To The Letter

The Ties That Bind

The big question most entrepreneurs have about a letter of intent is whether or not it binds the underwriter into doing the deal. Until the underwriting agreement is signed, the answer is no. Then, says Moceri, "the underwriter can't back out of the deal-unless there is cause."

Unfortunately, in the world of investment banking, "cause" comes in many forms. The ubiquitous catch-all that will cover almost any situation is market conditions. "If the market's not right for initial public offerings," says Moceri, "that's a perfectly valid reason not to do it."

Another reason that underwriters frequently cite is a deterioration of a company's basic business. "If a company shows meteoric sales and earnings," says Moceri, "and then starts going flat while we are negotiating, to the point where it shows a downward trend in its prospectus, that can cause very serious problems." The perception becomes that the underwriter and the company are trying to leave the public holding the bag when the bottom falls out.

And finally, there may be "material disclosures" that are made to or uncovered by the underwriter after the letter of intent is signed. "These are findings that, had we known them before we issued the letter, we might not have issued it," says Moceri. A typical example of a material disclosure might be the discovery that patents the company told the underwriter it had on products or processes were in fact never filed for or perhaps expired.

Many entrepreneurs, says Moceri, try to hide their warts. "That never works because we eventually find out everything," he says. "When we know something upfront, we can do something about it and save the deal. But when it creeps up from behind, that's a real deal-killer."

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This article was originally published in the January 1996 print edition of Entrepreneur with the headline: To The Letter.

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