Raj Kothari, Managing Director of Cascade Partners, and Kevin DiDio, Partner at Barnes & Thornburg LLP, discuss the nuances and power of a strong Letter of Intent (LOI)—it sets the scope and tone for a transaction and provides valuable protections for all parties if well-drafted. Learn more about the powerful LOI in this episode of Cascade Conversations.


Welcome to Cascade Conversations! Join the team at Cascade Partners and their network of trusted advisers as they work to demystify details, terminology and strategies in the world of acquisitions, divestitures and financings.

Rajesh Kothari – Cascade Founder and Managing Director
Thanks for joining us for another Cascade Conversations. I’m Raj Kothari, Managing Director of Cascade Partners, and joining me today is my friend, Kevin DiDio, a partner with Barnes and Thornburg. Kevin, it’s great to have you here. We really appreciate you spending the time with us to chat a little bit today about letters of intent (LOI).


Kevin DiDio – Partner at Barnes & Thornburg LLP
Appreciate the opportunity, Raj. Great to be here in your new office. Beautiful.


Rajesh Kothari: Thank you! So, one of the key questions folks always want to understand is, well, what exactly is a letter of intent? We talk about indications of interest and how do you describe letters of intent or how it applies to your clients?


Kevin DiDio: Well, it is an education process because people use the term letter of intent or LOI in a way that is not a defined term. And it’s a bit fluid in the sense that there are different kinds of letters of intent and I would say, generally speaking, they come in maybe two or three different flavors. The primary differentiating factor among them oftentimes is the binding nature of the LOI—what’s binding, what’s not binding.

Oftentimes, we hear at the outset, “Don’t spend too much lawyer time on the LOI, it’s all non-binding. Let’s just get on with the deal. We want to make sure closing it sooner rather than later.” And that’s all understandable and we are obviously receptive to those comments, but it’s our job as well as with the other advisors on the team to make sure that the client understands what they’re saying and what the implications are. Not only if the deal does go forward, but if the deal doesn’t go forward. So, we do spend a lot of time in the education process about what it is the LOI does and doesn’t do.


Rajesh Kothari: Yeah, it becomes really important, right? We often talk about how some people are like, “Oh well, we’ll just skip over that line,” and that creates its own set of problems because people don’t know what the deal is. So, what are you working for is what are you negotiating and all that live and in process doesn’t necessarily create the best outcomes.


Kevin DiDio: Yeah, indeed. And we have found there are times when maybe skipping the LOI does make sense, but it does make the process of getting through into the definitive agreements more challenging. I think one of the things to consider when entering into the LOI is whether or not—the 2016 case that got a lot of people’s attention out of Delaware—that the parties need to be very deliberate in understanding whether or not they are entering into a non-binding agreement with some terms that are binding like exclusivity. So, we’ll talk more about that confidentiality. Things that all the parties can agree upon.

But the big question to also come out is are the parties also agreeing a good faith obligation to continue the negotiations? Or is there no such obligation to negotiate in good faith? And this Delaware case caught everyone’s attention because it resulted in a couple hundred million dollar judgment against a party that no longer wanted to proceed under the LOI because it had a different business situation when it signed the LOI and it got them sideways.

And so, whether or not the parties have to continue to negotiate in good faith is a big question.


Rajesh Kothari: Well, that’s important. And trying to figure out what people’s intents are in the transaction. And when we work together, you’ve seen from us that we like to get to a relatively detailed letter of intent. And we often look at it as, “This is our maximum point of leverage in the negotiation.” Typically, we have multiple parties when we’re kind of negotiating a letter of intent to be able to get the best terms and best elements for our clients.

But what we often find out is people focus on, “Hey, let’s just focus on the top line,” and, as you know, there are so many other critical points to a deal that this is our best place to flesh those out—especially for shareholders and offers that aren’t as sophisticated and haven’t done as many transactions. So, they don’t know all the different points that are going to come up.

