Buying a Business in the U.S., Part 4: Letters of Intent (LOIs)
In business purchase negotiations, parties often execute an early‑stage document called a letter of intent (“LOI”). You may also see it called a term sheet or even a memorandum of understanding (“MOU”). The label matters less than the document’s language and the parties’ objective intent. An LOI, term sheet, or MOU can be binding, nonbinding, or partly binding, depending on how it is written and the law that governs it.
LOIs show up in most business acquisitions (and commercial real estate plays, and in many other types of deals). The typical workflow is to circulate an LOI early, but not too early: the LOI draft often arrives a few weeks or months after a non-disclosure agreement (NDA) is signed. The LOI draft will also come after parties have shared some information and are calibrating high‑level economics: purchase price, payment structure, and the basic shape of the transaction.
Unless the LOI is fully binding (more on that below), it won’t include the long list of representations, warranties and covenants that end up in the “definitive agreements.” Instead, it sets expectations on crucial deal points, so everyone knows what they’re building toward.
In larger deals, LOIs can run several pages and include detailed provisions. But even then, the LOI will be far shorter than the final purchase agreements. In smaller deals, a one‑ or two‑page LOI is common; and in the simplest situations, I’ll sometimes outline key terms in an email, and move straight to drafting once the counterparty signals they’re aligned.
The point with LOIs is efficiency: a solid LOI is often the fastest way to get consensus on the deal’s skeleton before spending heavily on legal fees. Definitive agreements should flow naturally from a good LOI.
Why use an LOI?
Deals with clear LOIs tend to close at a higher rate than efforts that skip this step. Deals framed by LOIs also tend to close sooner, with less friction, and with lower transaction costs.
The main job of an LOI is to force alignment on key terms before the parties invest significant time and legal fees. Few things are more frustrating than spending weeks drafting a set of agreements, only to hear “that’s not what we agreed to.” Or, even worse, receiving a completely reworked draft that ignores the earlier understanding.
An LOI can also function as a formal “offer,” especially where brokers are involved, or the parties have only had preliminary talks.
Finally, LOIs help anchor the negotiation. Nearly all LOIs include an expiration date, which can keep momentum going and prevent one side from dragging its feet.
Binding, nonbinding, and hybrid LOIs
Most LOIs are nonbinding, or nonbinding except for a handful of provisions (e.g., confidentiality, exclusivity/no‑shop). It’s critical to state the status clearly: if the document is ambiguous, a court may treat an LOI (or certain of its terms) as binding, even when one party thought it wasn’t. A nonbinding LOI can also serve as extrinsic evidence in a dispute if the transaction later unravels—including where the definitive agreements contain drafting or execution errors.
Hybrid LOIs—those that are mostly nonbinding, but include binding confidentiality and exclusivity terms—can be tailored to protect both parties. From a buyer’s perspective, exclusivity in particular can be essential; otherwise, a seller can quietly shop for a better deal while working with the buyer. In some cases, however, sellers will require an earnest money deposit or other consideration to grant exclusivity.
Fully binding LOIs exist but are less common and require great care. Because an LOI usually contains less detail than a definitive purchase agreement, making the entire document binding can leave the parties committed before they have resolved important issues involving indemnification, closing conditions, remedies, and post-closing obligations.
This dynamic creates a real risk: one side may decide the LOI already gives them what they want and simply stop negotiating—especially if definitive agreements would bring unwanted constraints.
Core terms to expect in a business purchase LOI
Every deal is different, but the following are the standard building blocks you should see (or consciously decide to leave out) in an LOI for buying a business:
Parties and target business.
Identify buyer (and/or assigns) and seller by legal name, and give a concise description of the business (entity type, jurisdiction, and what it does).
Transaction structure.
State whether the deal is an asset purchase or a stock/equity purchase. Generally speaking, sellers prefer stock deals and buyers prefer asset purchases. I’ll cover this topic in a future post.
Purchase price and payment mechanics.
Set the total purchase price and the form of consideration (cash, seller note, earnout, rollover equity, or a mix), plus high‑level timing, and any working capital or net‑debt adjustment formula.
Included and excluded assets/liabilities.
