At the beginning of every successful business deal is the essential step of negotiating and memorializing the key expectations and terms. This article provides a general guide on how to use an interim agreement, commonly known as a “Letter of Intent,” “Memorandum of Understanding,” “Agreement in Principle” or “Indication of Interest.” The following provides a brief discussion of the advantages and disadvantages in using a Letter of Intent, as well as an alternative for your consideration.
A Letter of Intent, if drafted appropriately, is an effective instrument to ensure that part of the agreement is intended to be binding, while the other part is intended to be non-binding. The binding terms often include confidentiality, non-solicitation, and exclusive negotiating rights. Some advantages include:
- a clear expectation of timeframe for completing the negotiation and transaction
- an outline of the terms and structure of the business deal
- identification of key issues that are deal breakers
For an intended exclusivity deal, Letters of Intent are also a good instrument to refrain the negotiating parties from engaging with others early in the negotiation process.
If a Letter of Intent is not drafted correctly, it may run the risk of being construed as binding upon the parties and hence can lead to unintended liabilities and potential damages if the deal is not subsequently consummated.
In light of the risks associated with using a Letter of Intent, many businesses have chosen to use a “term sheet” to set forth basic terms and conditions of a contemplated business deal. Such term sheet, although generally not signed by the negotiating parties, serves many similar functions compared to a Letter of Intent. It is a useful and cheaper alternative.