If you have just received a letter of intent (LOI) from a prospective buyer, you may want to know:
What is a letter of intent?
Is this the actual offer?
Or, what terms should be included in the letter of intent?
Understanding an LOI and knowing what it’s for is key to making an intentional, informed decision. After hundreds of deals over 20 years, we've seen our fair share of LOIs.
This document sets the tone for the entire deal moving forward, so we've created a guide on what to expect and what you should know before you sign an LOI when selling your business.
Let’s get started.
What is a Letter of Intent?
A letter of intent (LOI) is a document that outlines terms between both the seller and the buyer. It is generally submitted by the buyer and will lay out what they are willing to agree to if certain requirements are met by the seller and their business.
Think of the LOI as a sketch or blueprint of the asset purchase agreement.
While most provisions of an LOI are non-binding, signing a letter of intent is like agreeing to date someone exclusively - you’re not getting married, but you should still choose wisely.
Why Do You Use a Letter of Intent?
To save money, time, and headaches.
The purpose of a LOI is to make sure all parties are in agreement on the major terms, before engaging your attorney to draft the purchase and sale documents.
Once you receive, negotiate, and sign an LOI with a buyer, the LOI will create a period of time where the buyer will be given exclusive access to perform their due diligence.
During this time, you will be restricted from talking to or accepting offers from other buyers.
When Do You Use a Letter of Intent?
During the sale process, multiple buyers may send you a letter of intent. From those, you will choose one that you would like to move forward with.
The letter of intent will set you and the buyer up for the due diligence period. This will allow the buyer time to look into your company and confirm the details you represented in the confidential information memorandum (CIM) and the marketing materials.
In the sale process, a letter of intent will be submitted prior to an asset purchase agreement. Once the asset purchase agreement is signed, it becomes the governing document of the deal.
Disclaimer: Although effort has been made in providing accurate information, MidStreet does not warrant that accuracy and is not liable for any errors or omissions. MidStreet, nor its employees, are licensed tax professionals or attorneys. Readers are strongly encouraged to confirm tax and legal issues with accountants and attorneys in your respective state or province. The article is based on information as of summer 2021.
What Terms Are Generally Included in a Letter of Intent?
Because you will be giving the buyer total exclusive right to perform their due diligence on the business, it’s important to negotiate as many terms of the deal prior to signing the LOI as possible. The list below covers what we feel are essential terms of an LOI:
1. The purchase price
2. Whether its a stock or asset sale
3. What assets are being purchased
4. What liabilities will be assumed, if any
5. The examination period & closing date
6. An option to cancel and effect of no cancelation notice
7. The buyer’s expected financing method
8. How inventory will be handled
9. A non-competition agreement
10. The training and consultation the seller will perform
11. Real estate Sale or Lease Terms
12. The broker’s role/broker’s disclaimer
13. A confidentiality agreement
14. An exclusivity period
15. (Bonus) Purchase Price Allocation
The list above covers the “big-ticket” items, which we feel need to be negotiated prior to signing an LOI. Anything left out will need to be negotiated further down the road, which may result in wasted time and money for both parties.
Who Initiates a Letter of Intent and Who Signs it?
A buyer will typically initiate a letter of intent. They may get assistance from their attorney in drafting the letter of intent.
Once both the buyer and seller have come to agreement on the terms in the LOI, both the seller and the buyer will sign it.
How Much Time Does a Seller Have to Respond to a Letter of Intent?
Usually, the Letter of Intent will specify the amount of time the seller has to respond to it. Some LOI’s will include an expiration date and some may not.
MIDSTREET TIPIn certain cases, if a seller is still trying to decide between two buyers, they can inform the buyer that they need more time to review the LOI.
Who Should You Consult With When Reviewing a Letter of Intent?
When it comes to reviewing an LOI, you can bring multiple advisors in for varying reasons.
Attorney - Your attorney can give you guidance on your legal exposure, draft language, and provide their opinion on the terms of the LOI. We always recommend having your attorney review the offer prior to signing.
Broker - With the assistance of your attorney, your broker will help guide the deal structure, negotiate the agreement, and ensure the LOI covers all the important terms before you sign.
CPA - Your CPA can give you guidance on the tax implications of the LOI and help determine an advantageous purchase price allocation.
Wealth manager - Working closely with your CPA, your wealth manager can help you navigate and determine how the LOI will impact your overall financial plan.
If an owner decides to review an LOI with just one person, they will generally have their attorney review it with them.
What Does a Letter of Intent Mean Legally?
Most of the LOIs we've seen are non-binding, with the exception of some specific terms.
For example, the confidentiality agreement section of the LOI will typically be written in legally binding language.
Also, the exclusivity provisions of a LOI are often legally binding.
However, in some cases, a LOI may be upheld as legally binding if the language within it includes details that could come across to a judge as legally binding.
To check whether the LOI you have received is legally binding or not, you should review it with your attorney.
What Happens if Either Party Breaks a Letter of Intent?
If an LOI is non-binding and either party breaks the letter of intent, usually both parties simply go their separate ways. However, there is often language in the agreement that dictates certain fees or deposits be paid in the event either party breaches the contract.
Ultimately, these terms will be outlined in the LOI. Review your agreements carefully with the assistance of counsel before signing any document.
When Can You Negotiate the Details of a Letter of Intent
Obviously, you negotiate the details of a LOI before signing it, but can those terms be changed?
Of course they can. In deal-making, everything is negotiable and renegotiable until it’s not.
A buyer may request to negotiate terms after signing the LOI if they discover an inconsistency during due diligence. A seller may try to negotiate a slightly higher sales price after signing an LOI if there is a considerable spike in business performance.
Both parties simply need to understand what they are risking by attempting to renegotiate.
MIDSTREET TIPRenegotiating the LOI may be drafted as an amendment to the LOI, or written into the definitive purchase agreement, depending on the timing and progress of your deal.
What is the Difference Between an LOI & a Purchase Agreement?
An LOI will typically set the stage for what is to come in a purchase agreement.
Since the purchase agreement is based around the LOI, it will contain the key details of the LOI along with more specific terms.
Sign Confidently & Get Started on the Official Sale of Your Business
Now that you have the knowledge of what to expect from a letter of intent and how you can navigate negotiations, you will be able to move forward with the best LOI for the sale of your business.
You will also be able to tell when you have received a letter of intent that does not address all of the necessary terms.
Using this article as a resource and consulting with your attorney on each LOI you receive will set you up for success.