What is the purpose of a letter of intent in a business sale?

By: Attorney Dan Pettit

A letter of intent (LOI) in a business sale is a short preliminary document outlining key terms of a business purchase and sale without binding the parties to those terms. The LOI plays a crucial role in business sales by setting a clear framework for negotiations before the parties commit considerable time and money to negotiating a definitive agreement. A well drafted LOI outlines the key economic and structural terms of a proposed transaction—such as purchase price, deal structure (i.e. asset sale or stock sale), timelines, and major contingencies, including financing requirements—so the parties can make sure they align on big picture items early in the process.  This reduces the risk of the parties wasting considerable time and money on negotiations and due diligence with respect to a deal that was never going to happen from the get-go.

Why bother with a letter of intent if it is non-binding? An LOI signals to the other party that the party presenting the LOI is serious about their offer. Talk is cheap! It is one thing for a party to orally express their interest in acquiring a business; however, it is quite another thing to be willing to put those terms down in writing. A party taking the time to draft an LOI typically indicates a level of seriousness with respect to the proposed transaction. By putting agreed-upon terms in writing, the buyer (most LOI’s come from the interested buyer) signals a genuine intent to proceed, and a seller gains confidence to share sensitive business information and to devote resources to putting together preliminary due diligence materials for the buyer. While non-binding, the terms of an LOI give the party a figurative “moral high ground” to insist on inclusion of those terms in the definitive purchase agreement.

In addition to the key economic and structural terms mentioned above, LOIs often also include provisions regarding exclusive dealing (i.e. a no-shop clause), confidentiality terms, and provide the framework for due diligence. Despite the LOI’s generally non-binding nature, these terms are often expressly made binding on the parties. This sets the stage for the parties to share information and negotiate without fear that the other party will walk away casually or shop the deal in bad faith.

Finally, LOIs serve as a roadmap for drafting the final purchase agreement. An LOI provides a reference point that guides attorneys and advisors as they translate basic deal terms into detailed legalese. The LOI can keep the focus of the parties and their advisors on the end goal of getting to closing, rather than constantly revisiting fundamental deal points. As mentioned above, the LOI gives the parties a “moral high ground” when proposed language of the definitive purchase agreement gets too far afield from the basic terms already agreed to in the LOI. In this way, a well drafted LOI can serve to help move a business deal efficiently from concept to closing.

Parties often choose to skip the LOI process on smaller deals where the LOI might just end up being as long as the definitive agreement itself. However, with mid to large-size deals, where a lengthy purchase agreement is the norm, an LOI is a common means to make sure the parties are on the same page early in the process, and to keep them on point as the process moves along.

Please call Dan Pettit, Brett Ekes or Nick Verhaalen at Demark, Kolbe & Brodek, S.C. if you need assistance in drafting a letter of intent.