How to Write Letters of Intent When Buying a Small or Medium-Sized Business
Author: Elliott Holland
When purchasing a business, getting on the same page with the seller is important. A detailed letter of intent helps you achieve this goal. Learn why it’s crucial.
Key Takeaways
Learning to write a letter of intent is crucial when buying a business
Include financial details, a termination clause, and other details discussed below
An LOI can be used for business purchases, acquisitions, and proposals
When you decide to purchase a business, you must draft a letter of intent (LOI). While it's not a legal document, it represents a nonbinding agreement between you and the seller to enter into negotiations to buy a business. It specifies any tentative agreements that you verbally made with the business seller.
What is the purpose of the LOI?
The LOI is a reference point for you and the seller when you begin formal negotiations. It emphasizes the prioritized issues in the purchase agreement and creates room for negotiating any secondary details. Any previous agreements may become null and void or require modification before finalizing the deal.
Buying a business is one of your most significant decisions and investments. For the person on the other side of the table, selling the company is often a big deal for them, too. A lot is at stake, and emotions can run high.
That’s why you and the seller must be on the same page before proceeding. An LOI allows for a meeting of the minds. It identifies issues that need resolution to reach a preliminary agreement before due diligence. Talk to the seller about all the elements you'll capture in the letter to avoid surprises later in the negotiations.
Types of LOI
There are three types of LOI, depending on the type of business activity the document covers. Here are the three categories:
Business or real estate purchases: An LOI helps you to state your intention to buy a business or commercial property. It's not an official purchase agreement because the terms and conditions of the business deal will appear in the actual purchase agreement.
Business acquisitions: An LOI for an acquisition is similar to ones used for buying businesses. The big difference is this type must be marked "confidential," and you may want to include the basic terms of the deal in a nonbinding statement.
Business proposals: This could be an LOI for a business venture in which you express your interest in financing a project, working together on a common goal, or investing in a joint project. This type of LOI also works for a business partnership.
How to write letters of intent
You can write your letter of intent in short form or long form. The benefit of a long-form letter is that it gives you an opportunity to state and resolve any deal-breakers at the beginning of the process. That’s crucial because it can protect you and the seller from getting involved with legal issues (and fees) later.
If insurmountable issues arise during preliminary discussions, it’s better to handle them then – before more detailed negotiations begin and you have exclusivity. However, long-form LOIs may slow the process.
Whether the LOI is in long or short form, it should capture the names of the buyer and the seller in the first paragraph. You must also capture the proposed purchase price at the beginning of the letter.
Keep in mind that the purchase price may need to be updated due to changes in economic conditions, loss of a key customer, inconsistencies in the financial documents the seller didn't mention, or other reasons.
What to include in the LOI
While there’s no typical letter of intent, each has some standard features, including the following:
Financing: Outlines basic deal terms, like down payment, if the bank will finance any amount, and contingency details, if necessary.
Due diligence: Includes the length of time you have to complete your investigation process on the business. The start and end date should be clear.
Earnest money: Includes a set amount you'll pay to confirm the agreement. This expresses your seriousness in buying the business. It also protects the seller if the deal doesn't go through to compensate them for their time and expenses.
Expenses: Indicates who will pay which costs.
Expiration: States the details of the agreement’s termination, including dates and other requirements.
Closing conditions: Outlines big-picture details of closing the transaction, especially what you and the seller expect. It also includes information about who will write the final contract.
Your LOI should also include preconditions that need to be fulfilled before signing the final agreement. These may include:
Production of key documents, such as financial statements
Regulatory approval, if there are shareholders or other requirements
Due diligence procedures and timelines
Moving toward a final deal or pursuing new options
If the seller decides not to go forward with the deal, it’s best to find out quickly so you can draft a new LOI or pursue a different business opportunity. Since there’s no limit on how many LOIs you can send, you can save valuable time and money by sending the LOI to multiple companies to find serious sellers.
The LOI isn’t legally binding and cannot substitute a full legal contract. However, additional terms, like keeping the discussions confidential, may be included, just like in a nondisclosure agreement. There can also be an understanding for the seller not to negotiate a similar deal with another party until a certain period has passed.
Get professional help drafting your letter of intent
A well-written LOI should bring you and the seller together and help you lay out terms to minimize the risk of litigation. It also sets out the course for a successful deal negotiation. The process is long and complex. However, with patience and perseverance, you can create a letter of intent that everyone can agree on and reference throughout negotiations, and even after the purchase.
Knowing how to write letters of intent can be tough, so it can be wise to get help drafting the LOI and closing the deal to ensure you do everything correctly. At Guardian Due Diligence, we can help you with LOI negotiation before buying a business. Our team has evaluated over 1,500 business deals and can help you, too. Contact us to schedule a call or get a sample LOI. If you’ve already got an LOI underway, we can help – get it reviewed by an expert at www.offerfromelliott.com.