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  5. Letter of Intent (LOI)101: Everything You Need to Know

Letter of Intent (LOI)101: Everything You Need to Know

by | Nov 19, 2021 | Articles

When private companies are sold, a critical step is the signing of the Letter of Intent (LOI) to ensure agreement about important terms that create the framework for the sale of the business. Business owners should not proceed with the sale of their company without an LOI. The LOI should be reviewed by an experienced M&A attorney before signing. Here’s what you need to know.

What is Included in a Letter of Intent (LOI)?

A letter of intent (LOI) typically includes:

  • Deal structure which defines if the acquisition is a stock or asset purchase and a summary of the deal terms
  • Total enterprise value (TEV)
  • Consideration which describes the amount of cash at closing, stock, seller notes, earn-outs, rollover equity
  • Escrow holdbacks for Warranties, Representations, and Indemnification (WRI) and Working Capital
  • Definition of how working capital will be calculated
  • Exclusivity period during which the seller is prohibited from engaging in any discussions with other buyers
  • A summary review of the types of information that the buyer will review during due diligence
  • Management compensation, retention bonuses and one-time payments, stock options for key employees and clarity about which party pays fees associated with the closing process
  • Closing date and closing conditions
  • Each party’s confidentiality obligations
  • How disputes will be handled
  • Under what circumstances the agreement may be terminated

LOIs can be long or short form. A longer form is more comprehensive and legally detailed. Short-form LOIs are easier to negotiate and set general deal terms but offer less protection against a deal falling through because of a fundamental disagreement over key deal terms.

What Type of LOI is Best?

A long-form LOI is typically best for the seller. This is because once the letter is signed, leverage in negotiations transfers to the buyer. The more terms a seller can iron out ahead of time, the better. Buyers are more likely to offer concessions in a competitive bidding process—before the LOI is signed. The buyer’s perspective is the opposite. Buyers generally seek a short-form LOI with a long period of exclusivity. In most deals, the parties must ultimately balance these competing demands.

Binding or Non-Binding?

LOIs are generally non-binding except for key provisions. It’s common for terms such as confidentiality, deal exclusivity period and dispute resolution to be binding. An exclusivity period will be critical to the buyer because this gives the buyer time to undertake due diligence without fear that another buyer may interfere with the transaction.

Other Deal Terms

In addition to obvious factor like price, the LOI should also spell out other important terms, including:

  • Whether stock is part of the deal
  • The interest and principal payments associated with any promissory note
  • Whether there will be a working capital adjustment
  • Whether there will be an earnout, and what its terms will be
  • Dates by which key deal steps should be completed
  • The specific terms of any planned indemnification agreement
  • A full and thorough disclosure schedule
  • Conditions to closing
  • Agreements about an escrow or closing agent

For more information on M+A transactions and industry insights, read our blogs.