From Letter of Intent to Closing: An Oakville Merger

The situation

Ji-ho, an accountant by training, and Tharshini, a sales director, had spent a decade building an industrial packaging distribution company out of Oakville, competing for the same manufacturing clients as a similarly sized firm run by Kajan. The two businesses had circled each other for years, occasionally losing contracts to one another, more often losing them both to larger national suppliers. Over a series of lunches, Kajan and Ji-ho concluded that a merger made more sense than another decade of competing for the same shrinking pool of mid-sized manufacturers.

Within six weeks the three of them, working with an accountant to sketch valuations, signed a letter of intent: a document laying out the shape of a deal, roughly $38 million in combined value, split between cash and shares in the merged company, with Ji-ho and Tharshini's business valued somewhat higher on account of a stronger customer base. Everyone shook hands. Everyone assumed the hard part was over.

It was not. Ji-ho and Tharshini came to Treadstone Law shortly after signing, wanting a lawyer to "paper the deal." That framing was itself the first thing that needed correcting.

What the letter of intent actually said

A letter of intent, sometimes called a term sheet, is a document that sets out the parties' shared understanding of a deal's structure before the detailed legal agreement is negotiated. Most of it is deliberately non-binding: the price, the structure, the closing conditions are all described as intentions, not commitments, precisely so either side can walk away if due diligence turns up a problem. A handful of clauses are usually binding, though, most commonly confidentiality and an exclusivity period during which neither party may negotiate with anyone else.

Our review found that Ji-ho and Tharshini's letter of intent was fairly typical in this respect: binding confidentiality and a ninety-day exclusivity window, non-binding everything else. That distinction mattered enormously once due diligence began, because it meant the $38 million figure the three of them had shaken hands on was not a price either side was legally bound to honour. It was a starting point.

Due diligence is the structured review each side conducts of the other's business, financial records, contracts, and liabilities before a deal closes. It surfaced three issues that the letter of intent had never addressed. First, roughly $650,000 of the receivables on Kajan's books were more than four months overdue, well past what the interim financial statements had implied, which meant the working capital being acquired was worth less than assumed. Second, one customer accounted for close to a third of Kajan's revenue, a concentration risk that had not come up in the lunches where the deal was first discussed. Third, and least expected, neither letter of intent had addressed who would actually run the merged company, or on what terms Ji-ho, Tharshini, and Kajan would each continue as employees rather than simply as shareholders.

What we did

1. Separated the binding terms from the aspirational ones. The first task was making sure Ji-ho and Tharshini understood that the exclusivity clause bound them to keep negotiating in good faith, but the price and structure did not bind anyone to close on the original numbers. That distinction shaped how firmly they could push during renegotiation without breaching the letter of intent.
2. Built a due diligence request list around the specific business. Rather than a generic checklist, the requests focused on aged receivables, customer contracts and their renewal terms, and any employment claims or outstanding vacation pay obligations under the Employment Standards Act, 2000, since Kajan's company was taking on Ji-ho and Tharshini's existing staff as part of the combination.
3. Negotiated a purchase price adjustment for the receivables shortfall. Once the $650,000 in aged receivables was confirmed, we negotiated a corresponding reduction to the cash portion of the deal, bringing the total combined value down from about $38 million to roughly $37.35 million, rather than leaving Ji-ho and Tharshini to absorb a business worth less than what they had shaken hands on.
4. Structured an earn-out around the concentrated customer. Instead of walking away over the customer concentration risk, we proposed that a portion of Kajan's consideration, roughly $1.8 million, be paid over eighteen months and tied to that customer's contract actually renewing, so the risk of losing it sat with the party best positioned to manage the relationship.
5. Negotiated an indemnification framework and escrow holdback. Indemnification clauses set out who compensates whom if a representation in the agreement turns out to be false. We negotiated a holdback of roughly $1.9 million, about five percent of the adjusted deal value, placed in escrow for eighteen months to cover any undisclosed liabilities that surfaced after closing, with a cap on each side's total exposure.
6. Settled governance before signing, not after. We worked with Ji-ho, Tharshini, and Kajan to draft a shareholders' agreement covering board composition, decision-making thresholds for major transactions, and each founder's role and compensation as an employee of the merged company, so the question of who actually ran the business was answered in writing rather than left to goodwill.
7. Drafted the definitive agreement. The final share purchase and merger agreement incorporated the adjusted price, the earn-out mechanism, the indemnification terms, and non-competition covenants preventing any of the three founders from starting a competing distribution business in the region for a defined period after closing.

The outcome

The merger closed roughly four months after the letter of intent was signed, just inside the exclusivity window. The adjusted deal value of about $37.35 million reflected the true state of the business Ji-ho and Tharshini were acquiring an interest in, rather than the optimistic figure from the first lunch meeting. The earn-out structure meant Kajan retained a direct financial incentive to keep the concentrated customer relationship healthy through the transition, which by all accounts he did. The escrow holdback gave both sides comfort that undisclosed problems would not simply become someone else's to absorb.

Perhaps most importantly, the shareholders' agreement settled questions that would otherwise have surfaced as disputes six months into running the combined company. Ji-ho took on the finance and operations side of the merged entity, matching his accounting background; Tharshini moved into a senior sales leadership role overseeing the combined client base; Kajan stepped back from day-to-day management into a board and strategy role, consistent with the compensation and equity terms negotiated into the final agreement. None of that was in the original handshake. All of it was in the signed agreement.

What you can learn from this