- What Is a Letter of Intent?
- What’s Included in a Letter of Intent?
Accepting a buyer’s letter of intent (LOI) is the first step to closing the deal of your dreams. LOIs kick off negotiations and establish terms for a potential acquisition. But if you misinterpret the terms or sign an agreement you can’t honor, you could kill the sale.
To avoid that, we’ve outlined all the terms and definitions you need to know in an LOI. Whether buying or selling a business, learning LOI legalese helps you close the deal quickly since you know exactly what’s on the table. Read on to master the terms in an LOI.
What Is a Letter of Intent?
A letter of intent (LOI) declares the preliminary commitment of one party to do business with another. Before you finalize terms in a legally-binding asset purchase agreement (APA), your LOI establishes the basics like purchase price, assets, liabilities, and other conditions.
Hammering out the details in an LOI is like the opening gambit of a chess match. The buyer makes the first move, and the seller responds with their suggestions. Instead of trying to beat the other party, however, the goal with an LOI is that you both achieve satisfactory outcomes.
That said, if you can’t agree on terms, you’re free to back out of the deal since most of an LOI is non-binding. You must only uphold certain sections (specified below) until the deal closes or the LOI expires.
What’s Included in a Letter of Intent?
Below, you’ll examine a sample LOI generated in minutes by our free LOI Builder. After analyzing each section, you’ll be ready to draft or evaluate your LOI and secure the best possible deal.
An LOI starts with an introductory paragraph naming both parties (the buyer and seller) and the letter’s purpose. In this case, the purpose is to create “principal terms” (preliminary deal terms) for a possible acquisition. Note the use of “possible,” which allows either party to back out of the deal if they can’t agree later.
The example below lists Leonard Jackson as the Buyer and Lenny’s Little Library LLC as the seller. The LOI must include the business type (LLC, corporation, etcetera), which in Lenny’s Little Library’s case, is an LLC.
Acquired Assets and Purchase Price
After the intro paragraph, the first section reiterates the purpose of the transaction, which is for the buyer to acquire the assets and specified liabilities of the seller. In asset sales, liabilities typically do not transfer to the buyer unless both parties agree otherwise.
If the buyer only acquires some assets, they’ll be listed in this section or an attached appendix. Listing them ensures the buyer doesn’t end up with unwanted assets or liabilities they didn’t intend to pay for.
Section 2 defines the purchase price and payment terms for the potential acquisition. In this example, Leonard Jackson will purchase the LLC for $80,000 in cash at closing.
The LOI specifies the purchase price is “subject to adjustment,” which means it may change before you finalize terms in the APA. The parties may adjust it during due diligence or if the assets change throughout the acquisition process. An ecommerce business, for example, might continue selling inventory before the deal closes, causing the parties to account for the reduction in the final purchase price.
But not every deal ends with all cash at closing. To open up the potential buyer pool, some sellers offer seller financing, where they finance the acquisition for the buyer. In exchange, the buyer provides a cash payment at closing and pays installments over several years. Below, Leonard Jackson pays a $30,000 down payment at closing and agrees to a 24-month payment plan at a 3.7 percent interest rate to pay the remaining $50,000.
If Leonard had also agreed to an earnout or seller holdback, those terms would also appear in this section. Earnouts are additional compensation for the seller based on the company’s performance post-closing. For example, say the seller demands $100,000 for the business, but the buyer’s not willing to pay more than $75,000. An earnout can make up the $25,000 difference if the company hits a benchmark (say 25 percent ARR growth) in the following year.
Seller holdbacks are a portion of the purchase price “held back” until a certain period passes and an agreed-upon event does or doesn’t occur. While earnouts are conditional on performance, seller holdbacks are a pot of money set aside to indemnify the buyer against risks the seller should’ve disclosed before the acquisition closed. Holdbacks, in that sense, are a bit like an insurance policy for the buyer.
Transition from Non-Binding to Binding Asset Purchase Agreement
In Section 3, the parties indicate their intention to transfer the LOI terms into a legally-binding APA. As soon as “reasonably” possible after “executing” (signing) the LOI, the parties agree to negotiate a “definitive” (formalized) APA.
Our APA Builder automatically transfers the agreed-upon terms from the accepted LOI to the first draft of the APA. But, as this section points out, the APA also includes representations, warranties, conditions, covenants, indemnities, and more legally binding provisions. For now, the LOI doesn’t include those terms because the parties will negotiate them later.
