Pankaj Raval (00:00)
Buyer finds the perfect commercial property, seller is motivated. They spend three weeks going back and forth on price verbally. The buyer orders an environmental report, $8,000 out of pocket, and then the seller accepts a higher offer from someone else. No LOI, no exclusivity, no protection.

Three weeks of momentum and $8,000 gone, an LOI would have cost them an afternoon.

Welcome back to Letters of Intent. My name is Pankaj Ravel, founder of Carbon Law Group, and I’m here joined by my co-host, the one and only Sahil Chaudhary. Sahil, how are you?

Sahil Chaudry (00:46)
I’m doing great. I’m excited to be here and ready to talk deals.

Pankaj Raval (00:50)
All right, let’s talk deals. We are the Deal Making aptly named Letters of Intent. And today we’re actually playing homage to our namesake, the Letters of Intent, because we are gonna be talking a letter of intent. I don’t know why it took us a get here, but we are here now because we think, you know what, wanna come back to our roots. And I think more than ever, it’s important to talk about one of the early stages of a deal and why this letter of intent stage is so important, why.

maybe we even chose it as the name of our so we’ll get into all that today. Sahil, tell me a little bit more about like why are letters of intent so important? What are they comprised of and at what point do you need to start talking about letters of intent with a deal?

Sahil Chaudry (01:27)
So Pankaj, I think we have now drafted so many letters of intent and it’s a core part of our practice. It’s something we always recommend when two parties are coming together to make a deal. It’s such a critical part of the meeting of the minds. We talk a lot about that in law school, which is, was there a meeting of the minds when you’re coming together for a contract? And you would be shocked at

how many times people think they have a deal, how many times they think they are thinking the same thing in terms of the specifics of a deal. But when it comes down to it, there are a few points where they actually don’t agree. For example, you might agree on a price, but have you agreed on when that money gets paid? You might have agreed perform an environmental test, but how long does the current owner, let’s say, a property have environmental obligations? There are a lot of details

within a deal that need to be thought through and worked out because otherwise midstream they could really blow up a deal. And alternatively, you also don’t want someone to just change their mind in the middle of negotiating once you’ve agreed on the big picture terms because then you’re talking about a fundamentally different deal. Pankaj, I’ll give you a situation. So let’s take two business owners. One business owner is selling his to the other.

for $3 million. And they’ve agreed on the big picture terms. But then midway, one of the parties says, well, okay, verbally we’ve agreed on the price, but we haven’t talked about the due diligence period. We haven’t talked about financing contingency. We haven’t talked about if this is an asset sale or a stock sale. And then meanwhile, the seller has maybe turned down

multiple bids thinking there was some kind of exclusivity as part of the deal, and the other person may just drop out of the deal thinking that they’re no longer interested. We’ve seen this kind of thing happen. Can you tell us how an LOI could prevent a situation like this?

Pankaj Raval (03:17)
so the LOI is such a critical step, from my because I find like when we don’t have them, when people want to just rush forward to the the PSA or the, the full agreement, and it’s also important to understand for our listeners that like, term sheets, they’re sometimes used interchangeably, it kind of really depends on the industry you’re in. So, we’re talking about like real estate transactions, oftentimes LOIs are used. But if you’re talking about like a term sheet, then that’s more used in venture capital.

effectively, they are interchangeable in many ways. They are kind of out the basic terms

Sahil Chaudry (03:46)
Is there exclusivity here on this deal? What’s the diligence period? What’s the deposit? There are a lot of underlying terms that

even if they’ve agreed on the big picture purchase price, maybe they haven’t agreed on the details and that could be enough for one of them to walk away.

Pankaj Raval (03:59)
Absolutely, absolutely. Yeah, you have to understand that there’s different stages of every deal, right? And you have to understand what happens at every stage of a deal. And that’s why you have ideally competent counsel and lawyers and maybe brokers or other people guiding you because you have to make sure that you understand, if you don’t have an agreement on the initial higher level terms, and how the deal is going to be structured overall, then then when you get to actual PSA, that could be your

20, 40, 100 pages long, there’s a lot more to discuss and you’re gonna be actually spending a lot more money. So we tell clients honestly, like a lot of clients don’t have unlimited funds to spend on legal, you’re saving yourself a lot of money, a lot of time by making sure that we’re aligned on the LOI. Because once you have an LOI, it’s hard to also backtrack. So people recognize that. So once you have these terms, now to renegotiate those.

all the comes up that clients want to actually renegotiate or to adjust terms in LOI. And that’s not as easy counsel is going to be often saying, Hey, you’re trying open up negotiations on these terms that we’ve agreed to. And some will say, Oh, you’re doing this in bad faith, whatnot. So you got to be aware of that.

