What to Avoid When Writing a Letter of Intent in Business Acquisitions
Author: Elliott Holland
When writing a letter of intent in business acquisitions, certain factors could lead to costly mistakes. Here are some things to avoid.
Key Takeaways
We offer an overview of LOIs and their importance
The quality of an LOI matters, and some factors could cost you big time
Here are four mistakes to avoid when writing an LOI
Once you’ve found a business you’re interested in acquiring, the next thing to do is write a letter of intent (LOI). A letter of intent in business acquisitions is a precise transaction summary. It captures the details of the business, both parties’ information, the amount of the sale, and the time period. It also outlines the terms and conditions of the acquisition.
The LOI is the first sign the parties are interested in moving forward with the acquisition. Once the LOI is acceptable for both parties, you move on to the due diligence process.
One more crucial point about the LOI is that it clearly outlines an exclusivity period for the due diligence phase. During that time period, the seller can’t engage other potential buyers. It leaves enough time for the buyer to review the details of the business to decide whether to acquire it.
Why is the letter of intent important?
A letter of intent is not a legally binding contract but an expression of interest. Typically, the only clause that could land the seller in trouble legally is the exclusivity period. The buyer named in an LOI could sue the seller if they deal with a different buyer during the exclusivity period.
Even so, it’s a good idea to watch out for mistakes that could cost you in the future. Here's a look at four significant pitfalls to avoid when writing a letter of intent in business.
1. Not being ready to continue the transaction
Buying a business is a huge decision you should take seriously because the implications are life changing. You’ll want to carefully consider if you're ready to start this journey – and avoid the pressure to buy just because a seller makes an offer that’s hard to resist.
You’ll need to analyze profit and loss statements, among other documents. So, be sure to review the operations manual, tax returns, income statements, and customer lists to understand the health and status of the business.
2. Not thinking through the right timing for success
While it’s typically better to close a deal quickly rather than drag the process out, there’s a difference between being swift and careless. For example, not carefully evaluating the business’s profit and loss statements can make the deal sour.
To help you avoid moving forward too fast, here are some tips to help you and the seller work together amicably:
LOI negotiation should be explicit from the moment you start talks to establish ground rules, decide who will facilitate meetings, and determine other issues for discussion
Establish benchmarks and deadlines, which should be realistic and ambitious for both parties, and be clear on how to proceed if those factors are not met
Be comfortable not knowing an important piece of data at the LOI phase. Allow for that unknown in the letter by identifying it and stating it will be found during due diligence
3. Breaching a nonbinding agreement
Carelessly walking away from a deal could land you in trouble. Many people take the LOI casually because it is not legally binding. The buyer may think they have no legal obligation to proceed with the deal. As such, they may not put their best foot forward to go through with the purchase or convey their wishes in good faith.
If a seller, on the other hand, walks out of the deal and casually tells the buyer their intention, they could expose themselves to liabilities they otherwise would have avoided. Not keeping up with an obligatory clause in the LOI could make one party liable.
4. Not defining the binding and nonbinding elements
Many buyers make the mistake of not using precise language when writing a letter of intent. An LOI should differentiate between the binding and nonbinding terms. As an example, the following provisions in the letter of intent should fall under the binding terms:
The exclusivity period or length of the due diligence
Closing date
Confidentiality
Noncompetition
You should also clearly identify the nonbinding elements of the LOI. Examples include:
The names of the seller and buyer
Subject of the letter
The purchase price and related compensation
The final agreement
Requirements for finalizing the deal
If either party ignores the binding elements in the LOI, they may have to pay fines and fees. For example, if either party publicizes the LOI against a clause therein, a court could prohibit further disclosure and order them to pay damages to the other party.
Get professional guidance when writing a letter of intent
When writing a letter of intent, you want to avoid mistakes that could cost you dearly later. While a letter of intent is not legally binding, some clauses can have hefty implications. That's why it's crucial to know what you're getting yourself into. Hiring a professional can go a long way in helping you get the best possible outcome.
At Guardian Due Diligence, we can help you write a letter of intent while avoiding common mistakes. Our team has evaluated over 1,500 business deals and can help you, too. Contact us to schedule a call or get a letter of intent sample for business.