Ordinary Course requires the seller to keep their business running as usual (“in a manner consistent with past practice”) until the parties sign the APA. Not only that, but the seller also agrees to:
- Keep properties and assets in good working condition and
- Maintain the business’s employees, customers, assets, and operations as usual.
The seller can’t take their foot off the gas just because they received an offer. No buyer wants to acquire a business that’s losing steam, especially if growth slows during the acquisition process. They want a business on the rise, and it’s up to the seller to provide that upon closing.
Fortuna Burke, for instance, sold her lifestyle business It Really Works Vitamins because the buyer wanted to grow her social platform further. Fortuna already boasted 80,000 followers on Instagram, and the buyer sought to make a brand presence on TikTok. It fell to Fortuna to maintain her following and keep up her social media presence while the deal closed.
The conditions outline what the buyer and seller must do to complete the deal. You’ll see these conditions fleshed out in the APA, but agreeing to them in the LOI sets up both parties to take action before closing. In the example below, the buyer agrees to complete due diligence before the deal ends, and both parties agree to sign an APA.
But if you’re like Hosam Hassan, founder of SupportOps, you might wish to keep doing what you love at your startup. Hosam negotiated with his buyer, ParterHero, to continue working on marketing and sales for SupportOps post-closing. In the conditions section of the LOI, Hosam and ParterHero hammered out the details of Hosam’s “post-closing services.” Without adding this condition, neither Hosam nor ParterHero was obliged to provide or accept these services.
Post-closing services aren’t the only condition you can add to your LOI. The seller also agrees to enter “restrictive covenants” like a non-competition and non-solicitation agreement. If you’re buying a marketing agency, you don’t want the seller to set up shop three months later and steal all your clients. Most non-compete and non-solicitation clauses last two to five years, giving the buyer time to adjust to the business and help it grow.
Before agreeing to acquire a business, buyers will conduct due diligence to investigate the startup and ensure no troubling skeletons lurk in the closet. Section 6 of the LOI specifies that the buyer reviews the business’s “financial, legal, tax, environmental, intellectual property and labor records and agreements.”
Any relevant paperwork is up for review, and the seller must provide access to it. The buyer’s counsel or advisors can also request access to “matters” not listed in the LOI that they feel are relevant to the deal. Matters are subjects of consideration, disagreement, or litigation regarding the seller. For example, a buyer could ask for details about the terms of a loan, an unresolved dispute with an employee, or a pending legal issue.
Until now, the parties have not been bound by the LOI (as guaranteed by Section 12). But the exclusivity section is the most critical binding term in the LOI, preventing sellers from “initiating, soliciting, entertaining, negotiating, accepting, or discussing, directly or indirectly, any proposal or offer from any person or group of persons other than Buyer and its affiliates.”
Otherwise called a no-shop clause, it prevents the seller from shopping their business around to any other potential buyers. Once they sign this agreement, they’re tied to this buyer until the deal closes, the LOI expires, or the parties back out of the sale.
Even if another buyer comes along with a better offer, the seller cannot pursue it. They have roughly 30 to 60 days after signing the LOI to close the deal with the current buyer, or risk starting all over. If the founder’s looking to sell quickly, signing an LOI with the wrong buyer could ruin their exit.
In addition to staying committed to this buyer, the seller must stay tight-lipped about the deal and not enter into any “agreements, arrangements, or understandings” that cause the current deal to fall through.
Once you accept an LOI on Acquire.com, all your current conversations with buyers are suspended, including their access to your private information, and you can’t accept another LOI until you reject or cancel the one you accepted.
LOIs don’t last forever. To allow the buyer and seller to move on from the terms of the LOI, one of four possible events must occur:
- The parties sign the APA. Signing the formalized agreement releases them from the obligations of the LOI. Instead, the parties adhere to the terms and conditions of the new legally-binding purchase agreement.
- The parties agree to terminate the LOI. If the buyer and seller can’t reach satisfactory terms, it’s necessary to terminate the LOI before codifying anything in an APA.
- The buyer fails to respond. Sellers want deals to move quickly, so some LOIs include a provision that the buyer must communicate with the seller at least every five days. If they don’t, the seller can send written notice that they’re ending the LOI and moving on to other buyers.
- The expiration date passes. To avoid shackling either party to a stagnant deal, the expiration date kills the LOI so both parties can move on. In the example below, the LOI sent on March 14 will expire on May 13 if none of the previous events occur.
Some LOI sections are exempt from termination. Sections 9 (governing law), 10 (confidentiality and non-disclosure), and 11 (expenses) are enforceable regardless of LOI termination.
