A Few Terms to Include in an M&A Letter of Intent - dummies

A Few Terms to Include in an M&A Letter of Intent

By Bill Snow

Although no one-size-fits-all approach applies to writing an M&A letter of intent (LOI), the basics include some boilerplate legalese and some detail about the specific deal at hand.

As with all these specific legal documents, speak to your advisors.

M&A LOI: Holdback and escrow

Most deals delineated in an LOI include a holdback, an amount Buyer withholds from Seller for a period of time just in case the company has some sort of problem (usually a breach of a representation or warranty) after the deal closes. The holdback goes into a third-party account called escrow. This escrowed money is released to Seller, assuming Buyer doesn’t make claims to the money.

Escrow should be 10 percent (or less) of the purchase price, and that money should be paid to Seller within 12 months of close. However, a deal involving a Seller with a history of problems or challenged earnings may warrant a higher holdback amount and a longer period of time.

Some Sellers view the escrow as money they’re not receiving, but Sellers should remember that Buyers need to come to the closing meeting with that money. Just because Seller doesn’t immediately receive that money doesn’t mean Buyer isn’t providing it. If the purchase price is $10 million with $1 million to be placed in escrow, Buyer needs to come to the closing with $10 million!

M&A LOI: Representations and warranties

Buyer and Seller agree to a slew of representations and warranties (sometimes abbreviated reps and warranties or R&W). Representations and warranties are legal promises regarding past and future events, and you should take them very seriously.

Sellers can and often should provide Buyers with R&Ws for past events such as the previous year’s financial statements. But providing R&Ws for future events is a mistake because the future has no guarantees. Asking Seller to provide R&Ws that, say, the company’s top customer will still be the top customer in one year is an unreasonable request.

The R&Ws tend to be biased against the Seller, and so Sellers usually provide far more R&Ws than Buyers do because Buyers have many more worries about the deal than Sellers.

The biggest concern for Seller is that Buyer shows up at closing with the money; Seller isn’t too preoccupied with getting Buyer’s R&Ws. After the deal closes, Seller doesn’t have financial responsibility for the company; Buyer does. That’s why Buyer is so keen on Seller providing some reps and warranties.

For Buyer to have the ability to claim some of the escrow money against Seller, a problem usually needs be the result of Seller’s failure to disclose something to Buyer, or worse, of some sort of fraud or malfeasance by Seller. If the problem is the result of Buyer making a mistake post-close, it’s Buyer’s problem, and Buyer can’t claim a breach of a rep or warranty.

If the business takes a nose dive due to a general economic decline, that’s not the fault of Seller, and Buyer will not be able to claim a breach of a rep or warranty.