Love at first sight. It is very romantic. Boy meets girl. Boy and girl fall head over heels in love with each other and, before you know it, they get married and hopefully, live happily after.
The same thing happens in the business world. The president of a company finds out that another company is for sale. He talks to some friends in the industry and they all say that this other company is great.
So, without much of a thought, the president of the company makes an offer and buys the other company. Then, just like the couple who discover that their marriage may not be a match made in heaven, the president of the company starts to discover lots of problems under the hood.
How could our friend have avoided making this type of mistake?
Just as dating before marriage is a good idea, so is entering into a memorandum of understanding before buying another company.
The memorandum of understanding, also known as a letter of intent, is an “agreement to agree.” It sets out the basic terms of the deal, then gives the buyer time to make sure what appears great on the surface is, in fact, worth purchasing.
Regardless of what it is called, the purpose is to put down the main points of the deal. The main points that will appear will include the price, what is being purchased, anything that is not being purchased and, the things that are probably most important, the due diligence period, the agreement is non-binding and is subject to a complete agreement.
The reason why the buyer needs to include language that it is non-binding is in case something is discovered during due diligence that causes the buyer to want to walk away. This saves the parties the time and money (i.e., attorney’s fees) in preparing a lengthy agreement.
Even though the MOU/LOI is just the first step (and templates can be found online), it is still advisable to hire an attorney to draft it. One of the main reasons is because, even though the MOU/LOI may say it is non-binding, there are circumstances where a court may declare it is binding and the buyer is now stuck with a bad deal.
For example, if the MOU/LOI contains so much detail that a court can say that it looks like a complete agreement, the court may say that it is binding.
Also, while most people use MOU and LOI interchangeably, there may be some differences depending on where your company is located. Better to check with an attorney to see if there is a difference.
Here are some of the items that should go into the agreement to agree (regardless of what it is called):
- What is being purchased? List, at least in categories, what is being purchased. Include language such as “all other assets necessary for the normal operation of the business.”
- What is not being purchased? If there are assets not part of the deal, state that.
- Are any liabilities being included? Normally, in an asset purchase agreement, the buyer is only buying the assets, not any of the liabilities. If there are any that are included, that should be stated.
- The purchase price. This can be an amount that is subject to many things, including the results of due diligence.
- Due-diligence. State that everything is subject to the buyer performing whatever due diligence it needs to do (this could be financial, operational, or anything else that is relevant to the underlying deal).
- State that it is non-binding. This can be done by providing the conditions that have to be met for the parties to be bound (such as completion of certain agreements or approval of the Board of Directors).
- Do not call it an “agreement” or a “contract.” That may indicate to the other side (or maybe to a court) that it is binding.
- Include a termination date. Say that, unless a complete agreement is signed by a certain date, the MOU/LOI is void.
- KISS. Make sure that there are significant terms that need to be completed.
- Don’t have the MOU/LOI drafted so there is nothing left to negotiate and the only things left to do are mechanical.
This is not a complete list. Consider other things such as a “no-shop” provision (which means that the seller will not be looking to sell to someone else), an agreement to continue to do business in the ordinary course, and that no major assets will be sold.
Lastly, keep in mind that this is not legal advice for any particular deal you may be considering. It is just a broad overview and doesn’t cover everything or take into account the laws of any particular state. If you are considering doing a deal, it is important that you speak with your lawyer to make sure you are covering all of the bases in your state.