There is often a fair amount of ambiguity in regard to non-binding vs. binding offers (and which you need to use as a potential buyer). In this review, we discuss both non-binding and binding offers, highlighting what they are exactly, the differences between the two, and which one you should use when in the purchasing process.
What is a Non-Binding Offer?
A non-binding offer, or an indicative offer, is a document that proposes purchase terms between a buyer and a seller. It is not a commitment to purchase the company if the offer were to be accepted. Instead, it merely serves as a starting point for further negotiations and contingency planning. Initial offers to purchase a company that is for sale is, in almost every case, non-binding. However, it is important to state that the offer is non-binding in the written document to avoid any legal ambiguity.
The Benefits of a Non-Binding Offer
A non-binding offer lays out the intention of an investor to purchase a company and proposes the purchase terms, which launches the negotiation of a sale. The buyer can clearly state their intentions without having to worry about being legally obligated to uphold all of their proposals. This provides them more freedom to make an offer even if they do not have a definitive conviction on their offer.
More specifically, a non-binding offer protects the one who made the offer from lawsuits. This document protects both parties if a deal were to fall through during negotiations or due diligence, meaning the other side cannot sue due to a breach of contract as the document is not legally binding.
The Drawbacks to a Non-Binding Offer
The buyer is allowed to pull out of the offer if they change their mind. However, the seller is also allowed to pull out any non-binding commitment that is made. This provides less certainty and requires more trust on behalf of both parties. Of course, for the majority of the purchase process, more flexibility and less legal certainty is a good thing. However, when it comes to the purchase agreement (rather than offers and letter of intent (LOI), a binding contract is the better option.
When to Use a Non-Binding Offer
As mentioned, a non-binding offer is usually recommended. It is almost always recommended for the initial offer to purchase a company. In this case, it serves as a starting point to enter negotiations. In other words, you can think of it as an agreement to agree on contract terms, rather than serving as the agreement itself. In addition to the initial offer, most buyers choose to use a non-binding letter of intent (LOI) to protect themselves through the due diligence stage as well.
What is a Binding Offer?
A binding offer is one that is enforceable if the one who made the offer does not follow through with the contract terms. It sets clear obligations and requirements for both parties and establishes what recourse the other party can take if the other breaches the terms established in the legal document. Binding contracts are not usually enacted until the purchase agreement provides both sides (the buyer and the seller) with the opportunity to pull out of the deal without legal consequence.
The Benefits of a Binding Offer
A binding offer can provide more certainty for buyers and sellers. This certainty is not provided with a non-binding offer. For buyers, in particular, a binding offer is a great idea once the negotiations are complete and the buyer feels strongly about their commitment and intent to purchase the company. In this case, they can further ensure the seller is also serious about selling the company and is willing to uphold their end of the bargain through a binding offer.
The Drawbacks of a Binding Offer
As you can imagine, the inability to change the terms or pull the offer is the primary drawback to a binding offer. Any deal that is legally enforceable requires considerable thought, and as the buyer, you must be certain that you are able and willing to follow through with the offer if it is binding. Otherwise, you could find yourself in a position where you are obligated to purchase if no contingencies were broken by the seller.
When to Use a Binding Offer
You should use a binding offer when you are certain in your intent to purchase the company at the price (and with the terms) proposed in the offer. Your initial offer should not be a binding offer; this could lock you into a deal in which you later change your mind. However, as you go through due diligence and get closer to closing, you can begin to consider the binding offer. In many cases, the LOI, which is usually a non-binding document, is used as a template for the binding purchase agreement, assuming all stages of the due diligence process went well.
What Should Be Included in a Non-Binding Offer?
There are several important components that any potential buyer should include in their non-binding offer to acquire a company from a business owner. These components are:
- Offer price – A non-binding offer should discuss the amount the potential buyer is willing to pay to acquire the company from the seller.
- Financing terms – If applicable, the buyer should also outline how they intend to finance. For instance, are they paying the entire amount at closing or will they make a down payment and request seller financing?
- Contingencies – The non-binding offer should also establish any contingencies that must be met before the offer is valid.
- Legal status – The document should clearly state whether it is non-binding or binding.
- Deposit – Many offers include a deposit that is refundable. This shows the seller that the buyer is serious with their offer.
Considering Buying a Business? Contact Sigma Mergers and Acquisitions
We have helped numerous buyers find the right company to purchase. We offer coaching and consulting services to help you through the buying process, from determining the type of business you should buy to making non-binding (or binding) offers. Contact us today to learn more and get started.
