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Once start-ups seek investment, the first document they are confronted with is a letter of intent (“LoI”). [1] If negotiations go as planned, a share purchase agreement or share subscription agreement and a shareholder agreement are signed. The scope of this article will be limited to the Letter of Intent.
Letter of intent can be defined as a preliminary agreement that documents that a potential investor and a startup founder have started negotiations on a possible investment and that sets out a framework for the basic issues with the aim of signing a final contract. In principle, an LoI is not a binding contract for the parties. However, we often find that the parties agree that certain provisions of the LoI should be binding. It is important to clearly specify which articles of the LoI are binding.
Confidentiality and exclusivity clauses, for example, are binding clauses. The confidentiality clause is intended to prevent the information exchanged between the parties during the negotiations from being disclosed to third parties, and the exclusivity clause is intended to prevent the contractor from seeking another investment during a certain period of time. The provisions on the termination of the LoI, the applicable law and the settlement of disputes are also binding provisions of an LoI.
The number of shares that the investor acquires, the amount and type of investment and other general terms and conditions are also regulated in the letter of intent. However, these terms and conditions may depend on the results of the due diligence carried out on the company after the LoI has been signed. Basic agreements on the future management of the company can also be included in the LoI to provide a framework for further negotiations. For example, the appointment and composition of the board of directors may be among the issues that can be decided at this stage. If the founder will have control of the company, the investor will most likely demand certain veto rights in relation to certain key decisions. These decisions can be set out in the LoI. Another point that influences the investor’s decision is the possible exit mechanisms. Pre-emption rights, tag along and drag along rights are the most common exit mechanisms used. These mechanisms can also be included in the letter of intent and are then explained in more detail in the share purchase agreement.
[1] Terms of “memorandum of understanding” or “term sheet” are also used.
