What Is a Letter of Intent When Selling or Buying a Business?
| March 2022
Whether you’re in the market to sell a business you own or buy one as an investment, a lot of paperwork will be involved.
As quoted in an article by Small Business Trends, BizBuySell's most recent Insight Report shows "a total of 8,647 closed transactions were reported in 2022," after modest rebounds from the pandemic in early 2022 and a surge of business buying and selling activity in later in the year. The situation suggests many more businesses will be traded and a lot more paperwork will be exchanged in 2023.
One of the key documents that will be used in the process is a letter of intent to purchase a business (or LOI).
It’s important both to know what to say in an LOI as a buyer and what to look for if you’re presented with one as a seller. In either case, it’s smart to work with a broker who’s savvy in negotiating the terms of LOIs for parties on either end of a business sale.
The Purpose of a Letter of Intent
The letter of intent (LOI) is a document issued by a buyer who wants to declare their wish to purchase a certain business. It basically lays the ground rules for the business sale process, both on the buyer’s end and the seller’s end.
While it’s not legally binding at first, an LOI also contains an initial declaration of the business assets a buyer is interested in acquiring, a suggested purchase price, the timeline for completing the sale and the preceding due diligence process, and other legal and procedural matters.
Reducing Complications Later On
A letter of intent lays out the expectations for both parties over the course of the sale. Both the buyer and seller know what the transaction will entail and which items need to be clarified, such as whether or not the sale will proceed based on a buyer’s financing abilities. As a result, both parties can expect to be on the same page about how the sale will proceed.
Saving Time and Costs
When the seller and buyer agree on the basic terms upfront, it helps save time and money while avoiding delays and surprises that can quickly derail the process.
For example, the LOI can detail when buyers can get access to sensitive business information, such as vendor contracts and proprietary documents about the company’s products. If this isn’t settled, it can become a time-consuming obstacle for a buyer to overcome later.
Letters of intent also save money since buyers can start investigating a potential target business long before they start hiring a CPA and lawyers and making other financial commitments.
Establishing the “Right of First Refusal” for Buyers
With a letter of intent to purchase a business, a buyer can stipulate that the seller must not advertise to other businesses until due diligence is complete.
The stipulation allows the buyer the right of first refusal, which entails that the buyer currently engaged with the seller gets to be the first one to turn down the deal, if they so choose. It also provides the buyer a measure of security by not exposing the deal in progress, which often unfolds over the course of months to a year or longer.
Acting as a Template for the Purchase Agreement
Once both parties sign off on the LOI, it becomes a template for the purchase agreement in many cases.
Purchase agreements cover more detail about the sale terms and closing. After the basic terms of the transaction are settled with the letter of intent, however, drawing up the purchase agreement may simply become a matter of spelling out the details after both parties have completed due diligence and are comfortable with moving forward.
Important Sections of an LOI to Purchase a Business
A letter of intent to purchase a business will usually have sections that cover each of the following, to a larger or smaller degree:
Buyer and Seller Identification
Often until a serious, qualified buyer starts expressing interest in a business, the actual names of the buyer and seller are hidden from each other, preserving confidentiality for both parties.
Once a buyer and seller are matched, however, the names of each party are declared in the LOI.
Purchase Price and Payment Terms
An LOI will propose a price for the business and what the terms of payment will be, including a potential down payment, the total number of payments, and due dates. The buyer may also indicate whether or not the suggested payment plan depends on their ability to secure financing.
Buyers may want to stipulate that sellers don’t do anything prior to the sale that would compromise the deal. This might take the form of a non-disclosure agreement within the LOI. Buyers will also want to ensure that sellers don’t let product or service quality lapse before the business sale is complete.
The LOI will state that each party will have a period in which to do their due diligence before the closing, and may mention what that entails.
The letter might spell out what the closing process will look like, including whether one or both parties will be responsible for closing costs, and at what point the closing itself will actually take place.
What Sellers Should Know When It Comes to LOIs
You can expect buyers to propose terms that favor their end of the deal the most. However, sellers have a lot at stake and should know a few things when it comes to signing off on the initial letter of intent when presented with one from an interested investor.
Negotiate the Terms
By the very nature of the document, the terms of an LOI are negotiable. The buyer and the seller both have to agree to what it contains.
If a seller disagrees with what the buyer is proposing, some amount of negotiation should take place. Sellers should assert their needs in order to ensure satisfaction with upcoming dealings.
A knowledgeable broker can be very valuable for helping a seller through these negotiations. They know the implications of what LOIs commonly propose and can work in a seller’s best interest to secure better terms.
Have Your Due Diligence Done First
It’s important to start doing your due diligence as early as possible after you’ve decided to sell.
By performing due diligence, you’re not under as much pressure when working out terms with a serious buyer, and there are no vulnerabilities or risks in your business that can suddenly spring up and threaten a good deal in progress.
Ensure the Buyer Is Qualified
Only work with, and sign LOI from a qualified buyer who intends to keep their promises and stick to the reasonable terms they propose.
For sellers, working with a savvy and experienced broker is the best bet for accessing the most qualified buyers, as well as ensuring airtight due diligence and closing processes.
Work With Raincatcher When Selling a Business
The brokers at Raincatcher are very familiar with letters of intent to purchase a business. They are valuable allies to have, no matter which side of the equation you’re on.
For buyers, Raincatcher brokers are able to ensure the LOI proposes terms that will protect their interest in the target business and fend off the competition, ensuring a solid relationship with the seller.
For sellers, our brokers help negotiate LOI terms while ensuring that only the most qualified buyers are brought on board and the entire process — including the amount earned in the sale — works out to the seller’s satisfaction.
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