And so, we’ve been huge believers and we’ve worked together really well in negotiating and hammering those through to get to a really good letter of intent that has a lot of the details—not just around the purchase price, but what’s the employment agreement going to look like or what are the non-competition provisions going to be—if that’s critical for our client or even more importantly, if there are rollover equities, are clients going to continue to own a piece, what are those provisions? What are those limitations?


Kevin DiDio: Yeah, rollover, and yes, some of the things that the sellers especially like to focus on, of course, is the purchase price. Well, we also spent time with them educating—especially you on the finance side—to understand what are the purchase price adjustments and what could that look like? What challenges might we have in set and pegged for the working capital adjustment, if there is one? And if it’s a seasonal business, for instance, you could have a very different set of current assets or current liabilities 36 days after you signed that letter, which would really impact your purchase price, which is why we need you guys to be in there and digging through those financials and educating the client about that.

Representation of Warranty Insurance (RWI) is another big thing too, that we want to make sure in the deal world these days is a great tool, especially for sellers who are sensitive to us—as all sellers are—to allocation of risk and what that means after the deal closes to them. And so, we oftentimes spend time upfront, talking about the opportunity to perhaps obtain our reps and warranty insurance to address that allocation of risk issue.


Rajesh Kothari: Well, another two really important points—and part of it is letter of intent—is working capital. It’s a huge one that often people are not focused on because they’re worried about the end line and many times, I’m sure, who’s keeping the assets, the receivables and what have you. So, hammering out and figuring out what’s that working capital target? How is that going to be determined? What is the overall approach to getting the final letter of intent that can generate significant value either toward a seller or away from a seller?

But maybe talk a little bit about rep and warranty insurance and, you know, it’s about risk allocation, but it’s become a more recent common tool in the last 3 to 5 years, even in lower middle market deals. And today I’m very even down to $15 million transaction values, which we haven’t really seen that rep and warranty insurance can be available. Talk a little bit about why that can help a seller and why it can help a buyer in a transaction that you see, and why that’s an important part of a letter of intent.


Kevin DiDio: Sure, and that’s been our experience too, is that those policies have reached down into the lower middle market—which, typically, they were just priced out of those deals. It was too expensive to make it happen. But that’s not the case anymore, and if post-closing risk is a very sensitive issue for a particular seller, this is a wonderful tool for the parties to consider. And then again, I think if it’s not considered really seriously at the LOI stage, it’s likely not going to be done.


Rajesh Kothari: It’s a lot harder to do.


Kevin DiDio: Yes, pricing comes into into play. It was paying for the policy, those types of things. But it’s a wonderful tool to allow sellers to—not 100 percent, but a large percentage—to not have to worry after closing about the liability that may be there for indemnity claim post-closing to be brought by the purchasing party. So, in which case if there is a policy we would oftentimes step in, except for some things like fraud and other things, of course it might get carved out. But it’s a wonderful tool to help bridge a deal if there are challenges between the parties about risk allocation.


Rajesh Kothari: Yeah, we’ve liked that because, as you said, it’s going to leave more dollars in the pockets of our clients at closing. So, instead of having a 7 or 10 percent escrow—6 to 10 percent these days—all I have to do is typically leave half a percent of the transaction value and the rest is going to get covered by insurance if there’s an indemnity claim.

So, we describe it for our clients as, “Hey, it puts more money in your pocket at closing. It lowers that potential risk profile going forward.” But one of the other elements that we’ve found is it’s made it easier to negotiate the purchase agreement because, at the end of the day, we’re not as worried about where the claims are going to come from.

And, as you said in your comment, the key is if you don’t negotiate in the letter of intent, that’s the chance you can get the buyer to pay for it or maybe split cost depending on what you’re able to negotiate, and so that’s a great tool that we use at that point to hammer out as, “Is an all indemnity where there is no sharing of the retention? Or what’s our sharing or retention and who’s paying for the policy?” And it’s one that we’ve often described to clients that on the sell-side it can be a great tool. And even on the buy-side, we’ve seen it as a good tool because the buyer is going—if there’s indemnity claims—to a very objective insurance agency to get paid as opposed to the emotions of a deal going back to a founder or shareholder to make an indemnity claim tends to create a little bit more objectivity in that process.


