In the process of negotiating and structuring deal, one of the watershed steps is signing a MEMORANDUM OF UNDERSTANDING (MOU), also called Letter of Intent, Heads of Agreement etc.
Signing an MOU does not mean that the deal is finalized, but can be an important tool to set the tone, schedule and basic terms of the deal, and a way for the buyer and seller to gauge each other's willingness to proceed.
Signing a Memorandum of Understanding (MOU) is a crucial initial step when entering into an agreement to sell a business, especially in Australia, for several reasons:
Below are four major considerations for anyone executing a Memorandum of Understanding:
If the parties are confident that they intend to do a deal, and are comfortable with the material terms, they may choose to skip the MOU and go directly to the preparation of a Contract of Sale.
However, depending on the dynamics of a transaction, the parties may wish to begin the process with an MOU. Although one of the most common reasons for executing an MOU is to preserve the confidentiality of the process and the sensitive information that will be exchanged.
In order to prevent a bidding war, or to allow the buyer an exclusivity period in which to conduct its due diligence, an MOU can include a "no-shop" clause that prohibits either or both side or the Broker from approaching third parties for a limited period of time. Likewise, in order to protect a seller from wasting time, money and effort, an MOU may include a deposit (usually 1% of the Transaction Price) or in some larger transactions a non-refundable break-up fee that is paid if the buyer cancels the transaction for an unpermitted reason.
Many of these points (and more, of course) can be covered in a definitive agreement that provides for a delayed closing (i.e., a period of time between when the parties sign the agreement and when they finalize the transaction). However, the parties may want to set some ground rules before incurring all of that expense.
This is where an MEMORANDUM OF UNDERSTANDING comes in.
In situations, wherein the parties are not yet comfortable spending the time and resources to conduct due diligence and draft complex Share or Asset Sale Contracts, the MOU can be a relatively cheap investment.
An MOU can be used to set expectations around:
The Offer - The Purchaser has made the Offer to the Vendors subject to a share purchase agreement ("the Contract") satisfactory to the Purchaser and the Vendors.
Confidentiality - Keep confidential and not disclose any details of the of the Company, negotiations, transaction details that would be required to facilitate this transaction.
Exclusivity Period and Due Diligence - Commencing on the date of the MOU to enable the Purchaser to conduct due diligence.
The Contract - Vendors or Sellers proceed to prepare the Contract reflecting the terms and intent of the MOU.
The Purchase Price - payable by the Purchaser to the Vendors for 100% or less of the shares in The Company.
Knowledge Transfer - The Vendors working with the Purchaser to ensure the knowledge transfer to the Purchaser.
The completion date of the due diligence investigation.
Payment of the Initial Deposit.
Provision by the Vendors of Warranties etc.
Material terms that are essentially deal-breakers can be resolved early.
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It is important to differentiate between what parts of an MOU are intended to be enforceable, and what parts aren't. Examples of enforceable sections include clauses around confidentiality, no-shop, or break-up fees.
Although price and terms typically wouldn't be included among the enforceable provisions, they set an expectation that is difficult to change absent a good reason.
If the circumstances of the deal warrant, an MOU can be a valuable tool to save time and money. Because it is an important legal document, be sure to have it reviewed by a lawyer with experience in M&A transactions. It also makes sense to have your CPA review it for tax consequences.
