Commitment letter
| Commitment letter |
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| See also |
Commitment letter is a letter of the institution which undertakes to correct deficiencies which could lead to dangerous or risky conditions. Usually, a letter of commitment is initiated by the agency and sent to the management of the institution, accompanied by a request to the institution to execute the letter. Commitment letters are typically used in institutions which are in good general condition but have limited issues in isolated areas of activity.
While regulators usually require a letter of commitment, it may be initiated spontaneously by the institution's board of supervisors. In both cases, the letter of commitment is not prepared by the agency in a formal style (as opposed to a memorandum of understanding). However, these letters set out concrete corrective actions to be taken and timetables for their implementation. Commitment letters are considered less stringent than Memoranda of Understanding and are in fact officially considered the least painful corrective action by the Currency Competence Office, although some regulators consider that board resolutions are in fact the least painful[1].
Types of commitment letters
In principle, there are two types of commitment letters[2]:
- A one-page letter of intent from banks and some venture capital companies,
- Long, more specific letter of commitment from other venture capital companies.
What is in the commitment letter?
Commitment letters vary considerably from company to company managing the project. "Each company devises its own form. but this form is representative and contains the information and data normally provided in most commitments"[3]. They also vary considerably depending on whether they are preferred shares or mezzanine loans. A well-prepared commitment letter is much more preferred than its shorter brother, the term sheet that gives only a small portion of the transaction[4].
A number of items in the commitment letter duplicate or confirm in a more detailed way what was originally set out in the safety data sheet. Nevertheless, since this is to be a legally binding agreement, the language of the commitment is more formal, with a milder legalism than the language of the term sheet[5].
There are five basic segments in the standard commitment letter[6]:
- The first segment sets out the terms on which your investment in company is made and the terms of any capital options.
- The second part gives a hedge of the investment and this part usually exists only for mezzanineloans.
- The third part deals with the conditions of the investment, both negative and positive.
- The fourth part outlines the recapitulative statements that led the venture capital fund to make a commitment.
- The fifth part concerns the conditions under which the commitment was made.
Footnotes
References
- Collier N.S., Collier C.A., Halperin D.A. (2007), Construction Funding: The Process of Real Estate Development, Appraisal, and Finance, John Wiley & Sons
- Gladstone D., Gladstone L. (2002), Venture Capital Handbook: An Entrepreneur's Guide to Raising Venture Capital, FT Press
- Zisman B. S. (2018), Banks and Thrifts: Government Enforcement and Receivership, LexisNexis
Author: Dominika Kania
