Understanding Letters of Intent

If you’ve never sold a business before, you might not know what to expect with the process. While there are many steps between announcing that your business is for sale and closing the deal, the one we’ll focus on here is the letter of intent.

What is a Letter of Intent?

A letter of intent (LOI) is, as it indicates, a document that announces the intention of a potential buyer to purchase your business. It’s an informal but very important document that paves the way for negotiations in the sale process.

When Are They Used?

The LOI kicks things off as the first step when there’s a buyer ready to move forward. It is sent by the buyer to the seller after there has been an informal discussion about the business for sale, price and terms, et cetera.

After the letter is signed, the parties move on to due diligence, further negotiations, execution of the transaction documents and finally closing of the sale.

What Terms Do Letters of Intent Include?

Though the LOI is considered informal, it does contain important information. First, it serves as a written expression of both parties’ intent to enter into a deal. It lists the sale price, or a range, as well as terms for the sale. It also covers the structure of transaction: merger, stock purchase, asset purchase, et cetera. The LOI will likely also include non-disclosure and non-competition provisions, or state that the parties will execute a separate NDA. 

The LOI will outline how the buyer will finance the acquisition. There will also be a timeline for the rest of the process, including negotiation, due diligence, and closing. The letter will likely state the seller will not have discussions with or enter into a purchase agreement with a third-party for a specified period of time (often referred to as a “no shopping” clause). There may be other stipulations or details included, based on need and the situation.

Are They Binding or Non-Binding?

The short answer here is that most LOIs are non-binding, meaning the buyer is under no obligation to purchase the business. And if that’s the party’s intent, good business practice is to specifically state in the LOI that it is non-binding. It can also, of course, be explicitly stated to be binding if both parties agree.

But be cautious, even if a LOI was intended to be non-binding or specifically states it is non-binding, a court could find the document binding if the subsequent actions of the parties support such a finding.

Negotiating the Letter of Intent

While the buyer is the initiator of the LOI, you as the seller can absolutely negotiate the terms of the letter. After reviewing it, if there are points you do not agree with, such as the price, timeline, or terms, draft a revised letter with your proposed changes or a new LOI entirely if need be. It may take a few back-and-forth drafts, but negotiating now can pave the way for a smoother purchase process and clearer expectations when it’s time to make the sale.

What Sellers Should Watch Out For

If you’re selling a business and receive an LOI there are a few things to be aware of.

First, if you’ve had a conversation with a potential buyer and then signed an LOI, you can’t simply drop the negotiations in favor of a better offer. You’ll need to honor the aforementioned no-shopping clause and negotiate in good faith.

When reviewing the letter, determine whether it is binding or non-binding so you can avoid a potential legal hassle in the event that the buyer wants to move forward and you do not.

Make sure you are protected with confidentiality and non-disclosure clauses or agreements. Another thing to look out for is no-holds-barred access to your confidential data. Certainly, the potential buyer needs access to some sensitive information during due diligence, but you, as the seller, can specify what, if any, information should be withheld, if only until you are further into the negotiation process.

Look out for terms that are too good to be true. If the buyer is agreeing to your top price with terms better than you offered, there’s bound to be a reason, and it’s likely not a good one.

Pay close attention to the financing section. You need to be reasonably confident that the buyer can secure the necessary financing and that it won’t fall through at the last minute.

One red flag to be on the lookout for is an overly long exclusivity period. A long period benefits the buyer, but what happens if they back out? A shorter exclusivity period, like 45-60 days, is long enough for the buyer to determine whether they’d like to proceed but not so long that you can’t shop around for another buyer if this sale falls through.

Also, if you only have this one offer, you might consider waiting to sign the LOI. Having more than one interested buyer can help you get the best price and terms possible, so avoid jumping at the first interested party.

Trust Your Instinct

Before signing the letter, be sure you are actually ready to sell your business. It’s an emotional thing, letting go of something you put so much work into, so be sure you are 100% ready to hand it over to someone who may choose to run it completely differently than you did.

And avoid what some call “deal momentum:” Once the sales process starts, it can feel wrong to simply call it off if you don’t have a good feeling about the transaction. But trust your gut. If something about the deal feels off, don’t ignore it. Yes, it may be work to market the business and seek another buyer, but in the long run, you’ll be happier with the right buyer.

What Happens Next?

Once both parties have signed the letter of intent, the due diligence process begins. The seller will provide any necessary documents to demonstrate the financial stability of the company, as well as others that the buyer may be interested in. These may include (among others):

• Financial statements
• Bank statements
• Tax returns
• Revenue and expense analysis
• Financial projections
• Contracts
• Intellectual property
• Permits
• Supply chain evaluation
• Market analysis and industry trends
• Business plan

Having a Lawyer on your Team

While you may be tempted to sell your business on your own, there are many advantages to working with a lawyer who specializes in business sales.

When it comes to the LOI, an attorney can review the letter to look out for red flags like those we’ve discussed above. With more experience than you have in these types of transactions, he or she may be able to spot a potential sticking point and help you negotiate the terms of the letter of intent.

A lawyer can review your sale price and terms to determine whether the valuation is accurate or not. And if you’re not comfortable with hard-ball negotiations, a lawyer can act on your behalf to ensure your terms are met by the seller.

Also, an experienced lawyer can tell you if you should avoid a particular deal, even if you don’t see red flags.

Final Thoughts

Selling a business can be an overwhelming experience if you’re not prepared. The key is to do your homework and be ready when presented with the letter of intent. Read it carefully and consider hiring a lawyer to also review and help with the negotiations. But remember: you have the final say when it comes to agreeing to a sale, so trust your instincts!