These are just more hurdles to getting a deal done. So if you can be really clear about what you want the deal to look like early on and of the mind of minds about that, then your PSA is gonna be a lot smoother. And you’re to be a lot more efficient in getting to closing that deal.

Sahil Chaudry (05:16)
Is an LOI kind of like a movie trailer? I’m just thinking it’s it’s kind of like, you know, it gives you the highlights. It tells you, do you want to watch this movie?

Pankaj Raval (05:19)
Yeah

Yeah.

yeah.

It’s exactly like that. Do you want to watch this movie? Do you want to spend time going to this movie? Do you want to spend two hours or three hours of your day going to this movie if the trailer isn’t captivating to you? Right. So, a great metaphor. I also think about it like in relationships, too. Like I remember there’s a book I saw once. It’s about like the 10 questions you should partner before you get married. Right. Like the 10

Sahil Chaudry (05:43)
Yeah.

Okay.

Pankaj Raval (05:50)
questions to answer. And I think LOIs, that’s kind of the idea, right? There’s like, often maybe about 10 to maybe 15 deal points, you’ve got to make sure you’re aligned before you planning the wedding, which is like the PSA, right?

Sahil Chaudry (05:57)
Hello.

That’s right, yeah. Well, I actually really like this. so

yeah, an LOI is, yeah, I mean, it is kind of like a prenup. It can be binding or non-binding, but the difference is, prenup is in the event something goes wrong. So this is more like when you’re dating someone and you’re having the talk.

Pankaj Raval (06:11)
Yeah.

Sahil Chaudry (06:21)
and you’re having, hey, do we want kids? What religion? Where are we gonna live? Where are kids gonna go to school? house are we going to for Christmas? There are a lot of things that are helpful to work out when you’re in that dating phase and you’re ready to get serious.

Pankaj Raval (06:36)
exactly. So terms you think that every LOI should have?

Sahil Chaudry (06:42)
Yeah, okay. So this is what you’re going to do. You need to sit down with your attorneys and the person buying or selling and their attorneys and you need to light a candle over a nice dinner and think about these terms. One is what’s the purchase price? Okay, that seems obvious, but that’s important. You need to get that down on paper. What’s the deposit?

What is the due diligence period? So this is the period that the other person has to look under every rock and ugly truths about you. And so this is that person has the opportunity to discover are there any elements of this deal that they don’t like.

The diligence period is where that person gets to determine how long do they have to uncover any information, additional information they need to know if this deal is for them. So, we usually see on a business acquisition, a 45 to a 60 day close. And the diligence period is often paired with something called a financing contingency, because not everyone has all cash upfront to pay for a deal.

So instead they’ll go to a bank and bring a pre-approval letter, that’s something we recommend so that you know if you’re the seller, the person has the money to pay for the deal. So you have a diligence period, you have a financing contingency that allocates a certain number of days to check to see if you like the deal based on anything that you uncover and if you are able to get the money from the bank to pay for the deal. You also want to spell out exclusivity.

which is it lets both the parties agree that no one is gonna interfere during this exclusive period. So you are working out the terms of your deal and neither party is entertaining dropping out or neither party is entertaining an alternative offer during that time. If we talk about what’s being sold, is it an asset sale? Is it a stock purchase?

have so many times people say, I want to sell my business. And then we say, okay, well, what does that mean? Do you want to sell the shares in your business or do you want to sell the actual property of your business?

Pankaj Raval (08:36)
Right. And I think it’s important qualification there is just like anyone who’s listening needs to know that it really is deal specific too in terms essential terms, because if you’re doing an M&A transaction versus a commercial real estate transaction versus like a venture financing versus like a partnership or operating agreement, there’s gonna be different essential terms. But we’re talking kind of high level here as to like the 10 most important for an LOI.