Kevin DiDio: Yeah, agreed. You bring up a great point about easing some of those negotiations around the representations and warranties made in the definitive agreement. People don’t negotiate as hard without the understanding that there’s a backdrop in place to help if there’s a claim. It’s a wonderful tool and, yeah, we’ve used it.

One hundred percent of the time we have to make sure it’s in the LOI because it does impact closing time as well, because the underwriting also takes time, expectations around the parties’ closing date will be affected by the complexity of the underwriting. So, it’s become a key component to both letters of intent.


Rajesh Kothari: So, what are some of the other key components that you look at when you’re looking at a letter of intent—drafting one or making sure it’s up to speed for your client? There’s the obvious purchase price, but—you brought up two great ones—working capital and representation of warranty. Are there others that are important? So, I try to make sure these types of provisions are in the letter of intent to protect our clients.


Kevin DiDio: Sure, the other probably most obvious one is the structure of the transaction in question. It is it does happen. It’s fairly unusual in our experience, but it does happen to where the parties agree to punt on the structure, and to say that they’ll figure it out, and to maybe work together in good faith to help reach also a tax favorable result for selling parties.

But you want to try and do your best upfront in the LOI to address the structure, whether it’s the asset sale, stock sale, with or without a rollover, maybe it’s a merger or different flavors of those, and maybe it includes a Section 338 election too, which could impact things. And so, most of those decisions will impact the tax recognition for the seller and also sets some tax boundaries down the road for the buyer. So, structure is definitely what we’d like to make sure is in there because everything flows from it.

I would also say, we touched a little bit on earlier, but exclusivity becomes a touchy point as these things move from time to time. Who has more leverage in this particular deal? And sometimes it’s market-driven, sometimes it’s deal-driven or both.

But if the seller has some real particular leverage, they would likely oftentimes not to have to be bound by the exclusivity covenants and be able to have free discussions with others, especially if it’s a very competitive transaction. So, depending on the particular deal—that exclusivity that most buyers would certainly want—make sure that you have look over their shoulder for the next 60 or 90 days and know that all the money they’re spending isn’t going to be for naught. So, that can be a real hot button for the parties.


Rajesh Kothari: Yeah, we often look at it as there’s a balance of fairness to it, right? At some point the buyers can spend a lot of money, and as long as they live up to the deal you sign up to, everybody should move forward. But that’s one of the reasons that you’ve seen in our our approach with exclusive money is we’re fine with exclusivity at the right point in the transaction.

At some point, you’re almost—even in a very competitive process—you’ve got to have it at some point. So, one of the provisions that we’ve often used now is typically are 30-, 60-, 90-, 120-day exclusivities. We’ve now put in a provision that basically says, “Hey, if you change the material terms of the letter of intent, then within seven days we can terminate the exclusivity.” And really this has been in response to lots of folks retraining deals or changing the terms after their indulgence, after shareholders and founders are getting tired of the process. And what I describe is if there’s a legitimate reason the numbers were wrong or there was an issue, a skeleton in the closet, every buyer is going to have the same issue. So, we’re all incentivized to negotiate it and hammer it out. That’s why you’ve got that seven day period to say, “We said we did $10 million, and it turns out we only did $9 million, and the price came down.” Well, that’s a legitimate reason and every buyer is going to do that. Our challenge and experience has oftentimes been: there is no reason, there is no rationale. It says, “Wow, we feel like we can change it now.”

This has been one tool that we’ve used to protect our sell-side clients from that arbitrary changing of the deal; recognizing that for founders and folks that haven’t been through the transaction process, it’s an exhausting process—emotionally, time commitment and, “Oh, let’s just deal with it,” and…


Kevin DiDio: It gets in the way of day-to-day business.


