Negotiating A Deal? When to use a LOI, MOU, or Term Sheet.

A business deal often starts with a handshake and shared vision. But that is only the beginning. Deals often involve lengthy negotiations over complex terms. Questions will remain. Did you agree on the key terms? Are there terms left to negotiate? Do you want any obligations, such as confidentiality or exclusivity, while you negotiate?

This is when an LOI, MOU, or term sheet will help. In this article, I will discuss the purpose of each, when to use them, and how they can help in a negotiation.

What Are They?

These preliminary documents are essentially the same in concept and purpose, though they have different names and look different.

Letter of Intent (LOI) – usually structured as a letter, sets forth a party’s intent to enter into an agreement.
Memorandum of Understanding (MOU) – focuses on the mutual understanding of the parties and their respective obligations.
Term Sheets – lists the key financial and legal terms, typically in a bullet point form; it is often used in M&A, financing, and investment deals.

Why Use Them?

LOIs, MOUs, and term sheets are helpful when negotiating any business agreement, for example, a merger, joint venture, employment contract, or, frankly, any contract of sufficient complexity.

Use these documents to:

state key terms of the deal and ensure agreement on them before proceeding further in negotiations;
specify open terms, setting issues to negotiate and finalize;
lay out the framework for a final, definitive agreement;
set binding obligations during negotiations, such as confidentiality, exclusivity, or any result if negotiations do not consummate, such as a breakup fee; and
establish pre-conditions for the closing, such as approval by a board of directors, permits issued by an agency, or one party’s satisfaction after due diligence.

They Can Bind You Like a Contract – Be Careful And Clear!

It’s essential to approach these documents with care—what seems like a simple, informal outline can have unintended consequences. If you’re not careful, a court may interpret and enforce the document as a fully binding contract!

State your intent clearly – If you do not intend the document or negotiations to be binding, include explicit disclaimers in the document to make it clear, such as, “This document is non-binding and for discussion purposes only” or “The parties agree that they are not bound until a final, definitive agreement is fully signed.” If you want to be free to walk away if negotiations fail, make that clear.
Binding vs. non-binding terms – While negotiations may be intended to be non-binding, you may want certain obligations while you negotiate. For example, you may want to ensure confidentiality and exclusivity. Therefore, you should clearly differentiate those terms and state how they are binding and enforceable.
Results if no final agreement – Be clear about what happens if negotiations fail. For example, one party may pay a fee (often called a breakup fee) if merger discussions do not consummate. On the other hand, you may want to walk away without consequence, with each party bearing their own costs during negotiations. Make that intent clear.
Avoid ambiguous language – Remember that a court or your counterparty may interpret the words differently from you or impose a meaning you did not intend. Sloppy drafting can carry over into your final agreement.
Set preconditions – If an ultimate agreement is contingent on approvals or the happening of certain things, such as board consent, financing, or the issuance of permits, clearly state those conditions and that no legal obligations arise unless they are met. In addition, state how those conditions must be satisfied.
Remember the disclaimers – Be cautious. Make it clear that you do not intend the document to be binding. Some courts have even interpreted emails to signify consent and intent of the parties to be bound.

The Bottom Line

Negotiating with LOIs, MOUs, and term sheets is invaluable, but take care when using them.

If you are not thoughtful when drafting the agreement, you may unintentionally create binding obligations, causing yourself a legal dispute, costs, and an unexpected liability. Be explicit about intent, define binding and non-binding provisions, and consult experienced legal counsel to avoid costly pitfalls. Spending on legal advice now can save you a fortune in litigation later.