Letter of Intent
Our letter of intent template provides the basic framework for a buyer to use when pursuing a small business for sale.
What is a letter of intent?
A letter of intent is a document put forth by the buyer that lays out the parties' intent to enter into a transaction and includes a summary of the key terms of the deal.
The letter of intent (or "LOI") can be very detailed, and treated as a dry-run for the closing process and Purchase Agreement, or it can be relatively high level and focus more on the price, confidentiality period and diligence items.
When should I use a LOI during a transaction?
An LOI is useful when a buyer is serious and wants to prevent a business from being acquired by someone else.
For a seller, it helps to reduce risk that the deal falls through by allowing the parties to agree on as much as possible upfront and lay out a roadmap of what needs to be done to close the deal.
What's included in a letter of intent?
Even a basic letter of intent can really vary in terms of what it covers. It's ultimately up to both parties as to how granular they want to get at this stage. We'll dive into the common sections you may find below.
Given that transaction structure has tax and legal implications for both parties, the structure is typically defined upfront. This can either be a stock sale or an asset sale. In small businesses, an asset sale is normally most common.
The Purchase Price
This section of the LOI covers not only the price that the buyer proposes to pay but also the form of the payment. This could include cash, a seller note (e.g. a promissory note to pay the seller over time), equity or something else.
The Indemnification Framework
If the buyer wants indemnification, that may find its way into the LOI. For instance, the buyer may want indemnification but be willing to cap it to a certain amount of years and a certain amount of money.
For asset sales, this is less of a concern given that the original business entity will be closed down after the transaction occurs.
Key Closing Conditions
The closing conditions (as well as the management arrangements and diligence items) serve as a roadmap of sorts to getting the deal done. Common closing conditions may include the ability for the buyer to get financing through an SBA 7(a) loan or the former owner forming and agreeing to a non-compete (e.g. the owner cannot sale her business and move down the street to open up a new one).
Management arrangements are a subset of closing conditions. Here, you may find that the buyer will require the owner to stay on for a transition period, or offer some sort of earn-out package where if the business hits certain targets, the owner will receive additional payment.
Due Diligence Checklist
This is another part of the roadmap to closing: the scope of the buyer's diligence efforts. For instance, the buyer may want an appraisal of real estate, to interview key employees, or to have an equipment review. Such steps in the diligence process will often be listed in the LOI.
One key piece of an LOI that defers from the later sale agreement is exclusivity. This means that the owner cannot shop her business around to other potential buyers for a certain period. This may be 30, 60 or 90 days. Although this period may be extended by mutual agreement, it is important as it sets the pace for closing.
If you used our Non-Disclosure Agreement template, this will likely be irrelevant. However, if you have yet to sign an NDA, the confidentiality clause is important to keep any information uncovered during due diligence confidential.
Lastly, there may be language around who pays for various expenses during the course of diligence and closing. A common setup is that the parties pay separately for any expenses incurred for their own benefit but split expenses that benefit both (e.g. filing fees).
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Our letter of intent template is a great starting point for putting an offer on a small business.