In a business transaction, the letter of intent, also known as the offer to purchase or promise to purchase (and for the purposes of this article, the “Letter“), is a legal document used by the parties to a business transaction to endorse the main terms of the forthcoming transaction.
As you may guess from its wording, the Letter is a preliminary contract that the parties sign in anticipation of a future formal business sale agreement.
We will outline below 3 reasons why a Letter can be useful in the course of a business transaction. For the purposes of this article as well as future articles which will cover the topics below in further detail, we will discuss the importance of a Letter in a share purchase transaction.
- Establish the essential terms of the upcoming transaction
The main purpose of the Letter is to confirm in writing the essential terms and conditions of the upcoming transaction:
A. A description of the shares being transferred as part of the transaction;
B. The purchase price and terms of payment of said purchase price (see below);
C. The deadlines to be met with respect to the transaction, including the closing date of the transaction. The term “closing date” refers to the date on which the sale of shares will be completed, thereby transferring ownership of the shares to the buyer;
D. The closing conditions of the transaction; and
E. Any other terms and conditions negotiated between the parties that deserve to be addressed during the early stages of the transaction.
Regarding the purchase price of the shares, it is important to note that such price is often subject to adjustments after the closing of the transaction, to account for the target company’s short-term assets and liabilities, as well as the working capital which will enable the buyer to operate the business immediately upon closing. It is advisable to involve accountants at the Letter drafting stage to avoid issues later in the transaction.
2. Due diligence
Another important point addressed in the letter is that due diligence is the period during which the buyer reviews the target company’s business, while the seller gives access to all relevant documents to complete such review. At the end of this period, the buyer generally has the right to confirm, at his or her own discretion, whether he or she wishes to proceed with the business transaction.
3. The binding aspect of the Letter
The parties to the forthcoming transaction can indicate in the Letter that it is binding, meaning that it commits the parties to proceed with the transaction. The parties may also decide that the Letter is non-binding, meaning that it does not impose any formal obligation to conclude a transaction. In the latter case, it constitutes a document stipulating the parties’ intention to discuss the terms and conditions of the future transaction, without any formal commitment (subject to confidentiality obligations, which often remain binding upon the parties).
Conclusion
The Letter is an important step in the course of a business transaction, as it not only enables the parties to manage expectations on both sides, but above all helps to avoid the misunderstandings that regularly arise when parties come to a verbal agreement. It should be noted that the Letter is often subject to one or more amendments after it has been signed, particularly following the outcome of the due diligence review.
The above topics will be covered in detail in future articles, but don’t hesitate to contact us for further information!
Information provided in this article is intended as general introductory information only. The information provided in this article is not legal advice. It should not be construed as legal advice and should not be relied upon as such. Should you want legal advice regarding the information provided in this article, please contact one of our lawyers.
