Letter of Intent

Once the start-ups start to seek investment, the first document that they will face will be a letter of intent (“LoI“).[1] In the event that negotiations go as planned, a share purchase agreement or a share subscription agreement, as the case maybe, and a shareholders agreement are to be signed. The scope of this article will be limited to the subject of LoI.

LoI may be defined as a pre-contract, which documents that a potential investor and an entrepreneur started the negotiations with respect to a probable investment and which draws a framework for the basic issues with the aim to sign a final agreement.  In principle, an LoI is not a binding agreement for the parties; however we often notice that the parties agree that certain terms of the LoI are to be binding. It is important to clearly specify which articles of the LoI are binding.

For instance, confidentiality and exclusivity clauses will be among the ones which are binding. Confidentiality clause is to prevent  disclosure of the information shared between the parties during the negotiations to third parties and the exclusivity clause is to prevent that the entrepreneur will seek another investment during a certain period of time. Terms with respect to termination of the LoI, applicable law and settlement of disputes will also be binding terms of an LoI.

How many shares the investor will acquire, the amount and method of the investment and other general commercial terms are also regulated in the LoI. However, such commercial terms may be subject to the findings of the due diligence to be conducted on the company following signing of the LoI. Basic agreements with respect to the future management of the company may also be included in the LoI in order to draw a framework for further negotiation. For instance, appointment and composition of the board of directors may be among the issues which may be decided at this stage. If the entrepreneur will have the control of the company, the investor will most likely claim certain veto rights in respect of certain material decisions. These decisions may be determined in the LoI. Another issue which affects the decision of the investors is the potential exit mechanisms. Pre-emption right, tag along and drag along rights are the most common exit mechanisms that are used. These mechanism may also be included in the LoI and then detailed in the share purchase agreement.

 

 

[1] Terms of “memorandum of understanding” or “term sheet” are also used.

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