A seller's negotiating position is strongest in the days before the letter of intent is signed and weaker every day after. The LOI is described as non-binding, and most of it is. In practice it fixes the price, the structure and the allocation of risk, and it takes the business off the market. Terms left vague at this stage are usually resolved later in the buyer's favor.
What an LOI does
The letter of intent records the principal business terms on which a buyer proposes to acquire the company. It allows both parties to confirm they agree on the essentials before spending money on diligence, lenders and attorneys. The definitive purchase agreement, drafted later, turns those terms into binding obligations.
Binding and non-binding provisions
Most of the LOI expresses intent only. Either party can walk away without liability for the price or structure described. A few provisions are binding from signature.
- Exclusivity. The seller agrees not to negotiate with other buyers for a set period.
- Confidentiality. The terms and the existence of the LOI are kept private.
- Expenses. Each party bears its own costs.
- Governing law.
Of these, exclusivity has the greatest practical effect.
Price is more than one number
Speak with an advisor
Whether you are buying or selling, an initial conversation is confidential and carries no obligation.
Two offers at the same headline price can deliver very different amounts to the seller. The LOI should state how the price is composed.
Cash at closing. The amount wired on the day of sale.
Seller note. The amount, interest rate, term, payment schedule, security and any standby requirement imposed by the buyer's lender.
Contingent payments. Any earnout or holdback, with the measure, period and maximum.
Equity rollover, if the seller is retaining an interest.
A seller comparing offers should compare cash at closing first, then weigh the certainty and timing of each remaining component.
Structure: assets or stock
The LOI should state whether the buyer is purchasing the assets of the business or the ownership interests in the entity. The choice affects taxes, liabilities and third-party consents. It should also state which assets are included and which are excluded, such as cash, vehicles used personally and real estate.
Working capital
This provision causes more post-signing disagreement than any other. The LOI should say whether receivables, inventory and payables transfer to the buyer, and whether the price assumes a target level of working capital at closing.
A phrase such as "a normal level of working capital" without a number or a method is an invitation to renegotiate. At a minimum, the LOI should describe how the target will be calculated, for example as the trailing twelve-month average.
Financing and other contingencies
Most Main Street buyers depend on bank financing. The LOI should identify the sources of funds and the buyer's progress in obtaining them. A buyer who has a lender's prequalification letter is in a different position from one who intends to begin looking.
Other conditions may include satisfactory diligence, landlord consent, franchise approval, license transfers and the retention of key employees. Each condition is a way out for the buyer, so each should be specific.
Exclusivity
Buyers reasonably ask for exclusivity before investing in diligence. The questions are how long and on what terms.
Forty-five to ninety days is common, with the longer end typical when SBA financing is involved. Sellers can protect themselves in two ways. Tie continued exclusivity to milestones, such as submission of a complete loan application within fifteen days and delivery of a draft purchase agreement within forty-five. And provide that exclusivity ends automatically if the buyer proposes a lower price.
The seller's role after closing
The LOI should outline the transition period, any consulting or employment arrangement, compensation for that work, and the scope of the non-compete. Geography and duration matter. A five-year restriction covering several states is a different commitment from a three-year restriction within fifty miles.
If the seller owns the real estate, the LOI should also state whether the property is being sold or leased and on what principal terms.
Representations, indemnification and escrow
Sellers are sometimes surprised to find, in the first draft of the purchase agreement, an escrow of 10 percent of the price and an obligation to indemnify the buyer for several years. These terms are easier to negotiate before exclusivity than after. The LOI need not be exhaustive, but it should indicate the size and duration of any escrow and the general limits on the seller's liability.
Timeline
A target closing date, with interim dates for diligence, financing commitment and draft documents, keeps the process moving. Time rarely favors the seller once a business is off the market.
Common mistakes
- Signing for the headline price without reading how it is paid.
- Leaving working capital undefined.
- Granting long exclusivity with no milestones.
- Accepting vague financing language from a buyer with no lender engaged.
- Deferring difficult points to the purchase agreement, when the seller has less ability to resist.
- Signing without counsel. An attorney experienced in transactions should review the LOI before signature, even though it is largely non-binding.
A short test before signing
A seller should be able to answer five questions from the LOI alone. How much cash will I receive at closing? What must happen for me to receive the rest? What am I responsible for after the sale, and for how long? What conditions allow the buyer to withdraw? When will this close? If any answer is unclear, the letter is not ready to sign.
Twelve31 Advisors negotiates letters of intent on behalf of owners and works alongside their legal counsel through closing.
