Contracts come in a variety of flavors. Some are simple one page affairs. Others run dozens of pages. They can be unchanging boilerplate or fluid documents with several amendments and changes overtime. Even a verbal agreement can be enforceable as a contract under certain circumstances. Every contract is a different animal. Being familiar with the variations can save you a lot of headaches in your business.
A letter of intent (LOI) is a very curious beast. It is often used in major deals like business acquisitions or investments, but they are also used frequently in entertainment and media contracts. Sometimes they are called deal memos, short form agreements or memorandums of understanding. Each one has their own nuances and weight in a legal sense, but the basic concept behind each one is a sort of pre-contract; a meeting of the minds before a more formal agreement is negotiated.
In some instances, an LOI is helpful, even vital (See Forbes: The First Step in a Big Deal). In other situations it can signal a dead deal or deceptive maneuvers by the potential partner. Here are some of the pros and cons of LOI’s and what you should look for if they come up in your freelance or small business.
A LOI can help you close a deal in several ways, including:
- Wrapping Your Head Around the Deal: It can help you figure out what you’re getting and what you’re giving up. If you don’t understand the economics of your contract in a few pages, you probably won’t understand it in a few dozen pages. (See Considering Consideration)
- Understanding the Economics: A LOI is a good place to figure out who gets paid, how much they get and when they get it. (See Your Slice of the Pie)
- Getting a Feel for Your Negotiation Partner: Contract negotiation can be stressful or easy. A LOI can give you a sense of how hard it will be to both close the actual contract and work with the person once the deal is done. Someone who is easy to deal with for a LOI won’t always be the best business partner, but a difficult LOI negotiation can be a red flag for the road ahead.
- Creating Something Each Side Can Bring to Their Respective Camps: If you have partners, investors, attorneys or anyone else who has input on your business, it can be helpful to hammer out a LOI to get their sign off before slogging through a contract. One document with all the major deal points is a useful tool for getting buy in and advice on both sides.
- Creating Momentum: A LOI can generate a sense of inevitability in a business deal. Once everyone agrees on the major points, there can be more motivation to work together and close the deal. This psychological impact isn’t guaranteed and it might be fleeting, but it’s useful if you can get it.
- Space to Shop: Unless there is a specific prohibition in the LOI, both sides have the ability to continue negotiating with other parties while the deal terms are being laid out. Either side might feel jilted if the other partner decides to leave in the middle of the dance, but a LOI often gives both sides room to maneuver.
- Due Diligence: Related to the ability to shop around for a better deal and feeling out the other side, negotiating a LOI gives each side time to investigate and research the other side before the contract is negotiated. Potential problems and issues revealed in this stage can be corrected or avoided without much loss on either side.
- Savings: A LOI can be negotiated at a lower cost in terms of time and money than a formal contract. So if the deal breaks down at the LOI stage, both sides can often walk away without much loss.
There are also several ways a LOI can be used as a weapon, including:
- Contract Replacement: There are circumstances where one party might negotiate a LOI without any intention of executing a more comprehensive agreement. There have been several court cases where a LOI has been found to be an enforceable contract. If there are aspects of the deal one side was planning to negotiate in the main contract, they’ll never get the chance if the main deal never comes.
- Creating Confusion: A LOI often focuses on the business and economic aspects of the deal without much attention to the legal considerations. If this LOI is the only thing the parties have signed, many questions about the deal could go unanswered.
- An Inducement to Act: One side can use a LOI to pressure the other side to pay for something or perform some action before the final deal is in place. Once one side acts, their ability to negotiate might be hampered because they’ve already invested in a deal that may or may not exist. The other side can take advantage of this weakness and force a deal they couldn’t otherwise get.
- A Delaying Tactic: This is related to the Space to Shop benefit described above. If one side isn’t really looking to make a deal with you, a LOI might give them the space they need to find another partner and waste your time. In addition, if your LOI negotiations are not bound by a confidentiality agreement, the terms of your LOI could be used by your alleged partner as a negotiation tool to close a deal with someone else.
When faced with the prospect of negotiating a LOI instead of a full contract, how will you know whether the document is being used or abused? Every situation is different, but consider these questions when analyzing the situation:
- Is a LOI necessary for this deal? Does it make sense to have a LOI given the nature of the agreement or the parties involved? If not, the other side could have ulterior motives. Keep in mind, the larger or more complicated the deal, the more a LOI can make sense.
- Can you get some specific benefit from the LOI? If you aren’t exactly clear on the terms or economics, a LOI might be what you need to get comfortable with the process.
- Do you see the potential for abuses from the other side? If you don’t see an upside to drafting a LOI, ask for clarification and don’t be afraid to walk away. (See How to Reject a Bad Contract)
If you do decide to move forward with a LOI for any deal, be sure to compare the terms in the main contract to the terms you agreed to in the LOI. It does you no good to make a good LOI and then sign a bad contract.
PLEASE NOTE: THIS BLOG POST IS NOT A SUBSTITUTE FOR LEGAL ADVICE. IF YOU NEED A CONTRACT WRITTEN, OR YOU HAVE A CONTRACT YOU NEED EXPLAINED TO YOU, CONTACT ME ATgamalhennessy@gmail.com FOR A FREE CONSULTATION OR VISIT C3 athttp://www.creativecontractconsulting.com/ FOR MORE INFORMATION ABOUT MY SERVICES.