What Is a Letter of Intent for Business? How Do I Create One?
Letter of Intent for Business: Information, Tips, Sample
A business deal like the sale and purchase of a business, a joint venture, or sale of a property might involve many steps and documents and take months, sometimes years, to complete. The most important part of the process in a business deal is the letter of intent because it drives the process through a general understanding, up to the end of the deal.
What Is a Letter of Intent? Why Is It Needed?
A letter of intent is, just like it sounds, a letter clarifying the intention of the people involved in the deal.
The letter—sometimes called a memorandum of agreement or memorandum of understanding—begins and sets out the process toward a final agreement—for buying a business, for example.
At any point during the process, either or both parties can agree to walk away, based on information discovered or lack of agreement on a particular point. The letter of intent is an agreement to move forward toward a possible ending.
The purposes of a letter of intent:
- From the buyer's point of view, the letter of intent describes what detailed information is needed by the buyer about the business 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. That is, the seller agrees to put the buyer first in line to buy the business, even if other potential buyers may appear. This protects the buyer from having to spend a lot of time and money investigating a business, only to have the seller sell to someone else.
- From the seller's point of view, it gives the seller some assurance that the buyer is serious and it allows the seller to take detailed information about the potential buyer's financial position and business experience.
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.
Is a Letter of Intent Legally Binding?
If a legal document or contract is binding, it means the parties are bound to honor the terms, and the contract can be taken to court to enforce the terms. A letter of intent is, in the general sense, not binding on the parties. Either party may cancel the letter if they decide not to continue the process of the business deal; how this is done is spelled out in the letter. But some of the terms of the letter may be binding. For example, if the seller agrees to give the buyer right of first refusal and then sells the business to someone else, the buyer may be able to charge the seller with defaulting on the agreement.
What Are Some Tips for a Letter of Intent?
Not a Final Agreement: The most important thing to remember about the letter of intent is that it's not a purchase agreement. It's a general agreement on the specific actions and steps the parties will take to get to the purchase agreement.
Things Can Change: During the process, as both parties work through their parts of the process of verification and exploration (called due diligence), things may change.
For example, an issue may come up with a lien or pending lawsuit that involves the seller, and both parties will have to stop and agree on how this might be handled.
Use the KISS Principle—Keep It Short and Simple: If you have an attorney involved, try to get this person to avoid complicated legal language.
Keep It General: Don't get too specific at this point. You don't want to tie up either party in details, and you want to leave things open for changes and possibilities before your final agreement.
Can You Show Me a Sample Letter of Intent Template?
The exact structure of a letter of intent depends on the specific type of business deal. In general, you will find these sections in a letter of intent:
1. Introduction: The introduction to any legal document or contract includes a statement of the purpose of the document, descriptions of the parties and their part in the transaction ("buyer" or "seller," for example), and the date the document becomes effective.
If business property is involved, describe it, including the location. Terms used in the document may also be included.
2. Transaction and Timing: This section includes a general description of the transaction, including the type of business deal. It may also include a purchase price (still negotiable). You may want to include some deadlines, to keep the process moving, but allow for the possibility of changing the deadline if both parties agree.
3. Contingencies: A contingency is something that must happen before something else happens. In many real estate deals, for example, one common contingency is that the buyer must receive acceptable financing in order for the deal to be closed. A common contingency in business deals is that the buyer (or both parties) completes the due diligence process with all issues resolved.
4. Due Diligence: Speaking of due diligence, this is the 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. In some business deals, like a joint venture, both parties may do due diligence on each other.
The party or parties doing due diligence don't have to spell out everything they are going to do in the letter of intent, but they should give notice of what they are doing, requesting documents, for example. There are usually deadlines involved, to keep the process moving along. Permissions from the company's management (the board of directors, for example) or government agencies may be needed for the other party to get access to documents and other records.
5. Covenants and Other Binding Agreements: As discussed above, the letter of intent itself isn't binding, but most business deals include sub-agreements called (restrictive covenants) that are typically binding because if one party doesn't abide by them it can do damage to the other party. You may want to put some or all of these agreements in your letter of intent, but they are not required.
Some typical covenants are:
Non-compete agreement: 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 goes out and starts a business using that information, this competition is damaging.
Non-disclosure or confidentiality agreement: A confidentiality agreement prevents one party from using information gained in the process for gain or to injure the other party.
Non-solicitation agreement: This agreement protects one party from the other party soliciting employees or customers during or after the due diligence process.
Right of first refusal and Exclusive Dealing: This section states that the process is only between these two parties and no other. It is exclusive. You can go further and put in writing the understanding that neither party will deal with other potential buyers or sellers during this time. The right of first refusal language puts the buyer first in line and assures that the seller won't deal with anyone else during the process.
Expenses and Costs: This section 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.
Non-binding and Ending: Language should be included to state that the letter of intent is not binding on either party except for specific sections. Include an ending date. You can call it a closing date, with language saying that if the deal isn't finalized by the closing date, both parties agree to abandon it.
Sign and Date: After the letter of intent has been agreed to by both parties, both should sign and have signatures notarized. Include the date of signing.
Do I Need an Attorney for a Letter of Intent?
Since the letter is, for the most part, non-binding, you may be able to write it in general and pass it back and forth between the two parties until you agree to the terms of the letter.
If your letter is complicated, or you want to include some of the binding covenants mentioned above, you may want to get an attorney to help you write the letter.