What’s the Point of a Non-Binding Term Sheet or Letter of Intent?

You may have wondered, what’s the point of a non-binding term sheet or letter of intent?  After all, you want to move ahead with the deal, and you definitely spend enough on attorneys’ fees that you don’t want to needlessly add to that bill – why not just proceed with the “definitive documents?”  What possible benefit could there be to a non-binding document?

The answer is more pragmatic than you might think.  The point of a non-binding term sheet or letter of intent is actually to save you time and money.  Here are several ways that it does so: 

  • The non-binding term sheet is a relatively straightforward and direct way of determining at an early stage and for a minimal investment whether the deal you are considering is likely to proceed.  Is there a general “meeting of the minds?”
  • It lays out the most important deal terms and allows the parties to determine what the biggest challenges will be and where the “pressure points” will be in negotiations.
  • It forces the parties to identify those issues that might be “deal killers” sooner rather than later – after all, if the deal isn’t going to proceed, better to know early rather than late.
  • As a related matter, it identifies collateral issues/requirements that might not otherwise be apparent – e.g., the need enter into employment agreements with key employees or acquire key assets that are not owned by the target company but are critical to the deal.
  • It often signals the commencement of high level due diligence – while additional due diligence is almost always required, negotiation of the term sheet/LOI generally requires the exchange of some basic information by and regarding each party.
  • Although non-binding in most respects, the term sheet/LOI often includes certain binding terms that may be important, including:

o       Confidentiality – allows the parties to exchange meaningful information without fear that it will be misused or disseminated.

o       Exclusivity – allows the parties to negotiate without interference from competitors.

o       No-Shop – protects the buyer from the seller using the buyer’s offer to locate or drive up competing offers.

o       Break-Up Fee – sometimes included where the parties are reasonably confident the deal will proceed and the cost of due diligence, etc. will be high.

  • Finally, it accomplishes all of the foregoing before the clients spend valuable time, and the lawyers spend costly hours, on the finer points of the overall transaction – this saves money whether the deal proceeds or not.

The bottom line is a non-binding term sheet/LOI often has value.  You should consider using one in your next substantial business transaction.

The Right Tool for the Job – OR One Size Does NOT Fit All

We’ve all heard the expression many times – you have to have the right tool for the job.  Taken a step further, you could say you have to have the right tool to do this specific job and to do it right.  After all, you can turn a screw with a butter knife, and you can pound a nail with a rock, but neither would be mistaken for the “right tool.”

The flip-side of this – and something that is often misunderstood by both lawyers and non-lawyers – is that one size does NOT fit all in the practice of law.  This is true even when you know all of the facts and the applicable law.

Take an asset purchase transaction.  The actual procedure and documentation for an asset purchase can involve a letter of intent and a lengthy due diligence process, followed by a 60 page asset purchase agreement with numerous warranties, representations, contingencies, conditions precedent and antecedent, post-closing escrows and indemnities, etc.  Alternatively, it can be consummated by a handshake or a simple bill of sale.

The reality is, there is no one way to conduct or document a transaction.  That is why the client’s preferences and risk tolerance and the terms of the deal must dictate the process and documentation.  Just as a large scale livestock producer typically doesn’t want a 50 page document even for a complicated multi-million dollar transaction, a banker typically doesn’t want a 3 page document even for a fifty thousand dollar deal.  It’s the lawyers’ job to determine which of the many approaches is appropriate for the deal and acceptable to the clients.

The appropriate documentation is determined first and foremost by the terms of the deal and (a close) second, by the parties and their preferences.  The practice of law is not one size fits all – you need the right tool for the job.

Avoiding Surprises in Transactions – Part 2

Part 1 discussed some general ways to avoid surprises in business transactions.  Here, I’ll apply some of those principles to a hypothetical transaction.

Assume a longstanding attorney-client relationship – communication and trust are well established.  Client plans an acquisition of a competitor.  Here are some key steps to avoid surprises:

  • First – an initial discussion between attorney and client so that the attorney knows as much as possible about the target company and the desired deal terms.  If there are other consultants involved (e.g., accountants, investment bankers, lenders, valuation experts, etc.), they may also participate, since communication among consultants may be just as important as communication between attorney and client. 

This may be the most important step to avoid surprises – every deal is not the same, and all parties must understand this specific deal!  Of course, this will be the attorney’s first opportunity to advise the client as to, e.g., recommended deal structure, risks, potential challenges, etc. – this type of advice should be ongoing throughout the deal.

  • Second – a discussion as to the likely stages and desired timing of the deal, which would typically (but not always) include:
    • NDA;
    • Preliminary Due Diligence;
    • Initial discussions/negotiations between parties as to deal terms (will/should the attorney participate?);
    • Term Sheet or Letter of Intent;
    • In Depth Due Diligence (again, will/should the attorney participate?);
    • Negotiate/Execute Detailed Transaction Documents (attorney and client (other consultants?) should work closely here);
    • Pre-Closing Conditions and Contingencies;
    • Closing; and
    • Post-Closing Conditions and Follow-Up.

This discussion may be initiated by the attorney, but it must be interactive, and tailored to this specific deal.  The key is for attorney and client to understand and expect these stages and to communicate any specific issues or concerns early in the process.

  • Third – the attorney should prepare a transaction outline or checklist, including responsible party, deadlines, status, etc.  This should be continually updated by attorney, client and any other consultants to ensure that everyone knows where the deal is and who’s doing what at any given time.
  • Fourth – throughout the process any challenges, delays, unforeseen developments, etc. must be immediately communicated to the entire team, with an assessment of how they will affect the deal, and hopefully with a plan as to how they will be addressed.

While it may be obvious, the keys to avoiding surprises (and the related costs and consequences) in business transactions are planning and communication from the very beginning and throughout the process.  Challenges will arise, but they should not be unforeseen.