of the transaction can successfully expedite the negotiation process, or alternatively, make it obvious that a deal is not to be had.

Contracts generally bind all elements. However, the one consistent binding provision in an LOI is that the business terms of the proposed transaction, as set out in the LOI, are not to be binding on the parties. The LOI does not bind the parties in any way but does encourage the parties to negotiate in good faith a definitive agreement of purchase and sale incorporating the essential terms as set out in the LOI.

The purpose of the LOI is two-fold. It requires the parties to address their minds to the essential terms upon which they are prepared to pursue a transaction. It also forms the basis upon which the parties can negotiate a definitive agreement of purchase and sale.

Preparation of the LOI usually starts with the purchaser as a logical response to the vendor’s indication that it is prepared to sell its business. It is an excellent way to raise and clarify points that may be problematic for either of them. One aspect often not appreciated in the preparation of an LOI is the “moral persuasion” available when one party seeks to vary or move away from the transaction as set out in the LOI. Pressure can be brought to bear on a party if it tries to alter significantly the transaction as proposed in the LOI – most business people wish to avoid the perception that they are not bargaining in good faith.

For clarity, the LOI can be divided into at least two principal sections, the binding and the non-binding elements. The non-binding portion will deal with the proposed business terms and will vary depending upon the nature of the business. In essence, however, the essential business terms revolve around what is being purchased, how it is being paid for and under what conditions the transaction will proceed.

The binding portion of the LOI can include provisions pertaining to some or all of the following:

  1. Confidentiality and Publicity – the parties will want each other to maintain in confidence all confidential or proprietary information;
  2. “Stand-still” Arrangements – a purchaser is often reluctant to bear the time and expense involved in negotiations if the vendor is actively soliciting offers from others;
  3. Due Diligence – the parties will want to specify the information that will be made available for review by the purchaser;
  4. Deposit and Costs – at what stage and on what terms will a deposit be paid and will either party be compensating the other in the event of termination of negotiations.

A well conceived and properly drafted LOI will form the basis of a final agreement of purchase and sale and will more than justify the effort expended in its preparation. Negotiating the purchase and sale of a business can be a confusing process for the parties – an early effort to focus on the issues through the preparation of an LOI may well serve as the catalyst to a successful business transaction.