Definition
A letter of intent (LOI) sets out the main terms on which a buyer proposes to acquire a business, before due diligence and the full purchase agreement. It usually covers price, structure, how the price is paid, conditions, timing and a period of exclusivity. Most of it is normally not legally binding, although clauses on exclusivity, confidentiality and costs often are. In the UK the equivalent document is usually called heads of terms.
Due diligence is the investigation a buyer carries out before committing to a purchase, testing the finances, contracts, legal position and operations against what the seller has described.
An exclusivity period is an agreed time during which the seller will not negotiate with other buyers, giving you room to complete due diligence and arrange finance.
Worked example
A fictional buyer makes an offer for Redwood Lane Printing, a fictional US business. The letter of intent proposes:
- a price of up to $2,400,000 for the business's assets, cash-free and debt-free
- $1,900,000 at closing, a $300,000 seller note and a $200,000 earn-out tied to next year's revenue
- a normal level of working capital left in the business at closing
- 60 days of exclusivity for due diligence
- conditions: satisfactory diligence, bank finance and a new lease on the premises
Seller finance is when the seller lends the buyer part of the purchase price, to be repaid with interest after completion. It is also called vendor finance or a seller note.
An earn-out is part of the purchase price paid only if the business meets agreed targets after the sale. It can bridge a gap between the seller's price and the buyer's view of the evidence.
Why buyers care
The letter of intent is where the shape of the deal is set. Points left vague here, such as how working capital is measured or what the seller will warrant, are harder to negotiate later, once you have spent money on diligence and the seller knows it.
Before you sign, make sure the price basis, what is included and the conditions match what you can actually deliver, including your finance. Keep the exclusivity period long enough to finish diligence properly. Ask a lawyer to confirm which clauses bind you.