5 Critical Sections for Your Letter of Intent

Getting the initial offer to buy a business right is vital to ensure a smooth purchase transaction. Your best option is to have a business lawyer draft your letter of intent (LOI) to ensure it accomplishes the five goals of an LOI.

Those goals are dependent on having certain provisions and sections in the letter. Unfortunately, I have seen many business buyers make expensive mistakes with their letters of intent because they worded key provisions improperly or omitted them altogether. Before you send your offer to buy a business for sale, be sure your LOI includes these five critical sections.

One: Non-Binding, Unless I Say So

While not a “provision” or “section,” as such, this is such an important aspect, which affects the entirety of the LOI, that I have to mention it. Remember that most paragraphs of a letter of intent are non-binding. Some provisions, however, are binding and must be marked as such—for good reason.

There are a few common ways to handle the differentiation. I prefer to insert a paragraph explicitly at the beginning of the letter that the letter’s provisions are non-binding and subject to certain conditions, except when expressly stated otherwise. Then, I will add a short sentence to the beginning of each binding paragraph, as needed, to designate it as binding, e.g. “This paragraph shall be binding on the parties.”

Explicitly addressing the binding nature of the LOI and specific sections is important. On the one hand, you want to ensure the other party will be bound by the provisions that are beneficial to your interests. On the other hand, you cannot assume that the letter of intent will be nonbinding by default; enough case law now exists that you have to explicitly mark out provisions as nonbinding to protect yourself as well.

Two: Due Diligence

The due diligence paragraph is one of the most important paragraphs in the letter of intent. The due diligence review itself is time consuming and effortful, not to mention expensive. It’s also key to knowing whether the business purchase will be a good move for you. No surprise, this paragraph must be explicitly made binding.

First, the LOI should set a time frame for the due diligence. The span will require some negotiation. It’s a complex and labor-intensive process for you, and it is intrusive and cumbersome for the seller. A 90-day due diligence period will never be acceptable to a seller, but a 5- or 10-day period should never be acceptable to the buyer. A reasonable time frame for due diligence is 30–45 days.

The heart of this section states that the buyer (and any advisors) must be given reasonable access to the business and to the appropriate documentation of the business. Additionally, it instructs the seller to comply and cooperate with the buyer and answer any questions. The more specific you can be in this section, the better. Formal requests for due diligence documents and access will be made separately.

Word to the Wise

Beware that some fill-in-the-blank contracts will only let you out of the deal if due diligence uncovers a greater-than 5% discrepancy between a business’ actual and provided financial information. This is yet another reason to use a qualified business attorney and not form contracts for your business purchase.

First off, a 5% discrepancy is definitely not negligible! A 5% profit difference could mean the asking price for the business was overestimated by 10%–15%. Second, it is a huge mistake to think that due diligence should only look at a business’ financial information. So much more goes into assessing the overall health of a business. What if you discover a problem with some other aspect of the business, such as the lease or supplier contracts? What if you have the building inspected and it turns out the HVAC system has to be replaced? Well, if the numbers are still within that 5% range, you’d be stuck.

Three: Purchase Agreement

This paragraph will address the eventual drafting of the asset purchase agreement. It states that the drafting will begin once the due diligence review has been completed to the buyer’s satisfaction and give an estimated timeframe for completion. The paragraph’s primary goal is to lay out any conditions or contingencies for the purchase agreement or provisions that you and the seller have discussed or decided upon.

From the buyer’s perspective, the obligation to close should be conditional on things like:

• Obtaining third party consents (e.g. landlord or franchisor),
• Securing financing on terms that are acceptable to the buyer,
• Entering into a franchise agreement that’s acceptable to the buyer,
• Being able to enter into a written lease agreement with the landlord that’s acceptable to the buyer, or
• Executing restrictive covenants agreements with principal shareholders.

“Acceptable to the Buyer”

You’ll notice above that I repeated a certain phrase quite often: “acceptable to the buyer.” You should keep the Purchase Agreement paragraph, and the letter of intent as a whole, as buyer-centered as possible.

In particular, I would urge you to consider employment issues carefully since they are an area where I feel that many buyer’s fall short. Often buyers will opt for imprecise, vague language here: “mutually agreeable” is a particularly common phrase that I see.

The money and time you will spend up front discussing what these employment terms look like will be well worth it (even if that means hammering out a preliminary employment agreement). They will have to be negotiated at some point. If you wait until later, you may end up spending even more time and money working this issue out. And what happens if after you’ve spent many hours and thousands of dollars on attorneys and accountants to do due diligence, you absolutely can’t find “mutually agreeable” terms? Unfortunately, I have seen this happen. Luckily, the fix is simple.

Four: Transition Assistance

Generally, in the purchase and sale of closely held businesses the seller will remain on for a short time after the sale to help train the new owner in the business. This is, however, an area where many buyers drop the ball. Too often, short, imprecise sentences are used here; something like:

Buyer would require Michael Scott to be employed for two weeks.

I would push back against this wording because it gives no indication of what the terms of the employment are or what services the seller is and isn’t expected to provide to the buyer. It pushes off the negotiation to a future date, which can put undue stress on the deal and even tank it entirely.

Instead, be explicit and clear with exactly the type and length of the assistance the seller will provide to you after you take over. Address the following:

• The number of days the seller is expected to assist with the operating and transition of the business,
• Whether the assistance is it on a paid or unpaid basis, and
• Whether the seller will be available after this predefined period for advice or help.

Five: Exclusivity (aka “No Shop” clause)

This is technically an optional section, but one that I would strongly suggest to you is not optional and should be made explicitly binding. It states that for the period of time as defined in the paragraph, the buyer gets exclusive right to buy the business and that the seller will not make or accept offers, negotiate terms, or enter any sale agreements with another potential buyer.

The section has two goals. First, it lays out the provisions, i.e. the seller and its affiliates shall not solicit or enter into sales. Then, it further defines what the section means by various terms like “representative,” “solicit,” and “third party transaction.” While this might seem like overkill, you want to make sure that there is no way for the seller to work around the exclusivity clause by playing fast and loose with the definitions. As I’ve said elsewhere, contract writing requires a higher level of specificity than everyday writing.

Without this paragraph, you may find yourself in a very tough position.

Don’t Make This Mistake

Imagine Stark Industries makes an offer to buy Wayne Enterprises for $750,000 without an exclusivity provision (yes, I know I’m mixing Marvel and DC universes). After they begin the due diligence process, Wayne Enterprises sends out a letter to LexCorp suggesting a buyout for $770,000 ($20,000 more than Stark Industries offered). LexCorp accepts, and now Wayne Enterprises can leverage those two offers against each other to drive up the purchase price. An exclusivity provision prevents a seller from using your potential purchase to motivate another buyer and drive up the purchase price.

Contracts All the Way Down

Contracts really do permeate the business world from stem to stern. Making mistakes with your business contracts can wreak havoc on a business. This is especially true during the purchase transaction.

Before you get involved in a purchase transaction and send an LOI to a seller, be sure you have all the necessary legal protections included in the contract. Remember, just because a letter of intent isn’t entirely binding, doesn’t mean you should be cavalier with it. There is a growing precedent of case law that questions the nonbinding nature of LOIs.

Engage a qualified business attorney to draft and negotiate your letter of intent so you know your business purchase transaction will start off on the right foot, legally speaking. You don’t want any easily avoidable mistakes to harm your deal or put you in a bad position after the closing.