The Importance of the Letter of Intent

Every stage of a business sale deserves careful consideration, but few stages carry more significance than the Letter of Intent. A Letter of Intent in M&A establishes the framework for moving from preliminary negotiations toward a completed transaction. An LOI generally outlines the principal economic and business terms agreed upon by the buyer and seller. Although largely non-binding, the document establishes expectations that often guide the remainder of the transaction.

Why does such an important document remain largely non-binding? Buyers still need to complete due diligence before committing to acquire the business. Likewise, both parties must negotiate definitive agreements containing the transaction’s final legal terms. Even so, sellers should approach an LOI as though its major business terms will remain unchanged through closing. Renegotiating those terms later may become difficult and potentially damage the transaction.

A well-developed Letter of Intent in M&A should address several important matters:

• Purchase Price: Define the proposed consideration and explain how the buyer expects to pay it.
• Transaction Structure: Identify whether the buyer proposes an asset purchase, equity purchase, merger, or another structure.
• Working Capital: Establish the methodology for determining any working capital target and resulting purchase price adjustment.
• Contingent Consideration: Define significant seller financing, earnouts, rollover equity, escrows, or holdbacks.
• Seller Involvement: Address anticipated employment, consulting, transition assistance, or other post-closing responsibilities.
• Due Diligence: Establish the buyer’s opportunity to confirm financial, operational, legal, tax, and commercial information.
• Exclusivity: Define the period when the seller may not solicit or negotiate competing acquisition proposals.
• Timing: Establish expectations for due diligence, definitive agreements, financing, and closing.

Prior to signing, sellers should also disclose known issues that could materially affect the transaction. Early disclosure allows buyers to consider those matters when establishing their offer. Significantly, exclusivity changes the dynamics of the sale process. Once exclusivity begins, the seller loses the competitive leverage created by other prospective buyers. For this reason, sellers should negotiate important economic terms before granting exclusivity. Deferring major issues until the purchase agreement may expose sellers to unnecessary renegotiation.

A thorough LOI also reduces misunderstandings and provides direction for attorneys drafting the definitive transaction documents. Clear terms may improve efficiency and help both parties focus on the remaining due diligence and legal matters.

An experienced M&A advisor should carefully evaluate the Letter of Intent in M&A alongside the seller’s transaction attorney and CPA. Sellers should understand the economics, structure, risks, and obligations before signing. The LOI may be largely non-binding, but sellers should never treat it casually. A carefully negotiated LOI establishes expectations, protects negotiating leverage, and creates a stronger foundation for a successful closing.