Sahil Chaudry (09:00)
So I’m just gonna list out and then I will list out just for our listeners what are the 10 main terms that you wanna look for. Your purchase price, your deposit, your due diligence period, your closing date, exclusivity, financing contingency, what’s being sold, your key economic terms, what are your conditions to closing and confidentiality as well as whether this is binding or non-binding.

Pankaj Raval (09:07)
Yeah.

Mm.

Sahil Chaudry (09:23)
Those are some critical terms that you want to include

Pankaj Raval (09:26)
Absolutely, Yeah, there’s a lot there we could discuss. I mean, think with price, one thing also people need to make sure they understand is like, try to be specific, right? Try to be as specific as possible with these terms in terms of how you want price to work out. Like how do you want payment to work in terms of is there installments? Are there contingencies, right? Like what are the contingencies for the deal? deal breakers here? Are there specific deal breakers here for either side?

that we should be aware of at this onset because find out that there is the titles encumbered or there’s some title issues, because was that can be a deal breaker probably but right like you need advice on that. What are those deal breakers where you really should be walking away from this deal? that’s where also counsel can can advise you. Yeah, what other what are those terms? Do you think are most, you know, worth discussing?

Sahil Chaudry (10:04)
Yeah. Well, yeah, I think what you pointed out

just there, I mean, how many times do we see deals blow up based on financing contingency? That happens often where the bank comes in, looks at the numbers of a business you want to buy and says, we’re not going to fund this. And that could be seen as a bad thing, but sometimes it is a good thing because it means that the bank has done some kind of a calculation that actually it may protect you.

so I think we often see financing contingency. I think that’s very important. But then that also means when you’re a seller, if somebody comes to you with a financing, a finance deal that needs money from the bank versus all cash, you’d rather take the all cash deal because even, sometimes you might even choose that even if the all cash deal is less money because it might be less risky.

Pankaj Raval (10:50)
Yeah,

that’s a very good point.

Sahil Chaudry (10:52)
So there are many different

factors to weigh here and price does not, is the most significant factor, it’s something you have to weigh along with the other conditions of a deal. Additionally, sometimes you have to keep an eye out because somebody might be willing to put $100,000 for a deposit because they know it’s refundable.

Pankaj Raval (11:03)
Right.

Sahil Chaudry (11:12)
condition on diligence, now you’re tied up with someone who might not be a real buyer. And so as you’re approaching LOIs as well, especially a binding LOI, you want to evaluate who’s the buyer. So when you’re getting into a deal like this, we usually require some kind of proof of funds or some pre-authorization letter from a bank so that our sellers know that the buyer is serious and has real funds to make the deal happen.

Pankaj Raval (11:33)
Yeah.

Yeah, absolutely. I mean, I think you got to be really careful about tire kickers, especially with these deals, try to use a diligence period to get financing.

Sahil Chaudry (11:39)
Yeah.

Pankaj Raval (11:42)
which you got to be really careful about, right? Maybe you don’t have a lot of options, you’re willing to entertain people like that, but you got to be really careful about people who are going to waste your time too. If you want to get this deal done, you want to find buyers who’ve got funds who can pay you, who don’t have to worry about these other financing contingencies. And sometimes it might be better just to go with even an offer that’s a little bit lower, but is more secure than someone who’s depending on And a big red flag,

you had to watch out for is these people who want seller financing, right? Because now you as the seller are carrying a lot of the risk. And I tell people all the time, like, unless you’re prepared to be the bank and try to foreclose and try to deal with the property and take back the property, you do not want that. You do not want that headache. I would think that, to agree to something like that, you would be expecting a considerable premium.

Sahil Chaudry (12:28)
That’s actually a great point. mean, we do see that often where people are asking for seller financing and if they’re asking for seller financing, that usually means they can’t get a loan from the bank, which is a red flag. I mean, there are times where there are related party transactions. Maybe someone who’s a manager of a business is taking over and wants seller financing or there might be other reasons that it makes sense or sometimes someone has a business for many years and is basically looking for some kind of a pension or

monthly payment. We see that with law firms all the time. beware, I think is the important point is you’re not a bank. Most likely you’re not a That situation is favorable in very few situations. And someone stops paying you and you need to, you need to come after them. That’s going to get expensive. Do you think LOIs should usually be binding or nonbinding? How do you like to think about that?

