If you’ve ever considered selling your business, you may have heard that you should sign a confidentiality agreement or a letter of intent before getting started with a potential buyer. But have you ever wondered why these documents are important? After reading this article, you’ll better understand:
- What are confidentiality agreements and letters of intent?
- What are some main issues that each type of agreement should cover?
What are confidentiality agreements and letters of intent?
A confidentiality agreement, also commonly known as a non-disclosure agreement (“NDA”), is often the first legally binding document signed in the mergers & acquisitions (“M&A”) deal process. It allows a company to share its non-public information with another party while safeguarding how that information can be used.
A letter of intent (“LOI”), on the other hand, is a document that sets out a framework for the high level deal points that the buyer and seller have preliminarily agreed to. While not used in every M&A transaction, a LOI can help identify deal breakers early, focus negotiations, and signal that both sides are serious about moving forward.
What are some main issues that each type of agreement should cover?
Confidentiality Agreement
The main issues covered by a confidentiality agreement include:
- Confidentiality direction – Are both parties expected to maintain confidentiality or just the buyer?
NDAs for M&A transactions are often unilateral, meaning only the buyer is bound by confidentiality obligations. However, if the buyer expects to disclose information to the seller or wants to keep the discussions themselves confidential, a mutual confidentiality agreement may be used instead, which puts confidentiality obligations on both parties.
- Definition of “Confidential Information” – What information is considered confidential and are there exceptions?
When it comes to defining what is considered confidential information, the seller usually wants as broad a definition as possible while buyers prefer a narrower definition that limits confidentiality to information related to evaluating the deal. The definition is something that the parties can negotiate on, but if any confidential information has been disclosed prior to the NDA signing, be mindful about ensuring the agreement covers the time period before the signing date.
- Limitations on use – Who can the information be shared with and for what purpose?
The agreement should include language to restrict how the seller’s confidential information can be used by the buyer; for instance, the buyer is only allowed to share the information with its representatives (e.g. directors, officers, legal advisors etc.) on a need-to-know basis for the purpose of the deal and these representatives should already be bound by confidentiality obligations.
- Agreement term – How long is the agreement valid for?
The buyer will often push for the confidentiality agreement to have a defined term. While the seller prefers a longer term and the buyer prefers a shorter term, the parties will often compromise to end up with a term falling between 18 to 24 months for unilateral NDAs and between 12 to 24 months for mutual NDAs.
Letter of Intent
The key points that a LOI typically covers include:
- Deal structure – What are the key points of the deal and which are binding or non-binding?
The LOI should outline the high-level deal points (e.g. the parties involved, what is being acquired, and the form and amount of consideration) while leaving the details for negotiation in the definitive transaction documents. While the LOI may have provisions around which sections are binding or non-binding, it’s still important to consult the appropriate specialists (e.g. tax advisors) before signing it or else include qualifiers that allow for adjustments based on future advice. Attempting to make substantive changes after a LOI is signed can be difficult.
- Transaction closing conditions – What conditions must be satisfied before the deal can close?
The LOI identifies conditions that must be met before signing the definitive purchase agreement or closing the deal. Some examples include: satisfactory due diligence by the buyer, securing of financing, regulatory or third-party approvals, and completion of any ancillary agreements (e.g. employment contracts, intellectual property assignments, restrictive covenants).
- Key dates – What are the milestones and deadline dates for the proposed transaction?
The LOI often sets out various dates, some binding and some non-binding, to establish a tentative timeline for the proposed transaction. This typically includes a non-binding target closing date and a binding termination or expiry date for the LOI if the transaction is not completed by a specified deadline.
- Exclusivity provision – How long will the buyer have exclusive rights to negotiate?
Most LOIs include a binding exclusivity clause, giving the buyer a period during which the seller agrees not to solicit offers from or negotiate with other parties. Negotiated exclusivity periods often range from 30 to 90 days, balancing the buyer’s need for certainty with the seller’s desire to keep options open.
Both the confidentiality agreement and the letter of intent play important, yet distinct, roles in the early stages of the M&A journey. Whether a confidentiality agreement and/or a letter of intent should be used in a deal may ultimately depend on transaction specific considerations, but a savvy buyer or seller will carefully consider and consult with their advisors about how these agreements could assist them to move a deal forward.
Conclusion
For strategic guidance on the usage of the confidentiality agreement and letter of intent, kindly contact our firm and stay tuned for additional posts in this M&A series.
