Mergers & Acquisitions

Resources: M&A Encyclopedia

Comprehensive articles on every step of the process of buying or selling a business from the most exhaustive encyclopedia of M&A articles in the industry.

M&A Basics | The Letter of Intent

Key Points:

  • Offer to Purchase
    • Customarily used for individual buyers
    • Is normally binding
    • Often includes an earnest money deposit
    • Does not usually include a “no-shop” provision
  • Letter of Intent (LOI)
    • Used for corporate buyers
    • Usually non-binding
    • No earnest money deposit — a larger buyer has already made a significant investment in investigating the business, so we usually don’t require an earnest money deposit.
    • Usually includes a “no-shop” provision, which means you have to take the business off the market and you can’t sell to another buyer.
  • What happens after the offer or LOI is accepted
    • Once you accept the LOI or offer, due diligence begins. You can extend the due diligence time frame, if need be.
    • The purchase agreement is prepared and negotiated during the due diligence period. The offer/LOI is replaced by the purchase agreement.
    • Focus on running your business, even after you have accepted an offer. Don’t let revenues slip, or the buyer will likely reduce the offer.

In some cases, the parties may prepare a term sheet before preparing an LOI or offer.

The LOI/offer doesn’t contain the necessary language for a closing (it’s replaced by a purchase agreement prior to the closing); however, it allows both parties to agree to the essential terms of the transaction so they can begin the process of due diligence.

Once the offer or LOI is accepted, the parties begin due diligence, and the purchase agreement is usually prepared simultaneously while due diligence is being conducted.

Here are the primary elements of the LOI/offer:

  • Transaction structure
  • Purchase price & terms
    • Earnest money deposit
    • Seller note — length, interest rate
    • Bank financing
    • Earnout
    • Holdback
  • Due diligence — length
  • Contingencies
    • Bank financing
    • Third-party approvals — landlord, franchisor, distributor, etc.
    • Licensing
  • Exclusivity (no shop). This prohibits you from negotiating with other buyers during the exclusivity period. A “no shop” or “go shop” clause may be included in this section.
  • Confidentiality. Some offers/LOIs include language addressing confidentiality that supplements the initial NDA.
  • Expiration Date. The LOI should include an expiration date, so you don’t have an open-ended commitment.

Who should write the offer/LOI — the buyer or seller?

The individual who writes the offer/LOI exerts the most control over the timing and structure of the deal. We suggest that you, the seller, prepare the offer if the buyer is an individual or a smaller company. If the buyer insists on preparing the offer/LOI, it’s customary to let them do so.

What is the difference between an offer/LOI and a definitive purchase agreement?

An offer/LOI is usually one to five pages long and does not contain all the language necessary for a closing. It is signed immediately before the due diligence period begins. Letters of intent are not normally structured to be binding.

The purchase agreement is signed after due diligence is finished, normally at the closing, and is often 20 to 50-plus pages long.

When is an LOI vs. an offer customarily used?

Letters of intent are common for large transactions when the buyers are larger corporations or private equity groups. These types of buyers generally have credibility and have sometimes successfully completed dozens of transactions.

For smaller deals, we recommend accepting an offer to purchase, along with an earnest money deposit. For an individual, walking away is too easy with a non-binding LOI and no earnest money deposit. On the other hand, buyers of larger companies invest a significant amount of money and time, and this negates the need for earnest money deposits in cash.