Pankaj Raval (13:16)
Good question. I think there’s a lot of discussion about this in terms of whether you want a binding or think generally the market standard is non-binding. I think the reason is that you don’t want to be too tied into a deal if it doesn’t work out, right? You negotiate things as things come up. If you have a binding LOI, now the question is, okay, so you agreed to these terms.

but oftentimes the terms of an LOI are not as fleshed out as those in a PSA or lease or whatever it might be. So you’ve got to think about, well, what exactly does it mean if it’s If the PSA is not executed for some reason, right? And now a binding transaction based on this LOI, it raises a lot of questions. And I think for that reason, you want to go with non-binding.

because you want to make sure that all the deal terms and every is thought through and that’s generally done the PSA or full lease or other transaction documents.

Sahil Chaudry (14:07)
So, considering that in LOI the terms can change and usually they are non-binding terms, what’s the point? If the parties can change their mind midstream.

Pankaj Raval (14:14)
Great question. Yeah. What’s the point?

Yeah. Well, you know, generally speaking, when you have an LOI, signed LOI, you have less wiggle room. Yes, some details can be still fleshed out, which often they are. But if you’re trying to really change the whole economics of the deal and you’re trying to ask for more money after a signed LOI is in place, I think that’s going to be seen as bad faith and potentially actionable.

because there was some meaning of the minds here. So you just want to be careful about that people do it and people still try to get away with it. But the reality is that you have a meeting of the minds to a certain extent it’s really kind of often seen as bad faith to try to renegotiate major deal points and deal points that have been agreed to the LOI.

Sahil Chaudry (14:56)
Okay what’s a good rule of thumb for a deposit percentage in a deal?

Pankaj Raval (14:59)
So also Sahil, just to follow up on that, whether we want to go with binding or non-binding, I also wanted to clarify terms in an LOI that are binding. And that’s important to know. Like you want exclusivity, confidentiality, breakup fees, governing law, dispute resolution.

that all to be binding. that means if the parties walk away, and then someone breaches the confidentiality agreement, that’s still enforceable. And then you still have action that you can take if someone breached the confidentiality. So you do want certain terms like exclusivity, confidentiality, breakup fees, governing law, dispute resolution, all that to be binding. the rest of the terms are generally non-binding. I just wanted to make sure that point was clear.

Sahil Chaudry (15:35)
Yeah, that’s a very interesting point. mean, it kind of goes to the point of survivability where you want certain clauses to survive even if this agreement is terminated. But even further, knowing that most of the terms in here aren’t binding, it’s important to know which ones are binding and which ones aren’t. And you’re sharing so much information with the other party. You’re doing, in law we call it, you’re opening the kimono.

Pankaj Raval (15:40)
Yes.

Sahil Chaudry (15:58)
showing your cards and so that means that the other party is going to be able to see all of your operation and if they could be a competitor to you. So, how they’re using that information is important or they could use that information and share it with your competitors. So can see that point that certain provisions do need to be binding even if the major deal terms aren’t because just because you’ve signed an LOI doesn’t mean the parties aren’t going to walk away from the deal. They still can walk

Pankaj Raval (16:06)
Yeah.

so Sahil, now we talked about some of the essential terms. They can definitely differ based on the deal you’re doing. But when it comes to LOI where do you see a lot of business owners slip up?

Sahil Chaudry (16:34)
Well, number one is focusing on the price. The price is only one factor of a deal and you have to weigh that against many other factors.

The biggest risks I’ve seen in LOIs are when the parties have focused on the price alone. There are a lot of other terms that matter in a deal and each of them needs to be given some level of importance. For example, the diligence periods. Those are very important. contingency. That’s very important. So I think that would be one mistake would be just focusing on the price. The other.

thing I’ve seen happen, which is not necessarily a legal issue, it’s a human business issue, is when you haven’t actually aligned all the internal stakeholders, there’s one person negotiating on a company’s behalf and they haven’t actually received the support and approval from the right parties. And so that can really hold the deal up. The other thing where the other place an LOI can break is exclusivity. Oftentimes,

Buyers and sellers are unclear if by signing an LOI the terms exclusivity meaning you can’t shop the deal to anyone anymore. So those are a few places I feel like Buyers either either place too much importance on something like price or not enough importance like exclusivity

Pankaj Raval (17:48)
Hmm, very interesting. Yeah, those are good points. Yeah. So in terms of when it comes to exclusivity, why? Well, I guess we’ve already talked about that a little bit, right? In terms of why it’s important. Yeah.