List what is included (e.g., inventory, equipment, IP, customer lists, contracts) and what is excluded (e.g., cash, certain real estate, personal property). Specify which liabilities the buyer will agree to assume, if any.
Due diligence window and access.
Define the diligence period (which can begin before or after definitive agreements are signed) and the diligence scope (financial, tax, legal, contracts, employment, litigation, regulatory). Confirm the seller’s obligation to provide reasonable access to records, people, and premises.
Exclusivity (no‑shop) and break‑up fees.
Include a period during which the seller won’t solicit or negotiate with other potential buyers; and, if relevant, outline any break‑up fee or expense reimbursement if the seller breaches exclusivity, or accepts another offer.
Confidentiality.
State that negotiations and shared information are confidential, either by reference to an existing NDA, or by embedding a confidentiality term. Buyers should expect a seller to require these obligations to survive termination.
Closing conditions.
List major conditions to closing, e.g., satisfactory diligence, buyer financing, third‑party consents, landlord approvals, regulatory approvals, and execution of definitive agreements.
Restrictive covenants (non‑compete / non‑solicit).
Buyers should consider requiring non‑compete and non‑solicitation agreements (customers and employees) as part of many deals, with a high‑level description of duration, geography, and scope. Here, the parties may also agree to allocate a certain portion of the purchase price to these restrictions.
Timeline and milestones.
Provide a target closing date and key milestones (deadline for the definitive agreement, financing commitment, anticipated signing and closing), plus deadlines for deliverables.
Expenses and cost allocation.
Address how transaction expenses will be split (e.g., each side bears its own costs, or certain costs are shared), and what happens if the deal fails after specified milestones.
Governing law and dispute resolution.
Specify the governing law (state law) and the preferred forum or mechanism (e.g., arbitration, court venue) for disputes arising under the LOI.
Binding vs. non‑binding provisions.
Clearly state that the LOI is non‑binding except for specified clauses. As mentioned above, typically binding provisions include confidentiality and exclusivity/no‑shop; but they may also include expense allocation, governing law, and sometimes break‑up fees. Price, structure, and most closing conditions will generally remain non‑binding and subject to definitive agreements.
Termination and expiration.
Include an expiration date and the conditions under which either party may terminate negotiations. Clarify the treatment of confidential information and the status of any deposits upon termination.
Common LOI pitfalls
I could write an entire post just on LOI pitfalls. In the interest of time, though, here are four big ones:
The first pitfall is sloppiness. Deal parties (and their brokers) often try to save on legal fees by reusing old LOIs. The result is often a mismatch between the document and the actual deal, or terms that conflict with what the parties thought they’d agreed. I’ve seen LOIs with everything from incorrect party names to purchase price errors (including in the seven figures). All of this creates confusion and wasted time later.
The second pitfall is ambiguity as to an LOI’s binding or nonbinding status. This happens too often, either because the concept is not expressly addressed, or because of contradictions within an LOI (i.e., the title will be “Nonbinding”, but the body of the LOI will refer to a “binding” status). Ambiguity about whether or not an LOI (or any portion thereof) is binding can cause real damage. Courts have, in some cases, found LOIs to be binding where the parties disagreed on their intent. Clarity up front is essential.
The third is ignoring regulatory or industry‑specific issues. Many transactions involve regulatory or industry‑specific hurdles (licensing transfers, franchise consents, landlord approvals, etc.). I’ve seen LOIs that had to be materially restructured after execution, to comply with applicable rules. Nobody wants to renegotiate core economics after the LOI is inked.
The fourth is missing material terms. Even bad LOIs usually address price and payment timing (usually!), but other critical terms are often omitted. This can cause friction during definitive agreement negotiations. An LOI should not be a novel, but a half‑baked or incomplete term sheet can be just as problematic as an overlong one. It’s better to negotiate certain terms up front.
Wrapping Up
Buyers who use LOIs should consider working with counsel who can draft simple but sufficient documents. A good LOI can save a lot of time, legal fees, and headaches down the road—and in most deals, it will meaningfully increase the odds of a closing.
For earlier posts in this series, check out the following:
