A letter of intent, also called an LOI, is an essential component of the business buying process. For buyers, an LOI provides them with the right to first refusal and clarifies the purchase details if the buyer chooses to move forward. This document also includes certain protections for the seller as well. In this review, we take a close look at the purpose of an LOI, including the benefits and what is included in the document.
What is a Letter of Intent (LOI)?
A letter of intent (LOI) establishes the intent for two parties to enter into an agreement with one another. For mergers and acquisitions, the LOI establishes the purchase terms between the buyer and the seller. This is not a replacement for a purchase agreement. Instead, it establishes plans for the sale if all requirements are met during due diligence.
A letter of intent is usually initiated by the seller. Once the document is signed by the buyer, then negotiations usually end and the buyer has the right to purchase the company at the agreed-upon price and conditions. LOIs are not usually binding, which means the buyer is not legally obligated to purchase the agreement if they find issues with the company during due diligence. However, it is important to work with a broker who understands LOI language as some seller-side brokers may include a binding effect in the fine print.
What are The Benefits of a Letter of Intent When Buying a Business?
There are notable advantages to signing a letter of intent when you purchase a company. Notably, the benefits include:
- Establish the “right of first refusal” – You can halt negotiations between the seller and other potential buyers by signing a letter of purchase intent that stipulates you have the option to purchase or turn down the deal without others getting involved and making a higher offer.
- Clarify ambiguities and reduce the risk of complications – A letter of intent establishes the terms of the purchase if the buyer chooses to move forward. If there are confusions over the final sale price, payment terms, financing, etc., then the letter of intent can help iron out the details.
- The LOI serves as a template for the purchase agreement – The purchase agreement is not the same as the LOI, but the LOI can serve as a general template for the purchase agreement, which makes reviewing the purchase contract and closing the sale much easier.
What Does a Letter of Intent Include?
There are a variety of sections that your letter of intent may include. Each serves a unique and important purpose. Below we discuss some common sections that are included in LOI deals for buying a business.
The Basic Terms of a Proposed Transaction
An LOI first establishes the basic terms of a future purchase agreement. Notably, this includes the sale price, payment terms and type, a description of the assets, and contingency, limitations, and closing conditions.
Transaction and Timeline Details
This includes a more detailed explanation of the purchase deal. Notably, it can include the sale price, which may or may not be subject to change based on the results of the due diligence process. It may also include timeline details. For instance, the LOI may discuss the negotiation time frame after due diligence is completed.
A Statement That The Agreement is Binding or Non-Binding
Most LOIs are non-binding for both parties (the buyer and the seller). If the LOI is binding, then it should clearly state that it is in this section. It should also include a statement if the LOI is non-binding as well.
Contingencies
Contingencies are crucial to establish in the LOI document. Specifically, contingencies establish what must take place before the purchase process can continue. Common examples of contingencies are:
- The transaction will only take place as outlined in the letter of intent document if the buyer is satisfied with their findings during the due diligence process
- The purchase will only move forward if the buyer is able to secure the financing necessary to pay 100% of the sale price to the buyer at the time of closing
Of course, these are examples of possible contingencies. These specific examples may not be included in your LOI. It is important to work with your business broker and/or attorney to ensure the contingencies added to the LOI meet your needs and preferences.
An Explanation of The Due Diligence Steps
Many LOI documents also outline the steps that are involved with due diligence, and there may be a timeline included for each. This helps both sides know what to expect and further ensures that the deal progresses and closes sooner.
Closing Date
Many LOIs also include a closing date. This helps both sides progress quickly through due diligence to complete the sale sooner. In some cases, the LOI may state that the terms of the agreement are no longer valid (and subsequently the LOI terminates) if the deal is not closed by the stated closing date.
What Buyers Should Know When Preparing for The LOI
It is important to not blindly sign the LOI. Rather, you (along with the assistance of your broker and/or attorney, should closely review any LOI documents that the seller presents. If necessary, you should also negotiate the terms to ensure you are protected. For example, you should ensure you are not locked into a purchase deal due to a binding clause added to the fine print. You should also ensure you are fairly certain that this is a company you want to purchase (assuming all checks out during the due diligence process).
Make The Buying Process Easier With Sigma Mergers and Acquisitions
Sigma Mergers and Acquisitions assists you through all of the complexities involved with the purchase process, including concerns related to the letter of intent. Contact us today if you would like more information or would like to get started with buying a business.
