The Letter of Intent (LOI) is used by a prospective purchaser and seller to establish terms and conditions of the business sale. The letter outlines the basic terms and key points involved in the potential business sale agreement. Once a buyer and seller have agreed upon the key terms of a deal, the buyer normally sends the seller a LOI to purchase a business.
LOI is one of the first steps in the process of completing the business sale. A professionally written Letter of Intent provides a solid foundation for a potential transaction as it captures the parties’ intentions with regard to the deal structure, timing and terms.
A LOI is non-binding except for a few clauses. The most notable of these is the agreement between parties that they will:
- keep everything confidential, and
- the commitment by the seller that he or she will break off talks with all other prospective buyers for a period to allow the buyer time to conduct due diligence.
For the most part, the LOI is non-binding and either party can back out for any reason. It is rare for that to happen because, at this point, both parties have spent significant time in the negotiations phase leading up to the LOI.
The LOI defines what a deal may look like, and then allows both parties - but mainly the buyer - some time to perform due diligence to verify the information presented. It is also used as a road map for the attorneys when they craft the final business sale agreement and other closing documents. It is important for an LOI to have enough detail so there isn’t a lot of negotiating left to do on major deal terms. There is always going to be some bargain, but you really don’t want to have to deal with something so major that it impacts the overall value of a deal.
The obvious items, price and structure, are pretty hard to leave out, but we’ve seen some other basic items overlooked. Here are some other items that should be in the LOI:
- If there is a seller note, the LOI should contain the terms of the note and what, if any, security is on the note. If it isn’t a straight note, then a payment schedule as an exhibit can be helpful.
- If there is an earn-out, e.g. future performance-based compensation, then there should be detail on how that is actually earned. If there is any confusion at all, examples can be included to show how any formulas would actually work.
- Unless the seller is going away immediately (a rare case), there should be details on future compensation for the seller.
- The status of the accounts receivable, payables, cash in hand, and any working capital requirement should be very clear.
- There can be deals that include continued ownership for the seller. The structure to make that happen can be complex and it should be clear what the new ownership is. A new ownership table ("cap table") as an exhibit shall be included in the LOI.
Each LOI is different, and is based on the concerns of both parties. Let’s say we have a seller who worries that a buyer will mess with the compensation structure of the company’s top software engineer during the seller’s earn-out period. We might go to the buyer and ask that a clause be added that states the buyer will provide an employment agreement to this employee that sets the compensation. You can do this after an LOI and before close, but it is usually easier to get in the LOI.
While due diligence is going on, attorneys will take business sale agreements, and similar closing documents and modify them to include terms in the LOI. A two to four-page LOI can’t possibly include all details of an acquisition, so there are points and issues to resolve. Usually, these are resolved quickly. Some items are a little more challenging to figure out, but, at that point, buyer and seller are committed to a deal and able to compromise on a solution. Once due diligence is complete, and the purchase agreement and other documents are done, there is really only one thing left: closing the sale.