Letter of Intent to Purchase a Business
Jan 05, 2023
There are more than 32 million small businesses in the U.S., and with the Baby Boomer generation actively retiring, many of those businesses are becoming available for purchase. Buying an existing company creates an opportunity to become a business owner without having to start it from scratch. When you find the one you are interested in buying, a letter of intent may be your first and highly recommended step to completing the business purchase.
What is a Business Purchase Letter of Intent?
A letter of intent (LOI) is a formal letter that states your plan to do something. In the instance of a letter of intent to purchase a business, the LOI, alternatively known as a letter of interest or a term sheet, is used to establish an understanding between the buyer and the seller. It is a preliminary step in the process of conducting a business sale and the first of many legal documents.
The LOI provides a basis for the sale and clarifies specific points within a business transaction. It typically outlines a purchase price, due diligence requirements, exclusivity, contingencies, and many other initial terms of the purchase. The details may be binding or non-binding regarding the transaction. Binding means the terms will not change, whereas non-binding means they may change based on additional information received, such as items discovered during due diligence.
Why an LOI is important
There are a variety of advantages to using a letter of intent to buy a business:
- By creating a basic framework for the deal, and outlining its terms and structure, it documents and communicates your preferences, helping to facilitate the negotiation of the sale and the documents that support it.
- Terms of the LOI can prevent the negotiating parties from engaging with others during the early stages of the negotiation process.
- The LOI identifies any conditions or key issues that would allow either party to pull out of the deal if they wish.
- It clearly indicates the timeline for conducting the negotiations and completing the sale.
In sum, a business purchase letter of intent protects both the seller and the prospective buyer by defining both the binding and non-binding terms of the initial agreement.
What’s Included in a Business Purchase Letter of Intent?
Included in the letter of intent to purchase a business will be any conditions that the buyer and seller agree on and will usually begin with pricing and terms. These may include:
Common Binding Terms
- Confidentiality – Asserting a confidentiality agreement (also called a nondisclosure agreement) ensures that the negotiations between you and the buyer remain fully confidential and protects you and your brand.
- Exclusivity – A period of exclusivity is a critical term to include in an LOI. This provision keeps the seller from entertaining offers from other buyers for a designated time. Exclusivity helps to drive the process forward, though it is not inhibiting as the parties can always agree to extend the period at any time.
- Governing Law – This provision, sometimes called choice of law clause, identifies which state laws apply to the contract and which jurisdiction will oversee the enforcement of its terms.
Common Non-binding Terms
- Purchase price – This also includes details of the payment form, manner and timing, as well as any contingencies. Buyers typically want the ability to determine a final purchase price based on more complete information provided by the seller during due diligence.
- Structure – Is this an asset sale, stock sale, or merger? These details will impact tax responsibilities for both parties and liability of the purchaser. Similar to changing the purchase price, a buyer may determine that a change to the structure or terms of the deal may be in their best interest, such as including a holdback or earnout.
- Contingencies – Including any requirements to be met prior to the closing clarifies expectations for each party. It is important that the buyer has the ability to account for any previously unknown risks or liabilities before closing on the business.
Other areas to address in the letter of intent for purchase of a business may include who is responsible for the various expenses that will be incurred through the agreement, such as brokers or finders fees.
How to Write a Business Purchase Letter of Intent
A business purchase letter of intent can be short or long in form. Long-form letters of intent are, by definition, more comprehensive and generally will be written from a legal perspective. They deliver a unified approach to a potential deal with many key terms and details outlined. Long-form letters can potentially slow a sales process due to both sides reviewing and agreeing to more terms. This is why many buyers (and sellers) prefer to use a short-form letter of intent that only addresses the price and the most important conditions of the transaction. Short-form letters can speed up the process, but leave some important issues to be agreed to at a later date.
To create your LOI, begin as you do with most letters of communication, with an introduction that states the purpose of the document, a mention of both parties, and a brief description of the transaction you have planned. Explicitly state which assets you would like to purchase along with the expected timeframe, which is subject to change.
When it comes to the key elements of the deal, you should include as much detail as possible. It’s best to disclose certain tax and other legal information to prevent surprises down the road.
Employee issues are also a subject worth addressing in the letter, particularly if there are key executives to be considered. Their terms of employment and whether their status is conditional in any way should be stated in the letter.
Finally, you will want to include any conditions for closing, such as those regarding truth and accuracy, audited financial statements, any outside third party or governmental consents needed, and the inclusion of non-compete and non-solicitation agreements.
Next Steps
Once both parties review and agree to a letter of intent, you are now subject to the terms of the agreement. This stage could include buyer exclusivity for a period of time, due diligence commencing, and continuing negotiations on any outstanding terms. It’s crucial to abide by all the terms in the agreement, such as when the draft of a formal purchase agreement will be prepared or when an anticipated closing date will occur. If you anticipate needing to modify any terms of the original agreement, you must agree to revised terms with the seller, or the deal may fall through.
Fortunately, using these tips to write a solid, well-drafted letter of intent for business purchase will increase your chances of having the sale of your business close successfully and on optimal terms.