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.

Kajan, for his part, assumed much the same thing. He had run his distribution business for eighteen years without ever needing outside counsel for anything more complicated than a commercial lease renewal, and he treated the letter of intent as though it were the finished agreement, simply waiting to be typeset into something formal. None of the three founders had been through a merger before. That inexperience, more than any bad faith on anyone's part, was what turned the next four months into harder work than any of them expected.

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 exclusivity, and often the costs and governing law provisions. Exclusivity normally restricts the seller only, stopping it from shopping the business for a set period; the buyer stays free to look at other targets unless the parties negotiate something more.

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.

None of these findings meant the deal was a bad one. All three are the kind of thing due diligence exists to find, and none of them is unusual in a merger between two mid-sized, closely held businesses that have never been through a formal audit process. What mattered was how each side reacted once the numbers came in. Kajan's first instinct was that the receivables issue was being used as leverage to chip away at his side's valuation after the fact, and for a tense two weeks the two camps stopped speaking directly and communicated only through their respective advisors. Getting the deal back on a collaborative footing took as much work as resolving the underlying numbers.

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, and it also gave Ji-ho and Tharshini language to use with Kajan directly, framing the receivables discussion as ordinary diligence rather than bad faith.
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 and inheriting whatever entitlements those employees had already accrued.
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. We presented the number with the underlying aging schedule attached, so it read as a documented adjustment rather than an opening negotiating position.
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. This reframed a standoff over valuation into a shared incentive both sides could support.
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 so neither party was left with open-ended risk on a deal they had already closed.
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 built up over a handful of lunches.
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, closing off the one outcome that would have made the whole exercise pointless for everyone involved.

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 customer renewed on schedule, and the earn-out paid out in full on its eighteen-month anniversary. The escrow holdback gave both sides comfort that undisclosed problems would not simply become someone else's to absorb, and it was released in full at the end of its term with no claims made against it.

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.

The tense two weeks when the two camps stopped speaking directly turned out, in hindsight, to be the moment that mattered most. Working through the receivables dispute on paper, with numbers rather than assumptions, forced all three founders to have the harder conversations about governance and roles earlier than they otherwise would have. Ji-ho later remarked that the version of the deal they closed, adjusted price and all, was a sounder business arrangement than the one they had shaken hands on in the first place — not because the original number was wrong in spirit, but because nobody had yet tested it against the real state of either company's books.

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