Letter of Intent (LOI)
for the acquisition of a company
The letter of intent (LOI) marks an important milestone in a company acquisition. This document demonstrates the serious interest of the negotiating parties in an M&A transaction and can be legally binding depending on its structure. Careful drafting of an LOI is of great importance as it sets out the basic terms of the planned transaction.
As experienced specialist lawyers in the field of commercial and tax law, we are fully aware of the complexity of a company acquisition. We use our expertise to protect your interests and ensure that all legal requirements are met. Contact us now by email or phone.
What is a letter of intent?
The Letter of Intent is a declaration of intent between two or more negotiating parties. If the buyer and seller sign, the LOI is also known as a memorandum of understanding. It is suitable as a starting point for complex negotiations in various business areas, including Mergers & Acquisitions (M&A). The LOI serves to define the most important points and conditions of a future purchase agreement .
In most cases, the LOI is not legally binding. It is then referred to as a soft LOI. However, it can also be formulated in a legally binding form - a hard LOI. The LOI is usually followed by due diligence.
Contents of the letter of intent
There is no standardised template for a letter of intent because the content varies depending on the specific circumstances and interests of the parties. Essentially, however, an LOI always contains the following structures:
- Object of purchase: Important details about the object of purchase are recorded in the LOI. For example, in the case of an asset deal, information about land, buildings or machinery is included.
- Purchase price and financing: The LOI usually contains information on the purchase price calculation and any purchase price adjustments. It may also include payment modalities and financing options.
- Transaction structure: A description of the intended transaction is part of each LOI, including the type of transaction (e.g. merger, acquisition), timing, scope and material terms. Any reservations can be recorded.
Design options: "soft" and "hard" letter of intent
As already mentioned, the letter of intent can be issued as a non-binding or binding variant - i.e. as a "soft" or "hard" LOI. But what does this mean in detail?
Soft letter of intent
A soft letter of intent is concluded between the parties without the intention to be legally bound. It therefore does not impose any binding obligations to carry out the transaction. A soft LOI is essentially a documentation of the initial results of negotiations and serves as a starting point for further negotiations and the drafting of a final purchase agreement.
Despite its non-binding nature, it is important to choose the wording in the soft LOI carefully, as it can influence the scope for negotiation and the relationship between the parties. In addition, a soft LOI can refer to legally binding provisions, such as a time-limited exclusivity clause.
Contents of the letter of intent
Hard letter of intent
A hard letter of intent is a legally valid preliminary agreement that establishes a legally binding obligation between the buyer and seller. A hard LOI gives rise to the right to conclude the company purchase agreement. 5
In order for the contract to be legally valid, there must be certainty and agreement on minimum elements of the contract (essentiala negotii). In addition to the object of purchase and the purchase price, this also includes all other ancillary points considered essential by both parties.
However, the requirement of certainty can be suspended if a right to determine performance is granted instead. This means that one party allows the other or a third party to determine a certain point retrospectively. This can be, for example, a market price applicable at the time of purchase or the dependence of certain content on a future balance sheet date.
In addition, the hard LOI may need to be formalised if the same applies to the subsequent company purchase agreement. For example, the preliminary agreement for a property purchase would have to be notarised because the purchase itself must also be notarised in order to be legally valid.
Application of the "hard" LOI in practice
As the letter of intent precedes the due diligence (company valuation), the binding variant is rarely used as a preliminary agreement in practice. At this stage, a lot of information that is crucial for the company acquisition is not yet available. In addition, the necessary approvals from shareholders or the management board are often still outstanding.
If all preconditions have been met and all important information has been obtained, the purchase contract can in principle be concluded directly. If necessary, a deferred fulfilment effect can be agreed. This means that there is rarely a need for a hard letter of intent.
However, a preliminary agreement can be useful for very complex disposals if agreement has not yet been reached on all points, but the realisation of the transaction has already been determined. In this way, negotiating positions that have already been reached can be secured.
Examples
The following examples can be defined as part of a preliminary agreement or within a soft LOI as legally binding regulations: 6
- Due diligence: If tasks resulting from a due diligence audit are already known at the time of the LOI, the period and scope of the due diligence can be bindingly defined in the LOI.
- Confidentiality: Confidentiality provisions are often part of an LOI. To ensure that sensitive information is protected during negotiations, a non-disclosure agreement* can be drawn up.
- Non-solicitation clause: Sellers often want to protect themselves against the poaching of essential employees. In practice, however, such clauses are usually ineffective, as it is difficult to prove whether a poaching or a simple application has taken place.
- Break-up fee: To ensure the exclusivity of the contract negotiations, a penalty payment is agreed if the negotiations are broken off within a specified period. This must be notarised in order to be effective.
- Exclusion from competition: The LOI may contain clauses stating that the target company will not review or discuss any other offers during the negotiations.
* NDA: Non-Disclosure Agreement
A Non-Disclosure Agreement is a confidentiality agreement between two or more parties. The main objective of an NDA is to ensure that sensitive information exchanged during negotiations is not disclosed or used without authorisation. By specifying a contractual penalty, claims for non-compliance can be enforced more easily. An NDA can be part of a hard LOI. However, it is advisable to conclude the NDA separately in order to prevent formal invalidity. In addition, a separate NDA can exist in parallel to a soft LOI.
When does a letter of intent make sense?
The following examples can be defined as part of a preliminary agreement or within a soft LOI as legally binding regulations: 6
- Early negotiation phaseA letter of intent provides a formal framework for presenting the interests of all parties, especially in the early stages of negotiations.
- Price rangeA key advantage of the LOI is that it sets out the basic parameters of the transaction, including the purchase price. This creates clarity about the financial aspects of the transaction.
- SecurityThe LOI documents the basic agreement on the purchase interest. This creates security on a psychological level and reduces uncertainty.
- SchedulingJointly agreeing on a timetable ensures that the pace of the transaction suits all parties. The risk of failure due to delays is reduced.
Are there legal and financial risks?
A soft letter of intent does not give rise to any legal risks with regard to the company acquisition. However, all parties involved must adhere to exclusivity clauses, non-disclosure agreements and similar agreements that are listed in the LOI. A right to compensation or reimbursement of costs if negotiations are broken off only arises if a corresponding break-up fee has been agreed and notarised.
A hard LOI harbours similar legal obligations and financial risks as an actual purchase agreement.
Cost units
The costs for a letter of intent are generally borne by the respective contracting parties themselves, even if no purchase agreement is concluded. This also applies to the consultancy costs arising from the due diligence process.
Conclusion and our role as M&A lawyers
The letter of intent is a great way of defining important aspects of a company acquisition without losing flexibility. Particularly in the event of later differences, the document helps to remember the original basis of argumentation. It is therefore all the more important that your interests are appropriately reflected in the LOI - and that is exactly what we are here for.
We know the best practices in M&A transactions and implement them to your advantage. You can rely on our extensive experience with companies of all sizes. We advise buyers and sellers from the letter of intent through the NDA and specific transaction terms to the purchase agreement.
