There’s a lot to think about when you’re ready to sell a business, and finding an interested buyer is just the beginning. Once you have an interested buyer, it’s important to agree on some terms. of the sale before you allow the buyer access to your financial information and business arrangements.
This preliminary agreement is called a Letter of Intent, or LOI.
What is a Letter of Intent?
Photo by Andrea Piacquadio
A letter of intent is a preliminary agreement between the buyer and the seller. Most of it isn’t legally binding. Though it sets the important groundwork for agreement on payment terms, price, and other aspects of the ultimate business sale.
The Letter of Intent often provides the outline for the final purchase agreement. Both parties need to agree up front on the major terms of the purchase agreement through the Letter of Intent. This makes drafting and deciding on the final version of the sales agreement a smoother, quicker process.
Do not confuse a Letter of Intent with another type of letter called a Letter of Interest, Expression of Interest, or Indication of Interest. A Letter of Interest contains some of the same information as a Letter of Intent. It is more like an offer from a buyer that lets the seller know the buyer is potentially interested in purchasing the business under certain terms.
What is the purpose of a Letter of Intent (LOI)?
The Letter of Intent has a few purposes. First, it ensures both parties are serious about the possible future transaction. While it’s not a purchase agreement, a Letter of Intent shows that the buyer and the seller can agree on some basic terms before proceeding with the buying process.
The letter can also be used as documentation for each party’s governing boards, members, or other interested parties who need to be ready to make decisions about the transaction.
It also sets out the timeline for the agreement to be executed and lays out other terms such as who will draft the purchase agreement, laying out expectations for the discovery process, or clarifying anything else that is part of the buying process. The Letter of Intent ensures all parties are aware of timelines and expectations during the rest of the purchase negotiation process.
Why is a Letter of Intent important for selling a business?
Even though many portions of the Letter of Intent aren’t legally binding, the LOI contains terms that protect both the buyer and the seller. A well-drafted LOI can also save both parties a significant amount of time and even money during the sales process.
The LOI should set out a sales price. If the buyer and seller can’t agree on these terms up front, this will protect both sides from wasting too much time in due diligence, examining financials, etc. This is because a disagreement on price can kill the deal on the front end.
LOIs also protect the potential buyer by including an exclusivity clause. They can assure the potential buyer that he has a set amount of time to decide if he wants to buy the business. This helps to alleviate the fear of losing it to another buyer. The buyer may need to invest in a CPA to examine the seller’s financials, an attorney to review the agreement, or help in other negotiations. They may also have other up-front costs. The exclusivity clause ensures this money isn’t spent in vain.
This clause protects the seller as well, since if the buyer doesn’t agree to purchase the business within the clause window the seller is free to look for other buyers.
There are many other ways the letter of intent can protect both sides as well. Depending on how the LOI is drafted, it could include a nondisclosure agreement that can benefit both sides. It also ensures both sides are committed to closing the deal as long as terms can be agreed upon. It’s an important document for both parties, which is why creating and agreeing to the document shouldn’t be rushed.
Photo by Romain Dancre
What should a Letter of Intent include?
Every business is different, and the same is true of each Letter of Intent. Both parties should draft the LOI according to their needs, but the letter may include a few of these terms.
Introduce the buyer(s) and seller(s) – The LOI should list all parties on both sides of the transaction
Price and payment terms/payment schedule – Explain the purchase price, payment terms and schedule, and method of payment (e.g. cash, stock).
Assets – A list of properties to be included in the sale
Any assumed liabilities – Liabilities of the seller that the buyer accepts
Proposed closing date
Exclusivity period – The length of time the potential buyer has the sole right to purchase the business. This clause may include terms that allow the seller to be free from it if the buyer is no longer interested.
Transition plan – A plan for keeping key staff members on board, keeping the current owner on board for a period of time, or other staffing decisions.
Nondisclosure agreement (NDA) – This clause explains what information cannot be disclosed outside of the parties involved, such as trade secrets or other information that may be disclosed during due diligence.
Noncompete clause – This clause protects the buyer by keeping the seller from opening up a competing business.
Nonsolicitation agreement – This clause prevents the buyer from poaching the seller’s employees if the purchase falls through.
The Letter of Intent should also state which parts of the agreement are binding and which parts are non-binding. Some parts of the LOI should be binding, such as the exclusivity period, the NDA, and the noncompete clause. Other parts can be left at the discretion of either party.
Who drafts a Letter of Intent?
Typically, the buyer or their attorney will draft a Letter of Intent. But the draft of the letter is exactly that – a draft which can be edited and negotiated. The seller should not sign the Letter of Intent until it has been reviewed and agreed upon by all parties involved.
Even though the seller drafts the LOI, the buyer may request additional terms, clarify wording, or make other changes it. The Letter is not binding until both parties have signed it.
Tips for writing a Letter of Intent
The buyer typically drafts the Letter of Intent. However, it’s possible for the seller to draft the letter instead.
The most important tip for writing an LOI is to use a trusted attorney to help you draft it. The attorney can draft the LOI for the sale of your particular business, help you decide what to include. They may even be able to advise you during the negotiation process. Some parts of the LOI should be legally binding. So, you should ensure the language is correct and the LOI protects your interests.
If the other party wrote the LOI, do not sign until your attorney has had the opportunity to review it. If you’re ready to sell your business you may feel pressure to complete this quickly. However, take your time to make sure you’re comfortable with the terms and that you’re protected if the deal falls through.