Sahil Chaudry (17:56)
But like, why does it matter?

I mean, there’s a value to you deciding, there’s an opportunity cost to deciding you’re not gonna market your property, you’re not gonna market your business. Yeah.

Pankaj Raval (18:05)
Yeah, so let me ask you that.

So Sahil, when talking about exclusivity, why does it even matter that much? do we really need, is it always important to have exclusivity or sometimes maybe do you maybe not want exclusivity?

Sahil Chaudry (18:17)
Sometimes you don’t want exclusivity. If you’re the seller, usually you don’t want exclusivity because you would want to be able to shop your deal to other people. It’s really the buyer’s side that is pushing for exclusivity because they don’t want anyone to interfere in the deal while they’re doing their diligence. They’re going to spend a ton of money on diligencing all of your records. They don’t want someone to swoop in and steal that deal from them. But that being said, if you’re going to offer exclusivity, then

you need to know that there’s a value to that. There’s an opportunity cost. You could be entertaining other offers. when you bake that into an LOI, you need to ensure that you’re picking the right buyer, someone who’s genuinely serious. So make sure you’ve got proof of funds. You have done some research on who the buyer is. If there’s a pre-approval letter required from a bank, you need to make sure this person is serious. And you also need to bake in terms related to the deposit. So

When does the deposit go hard? When does the deposit become non-refundable? Is there a certain point in time where after which, the deal’s costing you too much money to keep off the market? So exclusivity plays a role with the deposit provisions as well. And a lot of these provisions are interrelated. So I would say you have to think about it’s an important step because it does demonstrate seriousness and you can value that level of seriousness

when you’re offering exclusivity. That is a value to the buyer.

So let’s say you’ve got two parties, Pankaj, who are ready to make a deal. How do you approach the drafting of the LOI?

Pankaj Raval (19:44)
So you want to be strategic about the LOI. You want to, I think, through most important deal points, right? With your counsel, with your broker, advisor, whoever it might be. What are your priorities before even getting into the LOI? You separate your must-haves from your nice-to-haves. I think that’s really important because that’s also kind of a hallmark of negotiations, right? it is all a negotiation, and I what deal-making is.

So really working with skilled negotiators is something we’ve done. We do day in and day out years now is that, we think about, okay, what’s the best alternative? What’s the worst alternative to this negotiated deal? think oftentimes asking for more and then, settling on somewhere in the middle is also something to think about with an yeah, think your must haves and your nice to haves. Pressure test the business points, not just legal language, right? Like

What is reasonable? What is market? Maybe do some research. Make sure positioning yourself in a way that is competitive, but not totally out of bounds. And then tighten the affect economics and leverage. You want to make sure that you are and the language is clear and unambiguous, even in LOIs. You always want that in any contract, you want to make sure that it’s definitely clear in LOI. And

You want to make sure you understand exclusivity, the pros and cons of like we discussed, kind of like try to define the process, right? Like what are the goals? When do you think this will be done? How much time do you want to allocate to this? And I think, lastly, I think very important is like have counsel involved early, like Sahil, you and I see this too often where people send us a signed now our hands are kind of tied, right? Like,

like we’re talking about LOI that is the name of the podcast too is because like, too many people forget that it is really important to have your counsel in the picture early on like at the LOI stage before that, when you’re thinking about doing a deal, you need to have those counsel and advisors there because you may not think about some of the legal points that a lawyer would think about. And we’re here to protect you. We’re here to protect clients from bad deals and bad decisions.

And I think we can definitely do that more effectively if we’re involved at LOI

Sahil Chaudry (21:42)
I completely agree and LOIs don’t just apply to your sale agreements. They also apply to your formation documents. So let’s say you’re forming a C Corp and you’ve got multiple people who want to be investors. to decide who’s on the board who are going to be officers. And LOIs loosely mirror the contract terms or the formation documents.

