What’s a Letter of Intent (LOI) To Sell
Selling your business starts to feel real with the introduction of a critical–yet misunderstood– document: the Letter of Intent (LOI) to Sell. This document, while not usually a final agreement, sets the tone for what is to come, acting as the “rules of engagement” in the negotiation process. Just as a marriage proposal signifies a commitment to a shared future, an LOI marks the start of a delicate dance between buyer and seller, where strategy, foresight, and negotiation play key roles.
As the seller, you will want to ensure you’ve completed your Deal Book prior to signing an LOI, anchoring the valuation benchmark as high as possible. This initial reference point in the LOI will be the number against which the buyer negotiates and tries to chisel away at the value.
Beyond outlining the intentions of both the buyer and the seller, the LOI has other key components to understand. In this article, you’ll learn about the purpose of the Letter of Intent, what to look for as a seller, potential red flags, and what to know about making changes before signing.
Purpose of Letter of Intent
At its core, the LOI serves multiple functions in the sale process:
Template for the Purchase Agreement
The LOI serves as the skeletal framework upon which the comprehensive purchase agreement is built. By clearly outlining the basic terms and conditions of the sale, such as the sale price, assets to be included, and any liabilities being assumed, it sets clear expectations for both parties. Early alignment is crucial for drafting a detailed purchase agreement that accurately reflects the intentions and agreements of both parties. This foundational document ensures that when lawyers draft the intricate legal documents required to finalize the sale, they have a clear, agreed-upon reference point, minimizing the risk of discrepancies and misunderstandings that could derail the deal.
Reduces Complications
By securing an early agreement on the major terms of the deal, the LOI reduces the potential for complications down the line. Misunderstandings and disputes are far less likely when both parties have already agreed to the sale’s primary structure and terms. This early consensus acts as a conflict resolution mechanism, providing a clear reference for disagreements that arise during the more detailed negotiations.
In addition, the Letter of Intent often includes clauses that address potential deal breakers upfront, such as contingencies related to working capital, financing, and governing law for disputes. By identifying and agreeing on these critical issues early in the process, the LOI helps prevent them from becoming insurmountable obstacles later, ensuring a smoother path to closing.
Efficiency in Time and Cost
The negotiation phase of a business sale can be lengthy and resource-intensive. An LOI streamlines this phase by establishing the deal’s main terms upfront, accelerating the negotiation process. This efficiency is not just about speed; it’s also about cost-effectiveness. With the LOI in place, both parties can focus their time, energy, and financial resources on resolving the finer points of the deal rather than debating fundamental terms and accruing hefty legal fees. By expediting the negotiation process, the LOI also protects the value of the business by minimizing the period during which business operations might be disrupted during the sale.
In essence, the LOI is a strategic document that balances commitment with caution. It secures the framework of the deal, reducing the likelihood of future complications, and streamlines the path to a successful closing, saving time and costs for both parties. This “vague commitment” is, paradoxically, a powerful tool for creating clarity and security, ensuring that both buyer and seller can proceed with confidence toward a mutually beneficial sale.
What Should the Seller Look for in the LOI?
- Introduction – company name, assets to be purchased
The introduction should clearly state the names of the buyer and seller companies, along with a precise list of the assets or shares being considered for purchase. This section sets the stage for the entire agreement by defining the parties involved and the subject of the transaction, ensuring there’s no ambiguity about what’s on the negotiating table.
- Transaction description and timeframe
This segment offers a detailed description of the transaction, including whether it’s an asset sale, a stock sale, a hybrid sale, or a merger (and thereby the corresponding tax responsibilities for each party), and outlines the expected timeframe for completing the sale. Clarity in this section helps both parties plan accordingly and aligns their schedules and priorities.
- Contingencies
Contingencies outline conditions that must be met for the transaction to proceed. These might include obtaining financing, satisfactory due diligence results, or regulatory approvals. When both parties are aware of the potential hurdles they can agree on the steps necessary to overcome them.
- Confidentiality and non disclosure protection
The LOI should specify the terms under which sensitive information disclosed during negotiations is protected. This clause prevents the misuse of proprietary information, safeguarding both parties’ business interests regardless of whether the transaction concludes successfully. Sellers should set the longest confidentiality term possible and include non-solicitation of employees as part of the NDA (non disclosure agreement).
- Guideline for negotiations
Here you will set a structure for how negotiations will be conducted so you can streamline the process and reduce misunderstandings. This may include preferred communication methods, decision-making timelines, and protocols for handling disputes.
- Working Capital
The LOI should address how working capital adjustments will be handled, defining the methodology for calculating working capital to ensure the business continues to operate effectively post-transaction. This becomes especially important when working capital affects the buyer’s ability to secure financing.
- Identify the governing law and venue for arbitration
Identifying the governing law and venue for arbitration in a Letter of Intent (LOI) establishes which laws will apply to the agreement and where any disputes will be resolved. Outlining this upfront lessens legal ambiguities around how or where to address conflicts that may arise during or after the transaction process.
- Who will be in charge of escrow
Identifying the escrow agent and outlining their role and responsibilities ensures that there’s a neutral third party to hold funds, documents, or other assets until the transaction conditions are met. This arrangement adds a layer of security and trust to the transaction.
