Being Exclusive - Why the Term Sheet Matters
A well-drafted Letter of Intent saves money, weeds out bad deals, and gives you (and your deals lawyer) peace of mind.
The Letter of Intent, or the LOI, or the Term Sheet, or the Deal Sheet, or the Memorandum of Understanding - all mean the same thing. It is a short document with several quick paragraphs (if that) and bullet points to summarize a “nearing of the minds” of the parties on a contemplated transaction. While it contains some definite terms that are rarely changed, like the purchase price, the asset being sold, who the brokers are, and any conditions that must be met before the transaction is consummated, it is often deafeningly silent on “TBD” matters that are punted down the road to be negotiated later. However, let not their brevity fool you; these are the LOI’s features, not its bugs.
The LOI is most famous for being “non-binding” - that is, it is not a contract that governs the deal, but a “good faith agreement to come to an agreement in good faith.” Because it is non-binding, neither party can go to court and complain that they’ve relied on the LOI to their detriment; legally, it’s basically not worth the paper it’s written on.
However, it is often good practice to include two special clauses that, if used in combination, make it a superb business deal tool. Firstly, “Exclusivity Clause”, which creates a temporary hold on the seller’s solicitation of other buyers; this way the buyer can confidently commit its attention and resources to analyzing this deal further. Secondly, the “Confidentiality Clause”, which prohibits the seller and buyer from disclosing the fact that a deal is being worked on for a certain period of time, which creates an atmosphere of candor and trust that allows the parties to truly understand the parameters and risk profile of the deal. In short, these two clauses create the lowest possible risk for the most yield for both parties at very little cost.
(FYI: this is an excerpt from my 15-page e-guide, “Seven Ways to Better Deals”, which you can get for FREE when subscribing to my Weekly Newsletter.)
Even though the LOI is non-binding, the actual process of negotiating and implementing one can be very revealing. In essence, the parties get a subtle preview of each other’s capacity for “good faith and fair dealing” for when the stakes are higher during the laborious work of painstakingly drafting a purchase agreement and performing due diligence work, when lawyers, engineers, and accountants - who famously don’t work for free - are involved. In addition, it tests the moral commitment levels of the parties; how quickly the parties sign an LOI is usually positively correlated with their level of interest in the deal. Paradoxically, the LOI reduces uncertainty while being anything but certain.
Perhaps the biggest “bang for your buck” when it comes to taking the time to put together an LOI is that it makes the parties focus their attention to the finer points of the deal, because the bigger points have already been agreed upon. If, say, you haven’t yet agreed on a purchase price, how could you possibly justify zeroing-in on the due diligence period timeline, for example.
The letter of intent, in other words, is an engagement, whereas the later more expensive purchase agreement is the wedding. And not unlike an engagement, one can break it, albeit without as much gossip.
