Consider Letters of Intent Carefully

21 September 2000
Letters of Intent are always non-binding documents. My clients are always telling me this. Apparently, it's what their Uncle Charlie told them. I have nothing against Uncle Charlie, but he's wrong. A Letter of Intent (LOI) could be the beginning of the end.

Over the last few years, being a technology lawyer has evolved into a practice with heavy involvement in the world of venture capital. It's simple. My clients often need funding.

One of those exciting moments for them is when they feel inches away from the Holy Grail - venture capital. At that point, among the many mistakes they make is setting aside their brains and common sense, along with their lawyer, so that they can get some real business done. Hello? Is their anybody home? You've never needed your brains, common sense and yes, even your lawyer, more!

My advice is that they slow down and take a deep breath. Yes, we've gone from concept to business plan to endless meetings with venture capitalists (VCs), and now we're almost there. Now is not the time to get giddy and stupid. Rather, it's the time to show some business maturity.

Remember that your VC is investing in you as much as, if not more than, your technology. Show them that you're seasoned and wise.

While you may be anxious to get your deal done, rarely is sophisticated business done with unsophisticated and barely negotiated documents. You should demonstrate your sophistication and business acumen by bringing the right lawyer to the negotiating table with you.

And guess what? The real negotiation starts with that Letter of Intent.

Letter of Intent Basics

"Letters of Intent" go by many names. They include "Expression of Interest," "Agreement in Principle," and "Memorandum of Understanding." For all practical purposes, they're all the same things.

An LOI is a written document which is usually in the form of a letter. In the LOI, the VC will typically outline the basic terms and conditions of the transaction.

There is no "typical level" of detail. I've seen one or two pagers and I've seen much longer LOIs.

Uncle Charlie notwithstanding, an LOI may be a binding contract. It depends on the intent of the parties and what the document says about it being a binding agreement.

It's a common misconception that if you take a contract, add the words "Letter of Intent" to the top, and write it so that it "looks" like "just" a letter and not a contract, you've now created something less than a binding contract. That's just simply wrong.

While it's true that calling it an LOI may be evidence that the parties did not intend be bound by the terms of the LOI, it may not carry the day in a courtroom if the words of the document read like a binding contract.

This is truly not a complex point. I harp on it only because my experience as a practicing lawyer tells me that even sophisticated clients don't get this point. Moreover, it's an easy problem to fix.

Binding or Not?

Sometimes, you want some of your LOI to be binding. For example, you may want the non-disclosure obligations to be binding whether you close the contemplated deal or not. Still, you may not want the LOI to require you to close the deal with the VC because you haven't yet agreed to or even discussed many of the provisions which will eventually be in the comprehensive agreement.

Ending the mystery of "binding or not" is as simple as clearly stating your intent in the LOI. While it's not quite as straightforward as just saying, "This is not a binding agreement," it's also not rocket science.

It's just that there are issues related to binding versus non-binding that you should generally address in your LOI. For example, who will be responsible for expenses if the deal never closes? Is any broker's or finder's fee implicated because of the LOI? Is the LOI an agreement to negotiate in good faith or is it just a document which is a part of the negotiating process, and not meant to even create an obligation to negotiate.

While not rocket science, these and other concerns are the reason that you should never sign an LOI without your lawyer's input.

To LOI or Not

When clients ask me about LOIs, the first question I ask is why are we bothering with this preliminary document. What's its purpose?

The irony is that business people seem to like LOIs and lawyers don't. It's true that there are some excellent reasons for a preliminary agreement of some type (a non-disclosure agreement being prominent among them). Still, there are many good reasons to skip the LOI and go right for the gusto -- the comprehensive agreement between the parties.

The best reason to skip the LOI is that it takes time to negotiate and prepare. It's a diversion preventing the parties from getting to the main act. So, the business folks say, "Let's just get something (anything) down on paper. It not meant to be binding anyway."

So, if it's not binding, why bother?

I don't like LOIs because I see a document that has the potential to haunt my client in a courtroom if the parties never agree to the "definitive agreement." Therefore, I usually recommend a LOI that's for the most part not binding as clearly stated in the LOI. Of course, this brings us full-circle yet again. Why did we bother with an LOI?

Negotiating an LOI

If you and your attorney agree that an LOI is the way to go, I suggest that you organize your negotiation as follows. You should start by dividing your LOI into two parts - binding and not binding.

On the binding side, I like to keep it short, sweet and truly essential. What's essential is the stuff that matters if the deal never closes. It might be things like non-disclosure, an obligation to return materials provided to the other side during negotiations and due diligence, and who pays for things like professional fees and other costs of the negotiation.

As for the non-binding stuff, I generally like to see an outline of the business terms of the deal. Bear in mind that for every term mentioned in the LOI,, there are many unspoken terms. For this reason, I am a strong believer is making the outline of terms non-binding.

In any negotiation, linkage between terms is an important element in the dynamic of discussions. "You give me this and I'll give you that." If the outlined terms are binding, you may find yourself at a tremendous disadvantage as you try to negotiate other terms that aren't mentioned in the LOI, but may nonetheless be quite important to you.

If the non-binding part is to serve any purpose, it should certainly highlight likely deal killers. After all, if you can't agree on these deal killers, there is no reason to continue.

Still, be careful about what you agree to in the LOI. Although you may write it in such a way that it's legally unenforceable, you shouldn't lose sight of its rhetoric value during the post-LOI negotiations.

If you later decide that you want something different from what's in the LOI, you'll find the other side waiving the LOI in your face. Your best response will be that the LOI isn't a contract and that in light of the your negotiations with them on other points since the signing of the LOI, you want to change your position.

You can avoid this problem if you carefully consider the LOI before jumping into it.

An LOI may just be a necessary step in getting your deal done. Never forget that "just" an LOI can be a binding contract with lots of bite.

Mark Grossman's "TechLaw" column appears in numerous publications. Mark Grossman has extensive experience as a speaker as well. If you would like him to speak before your group or corporate meeting, please call (305) 443-8180 for information.

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