- Scope and guidelines for due diligence
This section should define what due diligence will cover, the process for conducting it, and any specific areas of focus. Setting clear expectations for due diligence allows the buyer to thoroughly evaluate the business while ensuring the seller knows what information will be scrutinized. If you as the seller have prepared your pre-packaged due diligence, you can reduce the amount of time and energy required for this section.
- Timeline for closing
Outlining a specific timeline leading up to the closing of the transaction, including key milestones and deadlines, helps coordinate the efforts of all parties involved. It ensures that both the buyer and seller work towards a common goal and helps ensure your expert team will be available.
- There will likely be a non-compete clause
A non-compete clause is often included to prevent the seller from starting a competing business within a certain period and geographic area post-sale. This protects the buyer’s investment in the purchased business. The terms should be reasonable and clearly defined to ensure they are enforceable and fair to both parties.
Each of these elements plays a vital role in crafting a Letter of Intent that lays a solid foundation for the transaction, reduces risk, and guides the sale towards a successful conclusion.
Is the Letter of Intent Legally Binding?
While primarily non-binding regarding the sale, an LOI may contain binding provisions related to confidentiality, exclusivity, and other pre-closing covenants. Clear and strong language that states that the Letter of Intent in non-binding is essential to hold up in court.
Letter of Intent Red Flags for Seller (Poison pills)
Beware of red flags or “poison pills” that may compromise your position as a seller or force you into unfavorable terms.
Language Stating That the Parties Have Agreed to Anything
This type of language can prematurely bind the seller to terms or conditions without proper negotiation or understanding. If the LOI ambiguously states that both parties have agreed to certain terms, it might limit the seller’s ability to negotiate more favorable terms later in the process. It creates a false sense of commitment that might not fully reflect the seller’s intentions, potentially locking them into unfavorable positions before detailed negotiations have even begun.
Unintended Presumptions or Default Events (i.e., Unless We Hear from You to the Contrary)
Incorporating clauses that presume agreement or consent by default (e.g., “unless we hear from you to the contrary”) places the burden on the seller to dissent actively from proposed terms or actions within a specified timeframe. This can be problematic if the seller overlooks or misinterprets the significance of such a clause, leading to unintended agreements to terms, conditions, or actions they might not have actively chosen. It’s a coercive tactic that can force the seller into a corner, limiting their negotiation power and potentially leading to concessions that are not in their best interest.
Both points highlight the importance of careful scrutiny and negotiation of LOI terms to protect the seller’s interests and ensure a fair and equitable transaction process.
Can I make Changes to the LOI Before Signing it?
The Nature of the LOI as a Negotiable Document
While a Letter of Intent serves as a preliminary agreement between the buyer and seller, but crucial to recognize that an LOI, by its very nature, is a draft meant to be discussed, negotiated, and modified before both parties reach a full agreement. This document sets the stage for the detailed negotiations that will lead to the final purchase agreement.
Sellers should approach this process with a clear understanding of their priorities and deal-breakers. It’s often helpful to engage legal counsel to ensure that the language of the LOI accurately reflects the agreed-upon terms and protects the seller’s interests.
Empowerment to Propose Adjustments
Sellers, just like buyers, have the right and should indeed feel empowered to suggest changes to an LOI. This could involve adjustments to terms that reflect the seller’s needs, protect their interests, and ensure a fair transaction. Whether it’s the purchase price, payment terms, transition services, or warranties, each element of the LOI can be negotiated to better align with the seller’s expectations and objectives.
Ensuring Final Terms Reflect Seller’s Interests
The negotiation process for an LOI helps ensure that the final agreement accurately reflects the seller’s interests. This process allows the seller to clarify any ambiguous terms, add necessary protections (such as confidentiality clauses or non-compete agreements), and remove or modify any conditions that could pose potential risks. The goal is to create a balanced and equitable document that serves as a strong foundation from which to move forward.
Protecting the Seller’s Legacy
For many sellers, especially those who have built their businesses from the ground up, the sale involves more than just financial transactions—it’s about ensuring the legacy of the business they’ve created. By negotiating the terms of the LOI, sellers can include provisions that protect the business’s name, its employees, and its core values. This might involve stipulations about the future direction of the business, employment guarantees for key staff, or other considerations that preserve the business’s legacy.
What happens after the letter of intent is signed?
Signing an LOI is the first milestone in the transaction process, but it’s just the beginning of a series of detailed steps that lead to the finalization of the deal. After the Letter of Intent (LOI) is signed, the transaction process moves into a more detailed and intensive phase, starting with due diligence. From here, parties will work through purchase agreement negotiations, finalize financing, compliance, and regulatory approval, and prepare for transition before closing on the final sale.
The LOI as part of a successful business sale
The LOI is more than a preliminary agreement; it’s a strategic tool that sets the stage for a successful sale. By understanding its purpose, ensuring it contains key provisions, recognizing potential pitfalls, and embracing negotiation, sellers can proceed through this critical step with confidence and control.
Remember, the LOI phase is your opportunity to “set the anchor” high, to establish a strong foundation for the ensuing negotiations. With the right approach, informed by the insights and strategies outlined in this article, sellers can maximize their leverage, protect their interests, and pave the way for a successful and rewarding sale. For more on how to structure your deal and prepare documents for the sale of your business, request a copy Tips & Traps below.
Paul is the founder and CEO of Avion Wealth, LLC. He leads a team of wealth managers in building and executing financial plans for high net worth individuals and families. Contact Avion Wealth to speak with a financial advisor.
