What’s A Letter of Intent (LOI)?

A letter of intent is a fairly common instrument that is used to facilitate business transactions.  They are most often sent by the attorney on behalf of a potential buyer of a business.

They are formatted like a letter but in realty they are a basic contract.  The letter outlines the proposed terms that the buyer is willing to conduct the potential transaction under.  If the seller is willing to sell his or her business on terms that are near what the buyer is proposing, then he or she will sign the letter, binding themselves to the “binding” provisions of the letter and beginning the process leading up to the closing of the transaction.

Typical binding provisions of a letter of intent:

  • No-shop Clauses:

    These outline the terms and period in which the business owner must not advertise their business as for sale, or entertain offers from other potential buyers.  This clause is for the benefit of the buyer because the buyer doesn’t want to go through the effort and expense of negotiation just to have the seller quickly find someone that is willing to pay a little bit more, and then use that leverage to increase the purchase price.

  • Confidentiality Clause:

    This clause benefits both parties because both will be making disclosures that they likely don’t want to be made public.  For instance, the seller will disclose how much money they have made in the business, and the buyer will be forced to prove his or her financial ability to purchase the business.

  • Good Faith Clauses:

    This clause protects the potential buyer because often a buyer is forced to pay earnest money to the seller for a number of reasons.  The potential temptation for the seller would be to keep the earnest money, and then not cooperate with the buyer’s efforts to purchase the business, leading to a windfall of income for the seller.  This clause would force the seller to cooperate with the buyer or else return any money paid.

  • Representations and Warranties Regarding Authority:

    This clause protects both parties.  Generally, in small business situations where there is only one owner and a few employers, it’s easy to know if the person you are talking to has the authority to negotiate on behalf of the business.  However, in large companies, you want some sort of assurance that the person doing the negotiating has the ability to bind the company if you reach an agreement.  It is impossible to know if this is the case until you see all of the corporate documents, which normally takes some time to produce.

Typical non-binding provisions of a letter of intent:

  • Price:

    This will likely fluctuate after you review the accounting records, the bank statements, and the general condition of the business and it’s assets.  The main reason to include it in a letter of intent is because the potential seller will want to know if the buyer is willing to at least suggest paying something near what the seller would be willing to sell for.  For example, if the buyer suggests that the price be $50,000, but the seller wouldn’t consider selling for less than 1.5 million, there is no reason to continue the conversation.

  • Terms:

    These will change based on a number of factors, one of the most influential being a bank’s willingness to finance the the transaction after the numbers are disclosed and verified.

  • Representations and Warranties Regarding Inventory and Equipment:

    These will be often to subject to the opinion of an appraiser.  Additionally, they are contingent based on depreciation, and the business owners accountant would likely need to review their records before the owner is willing to say with certainty what they are worth.

  • Non Competition: This clause will fluctuate based on the seller’s plans post sale.  Often, a seller will want to use their expertise in a business segment for future monetary gain.  As a buyer, you will want to carefully consider what the seller’s plans are post sale, and have your business attorney draft a valid clause that protects you as a buyer, but also disrupts to least extent possible the seller’s future plans.
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