If you are considering buying or selling a business, one crucial document you will likely encounter is the Letter of Intent (LOI). In this post we will walk you through what you need to know about LOIs and their role in business transactions.
What is a Letter of Intent?
A Letter of Intent (LOI) is a formal document that outlines the preliminary understanding between a buyer and seller in a business transaction. While typically non-binding (except for specific provisions), an LOI serves as a roadmap for the eventual purchase agreement and demonstrates serious intent from both parties.
The Strategic Purpose of an LOI
Building Trust and Alignment
An LOI creates a foundation of trust between parties by documenting their shared understanding of the transaction's key terms. It helps ensure both buyer and seller are aligned on specific key details before investing significant time and resources into the deal.
Streamlining Negotiations
By addressing major deal points early, an LOI helps identify potential deal-breakers before substantial legal fees and due diligence costs are incurred. Buyers and Sellers are given the opportunity to see if there is a deal that could be negotiated — think of it as "dating" before marriage.
Typical Components of an LOI
Every Letter of Intent varies slightly, but perhaps the biggest difference in LOI content and format depends on the size and sophistication of the deal.
Key Elements to Include:
Purchase price and payment terms
Timeline for Due Diligence
Closing date expectations
Confidentiality provisions
Key conditions and contingencies
Duration of the agreement
Basic transaction structure
Key Elements to Exclude:
Excessive legal terminology
Detailed representations and warranties
Complex tax structures
Minute operational details
Final purchase agreement language
Small Business vs. Lower Middle Market: Understanding the Differences
Business sales can be broken down into four categories based on Revenue: (1) Main Street businesses (under $5M in Revenue)
(2) Lower Middle Market businesses ($5 - $50M in Revenue)
(3) Middle Market ($50M - $500M in Revenue)
(4) Upper Middle Market ($500M - $1B in Revenue)
For our purposes, this discussion applies to Main Street businesses and Lower Middle Market businesses. Here are some Best Practices for these categories when thinking through an LOI:
LOIs for Main Street Business Transactions:
Generally simpler in structure; typically 1-3 pages in length
Focus on basic terms and conditions
May not always be necessary
Less emphasis on complex financial terms
Lower Middle Market LOIs:
More comprehensive in scope; typically 3-10 pages in length
Include detailed financial structures
Always recommended
May involve more sophisticated terms and conditions
Best Practices for LOI Success
For Sellers:
Be extremely cautious when it comes to "no-shop" clauses
Maintain clear communication channels
Keep momentum in the sales process
Review all terms carefully with advisors
For Buyers:
Be specific about contingencies
Clearly outline due diligence requirements
Include realistic timelines
Specify any third-party approvals needed
The Role of Professional Guidance
Working with an experienced business broker and legal advisors can help ensure your LOI properly protects your interests while moving the transaction forward efficiently. These professionals can help structure the LOI to address potential challenges before they arise.
Conclusion
A well-crafted LOI sets the stage for a successful business transaction. Whether you're buying or selling, understanding the role and components of an LOI is important for protecting your interests and facilitating a smooth deal process.
To your success,
Jason Huett Business Broker | CEO | CMO
Collaborative Commercial Business Brokers, LLC.