In the case of a dispute or other legal issue, your LOI must include the state, country, or international laws that govern the agreement. Many parties choose Delaware because of its mature case law, which gives the state courts judicial predictability. Meaning, you can trust the judges to be experienced in corporate law, and you can reasonably predict how they’ll respond to your case.
Confidentiality and Non-Disclosure
During negotiations, you’ll provide sensitive information to the other party to close the deal. To protect that information (and your business), both parties must sign a confidentiality or non-disclosure agreement (NDA).
The NDA provides insurance for both parties to send over “information about business affairs, products or services, confidential intellectual property, trade secrets, third-party confidential information, and other sensitive or proprietary information” without it leaking publicly. The info doesn’t have to be marked as “confidential,” and can be delivered orally, electronically, or in writing.
The only info not covered by the NDA is anything already public knowledge, anything disclosed by a third party, anything you already told them wasn’t confidential, or anything federal or state laws require you to disclose.
The Disclosing Party is the buyer or seller who releases the information, while the Receiving Party is whoever receives the information. Per the agreement in the LOI, the Receiving Party agrees they shall:
- Protect and safeguard the info as if it was their own
- Not use it for purposes other than the transaction
- Not tell anyone the confidential information
If the Receiving Party breaches this section, they’re directly responsible for it. Meaning, the Disclosing Party can claim compensation against the Receiving Party.
Most of the time, the parties sign an NDA before drafting or reviewing a letter of intent. If that’s the case, you likely won’t see this section in the LOI.
Expenses (Escrow Costs)
Section 11 confirms each party will pay their expenses, including legal and advisory fees, or any other costs related to the acquisition. This is also where the buyer and seller break up the escrow costs, with either one party covering the expense or both parties splitting it equally.
The no-binding obligation guarantees that the agreement is not binding or enforceable – except for certain sections. In the example we’ve used, Sections 7-13 (exclusivity, termination, governance, confidentiality, expenses, no-binding, and miscellaneous sections) are excluded from this provision and can be upheld in a courtroom.
Otherwise, the rest of the terms won’t be enforceable until the parties put them in the formalized APA.
To round out our LOI, we’ve got the miscellaneous section, which confirms different parts of the LOI can be executed at different times, but it still counts for one agreement. Before signing, this section also makes the parties confirm:
- They’ve had the opportunity to consult counsel.
- They read and understood the LOI and know the potential legal effects.
- They enter this agreement “freely and voluntarily,” based on their judgment.
If the buyer and seller agree to those three conditions, they’re good to sign the LOI.
What Should You Avoid in a Letter of Intent?
When drafting or reviewing a letter of intent, watch for these common mistakes to help your acquisition go smoothly.
- Not establishing exclusivity or confidentiality. In most cases, the parties enter into an NDA before drafting or signing an LOI. But if they don’t sign a no-shop or non-disclosure agreement, one party might take advantage. The buyer can expose valuable information about the business for sale while the seller continues shopping the startup around after signing. Avoid both scenarios by agreeing to these legally binding terms.
- Not clarifying the terms. Avoid generalizing the deal’s terms and included assets. Establish what you expect to get from the transaction so you’re not short-changed or dealing with unwanted assets and liabilities.
- Not intending to follow through with an APA. If the seller properly evaluates the buyer, this likely won’t happen. But occasionally, buyers will enter into LOIs when they’re not serious about signing an APA. If you’re thinking of sending an LOI to a seller, ensure you’re committed to entering negotiations in good faith and closing the deal.
Luckily, if you sell on Acquire.com, our automated workflow minimizes these issues.
Worried about drafting and sending an NDA? Our NDA Builder will do it for you, requiring buyer signatures for every startup access request.
Not sure how to word the terms of your LOI? Our LOI Builder drafts the legal wording and integrates your terms into the letter in just five minutes.
How Serious Is a Letter of Intent?
Acquisitions on Acquire.com (and in many typical M&A scenarios) can’t move forward without a signed LOI. It documents the acquisition process and protects the buyer and seller from potential disputes or misunderstandings. Not to mention, clarifying preliminary terms saves time during negotiations for the asset purchase agreement.
But as a seller, you can receive dozens of LOIs and not accept any of them. Even post-signing, either party can back out of the agreement because it’s not legally binding (excepting a breach of the NDA or no-shop clause). Just ensure your wording doesn’t commit you to any promises, and you can move on to the next potential deal.
Can You Be Sued Over a Letter of Intent?
Yes, the other party can sue you based on the binding terms of a letter of intent.
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