They hit on the what we know to be generally conflict points things need to be spelled out. And that’s why it’s important to have counsel involved because you don’t know what you don’t know. We see what are the types of provisions that are drafted when it comes to exclusivity, confidentiality, the

due diligence periods, what are the financing contingencies, or even when it comes to formation documents, we can anticipate problems. For example, I would say that we generally don’t recommend a two-person board because there could be a conflict. Those are some issues you can catch early in an LOI. And if you can hammer out those details, it makes drafting the actual agreements go much more smoothly.

think as deal lawyers, the thing that we are most involved in is it’s not our job to determine for our clients what’s valuable to them, but it is our job to surface the problems or surface any blind spots that a buyer and seller have in a deal. And when we’re able to surface those issues, because a lot of those issues

most of the time the parties aren’t even thinking about, our job is to surface the issues and prepare the stage for a negotiation. And the earlier that negotiation happens, the better. So I would say that if there’s one thing that someone takes out of this episode or even the whole premise and title of our podcast, it’s make sure you have a letter of intent signed before you get into the serious deal-making element.

If there’s one takeaway, I would say for our listeners that I hope that they receive, it would be that you can’t read the other person’s mind. I remember one of my teachers used to say this all the time, if you assume you make an ass out of you and me, and I think that’s the biggest protection you have against making assumptions is the LOI. It surfaces major problems early.

Pankaj Raval (23:42)
Yeah.

Sahil Chaudry (23:50)
It usually mirrors the most important points that you’re going to be drafting and if you get counsel involved they can shine a flashlight on the issues that you might not have anticipated and You will have a way better time and an easier time Getting your contract your deal signed and done

Pankaj Raval (24:05)
Absolutely. Sahil, great insights, as always. It’s great to have your experience and insight on these deals because you’ve seen this, we’ve lived through it. We’ve dealt with very good LOIs and very bad LOIs. We’ve dealt with every stage of the LOI when send us an LOI or they get to us early and we help them draft an LOI. I think we’ve helped clients

through the use of an LOI facilitate deal closings, but also to save them time and money when deals were not good, right? And we were able to figure that early. So we realized let’s not move forward because it’s not a good deal. And we were able to get that at the LOI stage as opposed to later on when it would have cost them a lot more time, money and energy and also opportunity costs because now that property would have been tied up. So yeah, you don’t want to risk that, especially if you’ve got big deals.

This is something we’ve been working on lately. A couple of hotel transactions and other large financings. You want to make sure that, especially when the stakes are high, you have these deals really clear. For our listeners, I think I would challenge you to think about when you’re doing these deals, are you getting LOIs the real importance that they deserve? Are you just kind of looking at kind of cursory documents that are formalities that need to get done?

or are you spending the time and energy and interest to really make sure you understand what you want and why you want it and what your goals are? Because I think that additional work early on is going to save you time, money, and energy and really make sure that you’re in the right deal for you in the long run.

Sahil Chaudry (25:24)
that kind of brings to light also, I’m thinking about a deal we’re working on where the percentage that somebody wants in a formed corporation keeps changing. And then that person is, once you put something down on paper, it changes how you look at it. It’s much easier to just verbally talk and make all kinds of offers and promises and things like that. But do you want convertible debt? Do you want a promissory note? Do you want equity? Do you want stock options?

Pankaj Raval (25:32)
Right.

Sahil Chaudry (25:47)
All of these things become much more real once you put them down on paper and both parties are looking at them because there is this human level of accountability that comes from seeing something on paper. All of a sudden, you have to deal with the fact that you actually said that. a human element to just seeing down on paper and

being accountable to that now. So when you change your mind, have to acknowledge, I’m changing my mind. So, if you’re gonna change your mind, you’d rather change it at the LOI phase, because once we start drafting a PSA, it gets really messy if you wanna keep changing the terms.

Pankaj Raval (26:10)
Yes.

Thank you guys all for listening. We really appreciate your time and your comments and feedback. Please drop us a follow, like, share. If you found this information helpful or insightful, if you have questions about LOIs, please reach out. We always love to with our clients about ways they’re utilizing the different insights we share.

And until next time, this is Letters of Intent. Thank you all for listening.