Rajesh Kothari: Yeah, and buyers will try to take advantage. So, it’s one that we’ve used on almost all of ours now to protect our clients.


Kevin DiDio: Yeah. What you said earlier is sellers have to be aware of, during the process when the LOI is being negotiated, that is the time during which they’re going to have the most leverage. And if they don’t take advantage of it, it can lead to those issues and get the deal sideways, which no one wants, of course. So, yeah, that’s that’s a that’s a great tool to have.


Rajesh Kothari: And, you know, we look at the letter of intent, and how do you use it to set the framework for the negotiations and the deal documentation? We’re taking that letter of intent and turning it into a whole set of purchase documents. How do you guys look at that letter of intent as a guidepost or a resource for those negotiations?


Kevin DiDio: Well, ideally, if it’s well-crafted, it really does make the process of getting through the initial drafts of the definitive agreements that much easier. And it’s the more sophisticated clients who understand that when you put the hard work in upfront, with the LOI, to get through some of those more meaningful terms and conditions about the deal, it makes the rest of those three or four months to get to closing that much easier. So, a well-drafted LOI will make drafting a purchase agreement great.

And it also helps the relationships among all the professionals on the deal teams on both sides—it’s just easier in my experience. So, the adversarial relationships tend are more tempered when everyone has a good understanding upfront about what the expectations are. Now, oftentimes what you see the LOI about customary representations and warranties and customary covenants, those things are a little bit more subjectively defined upfront and you get into some negotiations about those during the the agreements.

But, generally speaking, a well thought out, well-drafted LOI will make the whole deal flow much easier.


Rajesh Kothari: Even though the provisions are non-binding, how do you make sure that someone who might not be as experienced or have a hold of their non-binding, how does that play out of the actual purchase agreement of those negotiations?


Kevin DiDio: Yeah, that’s a great point. And sellers love to say that upfront, “Don’t worry about it, it’s all non-binding.” And so, even the non-binding things; like purchase price, payment of the purchase, price the adjustment to the purchase price—which are all non-binding. Oftentimes, it sets the expectation certainly, and unless there’s some kind of material adverse change or some kind of…


Rajesh Kothari: Something different happens.


Kevin DiDio: Yeah, something comes out of diligence where the parties think that there’s now an opportunity to re-trade, as you said earlier—whether it’s purchase price or something else—the expectations have been set and it’s of our jobs, I think, as professionals on the deal team to educate the client about it, maybe about non-binding. However, this does set the expectation—especially if there’s maybe a rollover where you’re now negotiating with your future harder—you don’t want to get off on the wrong foot. And again I’ve seen it happen, as I’m sure you have. It doesn’t make for a great, three or four months. It can be really challenging to bring folks back to the table. So, we like to use those non-binding terms with with caution because it certainly does set the expectation and you don’t want it to get the deal sideways and lose the deal—worst case scenario.


Rajesh Kothari: I think your term and expectation is the right one. I mean, the biggest part of our job is setting everybody’s expectations upfront and clearly like, “This is what we expect the deal to look like, what we expect the deal to be,” if everything in diligence matches what they expected pre-diligence; what we represented, what the client shared about the business, we got a great business, it’s a clean business. Okay, well, when we get into diligence, as long as those expectations are met, everybody should live up to the deal that was defined. And so, that’s how we’ve use that as a critical tool. It’s like nothing’s changed, so the deal should stay as we described because there hasn’t been significant enough change. And, as you said earlier, when those changes happen and, “Oh, we’re going to change the deal structure, or we’re going to go from a stock deal to an asset deal, or some other dynamic,” it has significant economic impact—the tax consequences—but can also have significant exposure to your liabilities. Again, am I switching from a stock deal to an asset deal? What liabilities am I leaving? What am I assuming?

So, when everybody’s on the same page and sticks to that plan it makes the process smoother. And doesn’t mean things won’t change or if there’s something developed, we all have to be prepared. But I think your word of, “Hey, let’s set the expectation,” both the buyer and the seller become critical to making sure you can get to that finish line and negotiate that deal in a way that makes sense.


