The 5 Goals for Your Letter of Intent

As you go through the various steps in the process of buying a business, there will be key points that can make or break your deal. One such milestone is your official offer to buy the business, which you will make either through a purchase contract or (more likely) through a letter of intent (LOI).

We get questions all the time from business buyers about LOIs. They range from deal-specific concerns to more essential questions about what exactly an LOI is and what it should do. Unfortunately, we have also seen many business buyers make expensive mistakes with their letters of intent because they fundamentally misunderstand the purpose, function, and goals of a letter of intent.

Your written offer is important to the success of your business purchase. Before you send out your offer, there are two things you must understand about the letter of intent:

1. Its contractual nature, and
2. Its five goals.

Is a Letter of Intent a Binding Contract?

It’s important to understand what a letter of intent is and what it isn’t. Simply put, a letter of intent is a document that states your intention to purchase the business—that’s all. It isn’t, by nature, a binding contract. Certain sections can (and should) be made explicitly binding.

A letter of intent is akin to a promise ring. A promise ring symbolizes an intent for a future action, i.e. marriage, but it isn’t legally binding. If Ryan breaks up with Kelly a month after he gives her a promise ring, that’s solely between them. Had they been married, lawyers now have to get involved and it can get messy.

It’s the same in business purchases and sales. A buyer can make an offer with a letter of intent, but then walk away if she decides that the deal isn’t what’s best for her at that moment.

That doesn’t mean there would be no repercussions, just that those repercussions would likely be reputational rather than legal. All of Kelly’s friends and family may despise Ryan for what he did, and others may question his integrity, but he wouldn’t be obligated to pay alimony.

I do want to clarify that it is extremely rare for an LOI to be entirely nonbinding. In fact, there is now enough case law concerning letters of intent that you cannot assume that the letter is nonbinding unless otherwise stated. In other words, you must explicitly address the nonbinding nature of the letter by clearly stating this fact and identifying which paragraphs are binding.

There are a few common ways to handle the differentiation, but most attorneys (myself included) prefer to state 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.”

The Goals of a Letter of Intent

What a letter of intent is from a contractual perspective (i.e. nonbinding) is somewhat separate from what it is intended to accomplish. Yes, it communicates to the seller that you would like to buy the business. But, more likely than not, the LOI is a formalization of ongoing negotiations between you and the seller. So, she probably already knows you want to buy the business.

The letter of intent actually accomplishes much more. Principally, the goal of every letter of intent is to set out the terms and conditions of the deal, as fully as possible, as the buyer and seller understand them. To do this, your letter of intent needs to do five things:

1. Clearly state the purchase price and financing terms,
2. Set forth the basic structure of the transaction (e.g. stock purchase or asset purchase),
3. Explain any special features of the deal that the parties have discussed or agreed upon,
4. Explicitly disclose any and all conditions and contingencies to the closing, and
5. Identify any and all binding provisions.

Accomplishing these five goals is critical to ensuring that your business purchase is successful and that you won’t have any issues after you close. You especially want to be sure that any special aspects or circumstances of the deal get included in the LOI so that they will get written into the final purchase agreement. Remember, if the terms aren’t written into the final agreement, the other party will not be bound by them!

How Long Is Too Long?

Generally, letters of intent are seen as the skeletons of and precursors to the actual purchase contracts. Almost like the outline to a research paper from college, the (shorter) LOI sets out the basics of the deal, and after negotiations and due diligence, the (longer) purchase contract is signed.

This leads directly to one of the most common questions I get about letters of intent: How long should they be? Unfortunately, there’s no hard and fast rule here. As I say with all other contracts and agreements, a contract should be as long as it needs to be, no more, no less.

A too-short, underspecified letter of intent may get the ball rolling on the deal quickly, but it’s also dangerous. If the buyer and seller haven’t had a discussion about certain vital topics upfront, you (the buyer) might spend thousands of dollars on due diligence review, and then have the deal cave in when you and the seller cannot reach a compromise on one of these key issues at a later stage.

That being said, there is a point at which you could risk getting too far into the weeds and alienating a potential seller. Remember, the letter is mostly nonbinding and is contingent upon negotiation and execution of a satisfactory purchase agreement. So, the buyer could waste time and money insisting upon negotiating overly specific provisions in the letter of intent, only to have the seller come back after the fact and demand a renegotiation of those paragraphs. In this case, you’d be negotiating the same deal twice!

In the end, I can tell you that I’ve seen a ten-page letter of intent used for a $50,000 business deal and a four-page letter used for a $50,000,000 deal. Because the items that need to be addressed in the LOI are, by and large, the same across the board, there isn’t necessarily a correlation between the price tag and page count. You must account for certain key issues in a letter of intent, so the purchase price doesn’t drive the size of the LOI, but rather the precision with which the paragraphs are detailed and the particulars of the business deal.

This all underscores the need to have professional advisors assisting you in the negotiation and drafting of the letter of intent and throughout the business buying process.

Sometimes a Purchase Contract Can Do the Trick

With all of that being said, sometimes, with smaller and simpler deals, beginning with a binding contract rather than an LOI can actually be the best path forward. The fact of the matter is that there just are some transactions where it will save you time and money to have your business attorney write the original offer as a binding contract.

But don’t worry. A binding contract doesn’t need to sound scary.

As is the case with a letter of intent, the contract will go through revisions before the final draft is signed. Prices will be discussed and contingencies and conditions to closing the deal will be negotiated. Your attorney will write into the binding contract similar conditions and contingencies for closing the deal as would exist in the nonbinding letter of intent. If you were to discover something was terribly amiss with the business, you would still be protected.