are writings in correspondence form signed by a company and an investor that set out the broad parameters of the business deal between them. Letters of intent tend to be short and almost always anticipate additional formal documentation before funds are actually transferred.
Intent letters do not appear in all venture capital financings. Some venture capitalists prefer to proceed directly from negotiations to formal financing agreements. When intent letters are used, they always precede the formal documentation and often provide for interim working arrangements or bridge financing.
Letters of intent can be completed quickly, usually in an afternoon, and serve several purposes. First, by putting the business deal into writing they assure both parties that the other party agrees to the major terms of the deal. Also, they usually establish a time frame for finalizing the details and getting the necessary documentation completed. Letters of intent highlight the agreements of the parties. In so doing, they tend to solidify each party’s commitment to the financing and often make it easier for the parties to agree on the peripheral issues that have to be dealt with in the definitive financing agreements.
Although many people think of them as unenforceable expressions of intent, letters of intent usually contain some agreements that are binding. Some contain agreements regarding how the company will be operated until funding is provided. Others contain binding agreements for bridge loans or other immediate funding to hold the company over until the formal financing agreements can be completed.
Most letters of intent have three things in common. They contain binding agreements by management and the company not to negotiate financing with others for thirty days or more; they allow the investor full access to company records and facilities; and they require the company to continue to operate its business in the ordinary course. Some also require management and the company to make representations about the company’s business plan, financial statements, and management’s stock ownership.
When preparing a letter of intent, management should be careful to understand which provisions of the letter are binding and which are not. The alteration of only a few words in a letter of intent can mean the difference between a binding obligation and a simple statement of intent.
Management also should be careful to understand the full implications of the proposed funding. Intent letters set the tone for the negotiations of the final financing agreements. Because of this, it can be very difficult to change a poorly considered term of an intent letter even though that term may appear only as an expression of intent.
Managements who plan to use an attorney or other advisor in connection with the final financing agreements should consult with that advisor before the letter of intent is negotiated and signed. Many entrepreneurs, however, sign intent letters without first consulting their advisors. Some do so with the belief that they can fix what they do not like in the final documents. Others feel compelled to sign immediately when presented with an investor’s letter to show their good faith and to get the deal moving. Most are disappointed later when the investor resists changing the deal or when they discover the full impact of concessions they have made. These disappointments can usually be avoided by taking twenty-four hours to consider the letter before signing. During this time the entrepreneur can meet with his advisors to be sure he fully understands the investor’s offer and has addressed the business issues that need attention. See: Bridge Loans, Commitment Letters, Financing Agreements, Investment Memorandums, Lawyers, Letter Agreements, Negotiation, Structure.