Kevin DiDio: That’s right. Yeah, I agree with that.


Rajesh Kothari: And so, we had a lot of discussion about this and we both have seen where it’s been very important to our clients, and we’ve been very successful at using it as a tool to get the best deal and craft the best deal. And  it’s that expectation I often I hear from my attorney friends is their client came to them and there’s a signed letter of intent already without the help of their lawyer or without the help of any advisors.

Why do you think that’s really detrimental to the client in the end?


Kevin DiDio: Yeah, it does happen more often than you’d like it to. And on the rare occasion, you’ll take a look at it and it won’t be that bad. But, oftentimes, there are certain things you could point out—and you do point out—to the client that you could have negotiated to help position themselves to have a more favorable transaction. Maybe it’s economics or otherwise. You mentioned non-competes. Sometimes, they don’t realize what’s market and if they just sign it with the understanding that it’s not binding, they’re not worried about it, they’ll negotiate it later, etc. That becomes more challenging.

So yes, ideally we would love to be as close to the front of the negotiations as possible, even in some of these deals before the LOI gets signed, there’s a non-disclosure agreement that gets signed and, ideally, we’d like to be involved then as well, because it does make things go more smoothly, in my experience. Some clients are worried that it’s just more billable hours. But, honestly, I think those of us who’ve been doing it for long enough can explain to a client that it does make for an overall more efficient process, the earlier we do get involved, which oftentimes will lead to fewer billable hours.


Rajesh Kothari: They notice that. And I would say—not lawyer, not by the billable hour—is significantly different, right? Because all of those things that you spent time hammering out in negotiating during an LOI, the scope of it, the depth of the language is not as robust as a purchase agreement. So, that time spent figuring it out saves you multiple hours on the back end when you’re having to renegotiate a position or build the clarity that didn’t exist in the letter of intent. So, I’m not the person that’s doing the billable hours, but working in tandem with the client and the attorneys to get a deal done, spending those few dollars and making that investment upfront to get a good letter of intent will pay dividends both in economics and in the parameters of the deal.

You talked about some of those, but more importantly, it’s going to even save significant dollars on that negotiation and that documentation back-and-forth and trying to get the document to meet the expectations. Because if you didn’t define the expectations in the LOI, then everybody is starting from completely different places and you’re doing that all under billable hours as you try to bring everybody together. The effort now, the expectations are aligned with reality.


Kevin DiDio: 100 percent, that’s right. And I think the other thing it does, the earlier that professionals are brought in—whether it’s the financial advisors, lawyers, accountants, the whole deal team—from the sell-side perspective, it does a good job of sending the right message to the buyer and their team that the seller is taking this seriously, they’re putting the time and the resources necessary to do everything they can to make a successful transaction. Buyers don’t want to waste their time and money. They want to make sure that they’re dealing with a seller who’s taking the process seriously and is getting the right deal team around them.


Rajesh Kothari: Yeah, and part of that right deal team is having a true M&A attorney. Not the company’s attorneys that they’ve used for a long time. It might be a trusted advisor, but a real M&A attorney will know its market terms and market language. So, when you’re crafting and negotiating that letter of intent or the purchase agreement that you’re negotiating around and things—there’s lots of things to renegotiate. I focus on those ones that are relevant to the transaction and that aren’t the industry standard or the norm, accepted norms. So, engaging someone like you to help in that process can be a great, great part of that.


Kevin DiDio: Well, I appreciate that, Raj. And on the flip side, working with a financial advisor that an investment banking firm that has the necessary expertise is just as valuable, if not more so for certain deals. So, it’s really a team approach that works best for all parties.


Rajesh Kothari: Absolutely. Well, again, thanks for joining us for another Cascade Conversations. And again, thank you, Kevin, for joining us on this discussion about letter of intent. Thank you very much.