What is a Letter of Intent for Selling a Business?

This article originally appeared at: https://www.sarahsshepard.com/blog/letter-of-intent

When it comes to buying or selling a business , the parties involved often have selective hearing. As a result, they disagree on the transaction terms when it comes time to sign the official papers.

It happens a lot more often than people realize. The seller names their price and what may be included or excluded in the overall deal. The buyer gets cold feet at the last minute because they didn’t realize what they were getting themselves into.

That’s why some parties will begin these business transactions with a letter of intent.

A letter of intent is the document that precedes the official documents that bind a seller and buyer to their deal.

To learn more about the components of a letter of intent and how it works,

keep reading.

What Exactly Is a Letter of Intent? A letter of intent (LOI), also referred to as a letter of understanding, a memorandum of agreement, or a memorandum of understanding, is essentially a starting point for business negotiations between two parties planning a type of transaction. The transaction in question can be the sale of said business, the purchase, a merger, or even a joint venture.

The LOI is meant to clarify and outline the intentions of the parties involved in this business transaction and the significant provisions that they must agree upon before signing any contracts and moving forward.

It’s essential to keep in mind that the overall letter, generally speaking, isn’t meant to bind the two parties. Therefore, the letter needs to clearly explain which provisions are binding and which are not. In addition, it may include responsibilities for any damages to the primary party should the non-definitive agreement fall through.

Since the LOI itself is not binding as a formal contract would be, either party may have the right to walk away at any point during the ongoing negotiation process. This is especially important for new information that crops up during negotiations or disagreements regarding specific provisions.

In essence, you can consider an LOI as a steppingstone or several stepping stones that establish the intended transaction between two parties on the way to a definitive and binding agreement.

How Do Letters of Intent Work? Letters of intent describe the necessary detailed information that allows both parties to understand the intended transaction.

In most cases, an LOI is also used specifically to allow the “right of first refusal” for the buyer. This means that the seller may not come to a definitive decision in the agreement to sell itself or as a subsidiary to another person or entity before it reaches a specific agreement with the buyer.

In addition to setting the terms for a potential final agreement, the letter of intent also allows the buying party to begin its due diligence , formally speaking.

This is when the buying party is given total access to the selling party’s information regarding the business in question and its history. This would include access to financial accounts, company records, customer information, and so on, to verify that the initial information given by the seller is accurate.

While a letter of intent works as an outline that gives both parties time to come to terms on what will be and won’t be included as the transaction conditions, there are plenty of instances in which an LOI is binding. This is mainly because the parties involved end up including overly detailed provisions, giving the LOI the appearance of being a final agreement.

What Goes Into Writing a Letter of Intent? Not all letters of intent are created equally. Depending on the type of transaction involved, the structure differs.

However, they almost always involve the following components:

Introduction The intro of an LOI is essentially the statement of purpose. It describes what terms will be outlined in the document and the date it will become effective.

The Identification of the Parties Involved All parties involved in the upcoming transaction are specified in this section to avoid confusion and their role in the business transaction.

Description of the Transaction and Timeline Here is where a general description of the transaction will be given, including the business deal type. The purchase price can also be included here, although negotiations may still be underway.

Part of the description should include deadlines for all parties to ensure the process leading up to the transaction runs smoothly — although there’s usually wiggle room for extensions as long as the parties agree.

Contingencies Typical contingencies in LOIs include securing finances on the buyer’s side via the approval of third parties, such as boards of directors or government agencies. This is also where the parties must agree on which state’s laws will be involved in the final agreement.

Due Diligence The due diligence component should be involved in the timeline above. All parties will want to go over every detail to ensure there aren’t any pending litigations or unknown liabilities. This process consists of checking all business records, tax, and legal documents and asking many questions.

There should also be a statement that all parties will cooperate in good faith.

Binding Agreements Especially when it comes to selling a business, the transaction will often include sub-agreements known as restrictive covenants (binding agreements). If one of the parties doesn’t follow the rules governed by these agreements, it can cause damage to the other party.

Therefore, letters of intent should include of or more of the following if they apply:

A non-shop agreement which protects the seller from competition from the other party

A confidentiality agreement, also known as a non-disclosure agreement (NDA) which prevents one party from revealing proprietary information found during the due diligence process about the other party to outside sources

A non-solicitation agreement protects each party from the solicitation of employees or customers after the due diligence process.

When drafting a letter of intent, the language should also be exclusive and concise in stating that neither party can negotiate with other potential sellers or buyers for the duration of the timeline set in the agreement.

Lastly, there should also be a section outlining the expenses that each party will be responsible for during the process, including legal fees, travel costs, accounting fees, and costs for documents.

Are There Any Alternatives? While some sellers and buyers can get away with using a term sheet, it’s not necessarily an alternative to drafting up an LOI.

Term sheets differ in that it’s essentially just a list of terms for the upcoming deal and don’t really involve the above-listed components.

The same technically goes for an indication or expression of interest (IOI, EOI). These informal and non-binding statements typically precede a letter of intent. They simply express an interest in carrying out a transaction. However, they aren’t part of the overall deal being made.

Letters of intent are meant to strike a deal and ensure that the agreement in question is legitimate and agreed upon by both parties before a transaction is made.

While LOIs are designed to outline the terms of the negotiations and transaction, it’s essential to be careful with the language used and how much detail is included. Otherwise, they can hurt the trade rather than ensure the process runs smoothly.

When you’re ready to sell your business, we’re prepared to help. Contact us today to consult with Sarah S. Shepard or another experienced Huntsville corporate attorney to ensure your upcoming transaction goes as planned.

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