What Is a Letter of Intent for Business Purchase?
A business deal such as the sale or purchase of a business or a joint venture can take months, sometimes even years, to complete. It can involve numerous steps and documents. The most important part of the process is where it begins, with a letter of intent that drives the process through a general understanding up through the end of the deal.
What Is a Letter of Intent?
A letter of intent clarifies the intentions of the people involved in the deal. The letter—sometimes called a memorandum of agreement or a memorandum of understanding—begins and sets out the process toward a final, firm agreement to buy a business.
Either or both parties can agree to walk away at any point during the process based on information that's discovered or a lack of agreement on a particular point.
A letter of intent(LOI) is used in two different ways.
As a preliminary agreement to move forward toward the purchase of a business.
As a purchase agreement.
This article about the steps to buying and selling a business explains how the letter of intent fits into the process.
Why Is a Letter of Intent Necessary?
The letter of intent describes what detailed information is necessary for the buyer and the seller to make an informed decision for buying the business or entering into a joint venture.
The letter also puts the buyer in a "right of first refusal" position. The seller agrees to put the buyer first in line to buy the business even if other potential buyers should appear. This protects the buyer from having to spend a lot of time and money investigating a business only to have the owner sell to someone else at the eleventh hour.
From the seller's point of view, a letter of intent gives the seller some assurance that the buyer is serious. The seller can review detailed information about the potential buyer's financial position and business experience before they make a final decision.
From the buyer's point of view, it allows the buyer to dig deeply into the seller's business to find any "red flags" or pitfalls.
When Is the Letter of Intent Created?
The letter of intent is created and signed at a specific point in the process of buying or selling a business. It's usually written when both parties agree that they want to complete the deal and they're ready for more detailed information to change hands so they can begin progressing toward a closing date.
Is It Legally Binding?
A legal document or contract is binding when the contract can be taken to court by either party to enforce its terms. As a legal document, a letter of intent is legally binding if the parties agree that it is. A letter of intent is usually not binding on the parties if both parties have the option of canceling the deal at any time. the letter of intent should spell out how one of the parties can cancel.
Even if the general terms of the letter say it's non-binding, some of the specific sections of the letter might be binding. For example, the buyer could possibly charge the seller with defaulting on the agreement if the seller agrees to give the buyer the right of first refusal then sells the business to someone else.
Some Tips for a Letter of Intent
A letter of intent is not a final agreement. It is not a purchase agreement. It simply outlines the specific actions and steps the parties will take to get to the purchase agreement.
As both parties work through the process of verification and exploration, called due diligence, the situation can change. An issue might come up with a lien or a pending lawsuit that involves the seller, and both parties will have to stop and agree on how this new information will affect the deal.
Use the KISS Principle—keep it short and simple - as you write the letter of intent. Try to avoid complicated legal language. Also, keep it general. You won't want to get too specific at this point. You don't want to tie up either party with multiple, complex details. You'll want to leave things open for changes and possibilities before your final agreement is drafted.
A Sample Letter of Intent Template
The exact structure of a letter of intent depends on the specific type of business deal you're involved in, but you'll generally find these sections:
The introduction to any legal document or contract includes a statement of the purpose of the document, descriptions, and identification of the parties involved, and their part in the transaction. It also states the date upon which the document becomes effective. Business property is described, including its location. Various terms used in the document might also be defined and included here.
Identification of Parties.
The "Buyer" and "Seller" are described completely so there's no possibility of confusion.It also describes what is being sold, including real estate, and assets.
Transaction and Timing
This section includes a general description of the transaction, including the type of business deal that will be entered into. It can also include a purchase price, although this remains negotiable. You might want to include some deadlines to keep the process moving along but allow for the possibility of changing these deadlines if both parties agree.
A contingency is something that must happen before something else happens. A common contingency in many real estate deals is that the buyer must receive acceptable financing before the deal can be closed. A common contingency in business deals is that the buyer must complete the due diligence process with all issues resolved.
This is a process used by the buyer and sometimes the seller to go over the deal with a fine-toothed comb. The purpose of due diligence is to bring everything out in the open so there are no surprises. The due diligence process involves checking records, verifying tax and legal documents, checking for liabilities or pending litigation, and asking lots of questions.
The party or parties doing due diligence don't have to spell out everything they plan to do in the letter of intent, but they should give notice of what they'll be doing, such as requesting documents. Permissions from the company's management, its board of directors, or government agencies might be necessary for the other party to gain access to all necessary documents and other records.
Covenants and Other Binding Agreements
Although a letter of intent itself isn't binding, most business deals include sub-agreements called restrictive covenants that are typically binding. If one party doesn't abide by them it can damage the other. You might want to include some or all of these agreements in your letter of intent, but they're not required.
A non-compete agreement protects one party in the deal, usually the seller, from the competition by the other party. For example, if the buyer learns information about the seller's business or its customers then starts a business using that information, this competition would be damaging.
A nondisclosure or confidentiality agreement prevents one party from using information gained in the process for gain or to injure the other party.
A non-solicitation agreement protects one party against the other party soliciting employees or customers during or after the due diligence process.
The right of first refusal and exclusive dealing language states that the process is only between these two parties and no other. The process is exclusive. You can go further and state an understanding that neither party will even deal with other potential buyers or sellers during this time.
A section devoted to expenses and costs typically states that each party will pay its own costs for expenses incurred during the process. These costs might include legal and accountant fees, costs for documents, and travel costs.
Language should be included to state that the letter of intent is non-binding on either party except for specific sections. Include an ending date. You can call it a closing date with language saying that both parties agree to abandon the deal if it isn't finalized by this time.
Both should sign the letter of intent after they have agreed to its terms and have their signatures notarized. Include the date of signing.
Do I Need an Attorney for a Letter of Intent?
This article is a general overview of letters of intent; it's not intended to give you all the details of this important contract. Every business situation is different.
Using an attorney is almost always best. You don't want to miss something important, and the attorney can guide you through state laws and pitfalls.
If the deal is not complicated, you might be able to write your own letter of intent if it's non-binding for the most part. Pass it back and forth between the two parties until everyone agrees on the general terms.