Before You Sign a Letter of Intent: What Business Owners Should Understand

Sep 1

A letter of intent—often called an LOI, term sheet, or memorandum of understanding—can help buyers, sellers, investors, and strategic partners determine whether they have enough agreement to spend additional time and money on a transaction.

An LOI is usually shorter and less detailed than the final agreement. That does not make it unimportant. It can establish negotiating leverage, define the diligence process, restrict discussions with other parties, and create binding obligations even when most of the proposed transaction remains nonbinding.

Decide what the LOI is supposed to accomplish

Before drafting language, leadership should identify the purpose of the document. An LOI may be used to:

Confirm the proposed price and basic structure
Identify the assets, equity interests, or business being acquired
Describe payment terms, financing assumptions, or earnouts
Establish a diligence period and access to information
Create confidentiality and non-use obligations
Give the buyer an exclusive negotiating period
Allocate transaction expenses
Identify necessary approvals and closing conditions
Set a target timeline for definitive agreements and closing

An LOI should be detailed enough to expose major disagreements but not so rigid that it prematurely settles issues the parties have not investigated.

Separate binding and nonbinding provisions

The document should state clearly which provisions are intended to bind the parties and which are only expressions of present intent. Provisions commonly intended to be binding include:

Confidentiality
Exclusivity or “no-shop” obligations
Access to records and personnel
Public announcements
Responsibility for expenses
Governing law and dispute procedures
Return or destruction of diligence information
Termination of the LOI

The proposed purchase price, transaction structure, and obligation to close are often nonbinding until the parties execute definitive agreements—but the actual language and surrounding circumstances matter. A general disclaimer can be undermined by mandatory wording, extensive detail, conduct inconsistent with the disclaimer, or an obligation to negotiate in a particular manner.

Understand the proposed deal structure

For an acquisition, one of the earliest decisions is whether the buyer proposes to acquire equity or selected assets.

An equity purchase generally transfers ownership of the entity itself. The entity ordinarily continues to own its assets, remain party to its contracts, employ its workforce, and carry its existing liabilities, subject to the transaction documents and applicable law.

An asset purchase allows the parties to identify assets to be acquired and liabilities to be assumed. But contracts, permits, employees, titles, liens, taxes, and successor-liability issues still require careful analysis. “Buying the assets” does not automatically mean the buyer receives everything necessary to operate the business or avoids every historical liability.

The LOI should identify the assumed structure while preserving flexibility if diligence reveals that a different approach is appropriate.

Treat price as more than one number

The headline price may not describe the actual economic deal. Consider whether the LOI addresses:

Cash paid at closing
Assumed debt or other liabilities
Working-capital or balance-sheet adjustments
Escrow or holdback amounts
Seller financing
Earnouts or contingent payments
Treatment of cash, receivables, inventory, and transaction expenses
Post-closing employment or consulting arrangements

If a price depends on a financial metric, the parties should identify how that metric will be calculated and which accounting principles will apply.

Use exclusivity deliberately

Exclusivity can protect a buyer that is investing substantial resources in diligence and documentation. It can also prevent a seller from responding to better opportunities. The LOI should define:

The duration of exclusivity
Which communications or transactions are prohibited
Whether the seller must stop existing discussions
Whether the seller must notify the buyer of unsolicited interest
What happens if the buyer does not meet agreed milestones
Whether exclusivity extends automatically

An open-ended or vague restriction may create more uncertainty than protection.

Protect the diligence process

The parties should have an appropriate confidentiality agreement before sensitive information is exchanged. The LOI can then define access, permitted use, disclosure to advisers and financing sources, cybersecurity expectations, communications with employees or customers, and the return or destruction of information.

Diligence access should not give the buyer unrestricted permission to disrupt the business or contact stakeholders without coordination.

Identify conditions that could stop the transaction

Typical conditions include satisfactory diligence, negotiation of definitive documents, financing, board or owner approval, third-party consents, regulatory review, and the absence of a material adverse change. The LOI should not imply that a condition is assured when it is not.

Some transactions may require premerger notification to federal antitrust agencies, and transactions below reporting thresholds can still receive antitrust scrutiny. Regulatory analysis should occur early enough that the timetable is realistic.

The practical takeaway

A sound LOI creates a disciplined path toward a possible transaction without pretending that diligence and final negotiation are complete. The best time for legal and financial review is before the LOI fixes expectations, limits alternatives, or gives the other party access to sensitive information.

Primary legal sources

This article provides general information and is not legal advice. Reading it does not create an attorney-client relationship. Whether an LOI or any provision is enforceable depends on its language, the parties’ conduct, applicable law, and the surrounding facts. Businesses should consult qualified counsel about a specific transaction.

Considering a letter of intent or business transaction? Learn more about Business Contracts and Project-Based Legal Services, or request a consultation.

Seth Jewell