9 Key Parts of the Letter of Intent (Part 2 of 6)
(For those just joining us, this is the second in a seven-part series on how to buy or sell your business. Please see the first blog post for more context.)
Buying and selling businesses can certainly be intimidating. There are so many moving parts to consider. Some people are not able to move forward with deals because they worry they will not get a good deal (this can be remedied by finding an experienced lawyer – Hi!). Other people jump on deals too fast and do not take time to think through the moving parts or even hire counsel.
The Letter of Intent, also known as the LOI, is a very brief formal offer letter that serves the purpose of getting the parties to agree to the primary material terms of a deal and then punts agreement on the less important items to a later date (usually to when the asset purchase agreement is drafted).
You want to keep the LOI short and sweet so that the other side can understand what it means without a lawyer. I recommend two pages maximum, but one page is ideal. On the other hand, the longer the LOI is, the less you will have to negotiate over in the asset purchase agreement later. But, then again, a super long LOI may kill the deal.
The beauty of an LOI is that there are usually contingencies that, in effect, make the LOI non-binding for either side if they really wanted to get out of it. This means that the deals go faster.
Things To Consider In A Letter of Intent:
- Entities. Are you entering the deal personally? Are any personal guarantees required for this deal? Most LOIs clarify that an individual buyer may transfer the agreement to an entity the buyer controls.
- Assets. What is it exactly that you are buying? You will want to list the categories of items being purchased, such as inventory, equipment, fixtures, etc. If you are buying a franchise brand or concept, you will want to make sure to make it clear that you are purchasing intellectual property, website, and proprietary business systems.
- Excluded Assets/Liabilities. What items are not part of the deal? Sometimes there is a car or a specific peace of equipment that is not part of the agreement. This should ideally be noted in the LOI. If you forget to raise an issue like this in the LOI, you risk the other side accusing you of changing material terms (which is usually not allowed in an LOI). Debt is not typically transferred from one party to another unless it is specifically bargained for. At any rate, you should address whether the buyer is responsible for any seller liabilities in the LOI.
- Offer. What is the most you are willing to pay for the business? Maybe even more important, how much cash do you have to buy the business and how much do you need to be financed? If you are the buyer, always ask for seller financing in a small business acquisition. If the seller doesn’t particularly need or want to sell the business, you may not get any financing. But, for restaurants in particular, seller financing is extremely common. The key with your offer is to understand the numbers of the business and make sure that you can easily cover any debt.
- Deal Specific Miscellany. It seems like every business sale has some important term that seems random to the lawyers not involved in the transaction. For example, the seller of a business may insist that a certain employee is not fired and is paid a minimum salary for a period of time as part of the deal. If so, such a material term that the parties would not normally consider should be included in the LOI.
- Contingencies. All of the contingencies that have to be true for you to agree to the deal are included in the LOI. This is what makes the LOI like “business dating for entrepreneurs.” (It’s like giving the guy or girl you like a note on your second date that says “I like what I see so far and I will marry you if all of the following end up being true…) Of course, agreeing to the other terms in the LOI are a contingency. But, this section deals with things that have not happened yet that would have to happen for the deal to go through.
The greatest hits of contingency terms I have seen are: contingent on buyer obtaining financing (meaning “I don’t have any money for this deal yet, but if I can get some by a certain time can I do it?”), securing assignment of lease from landlord, approval by some third party, seller providing bank and financial records to buyer for due diligence approval, and, contingent on the parties reaching a mutually agreeable long form asset purchase agreement.
- Timelines. Timelines are often included in contingencies. Otherwise, they can be their own paragraph, usually in the form of “Pending contingencies, the parties agree to work in good faith to close on this transaction by October 1, 2020.”
- Binding or Not?. The most important thing about the LOI is whether it is binding. As mentioned above, there are many contingencies which can make an otherwise binding LOI become non-binding. Most LOIs have a term that says that “The material terms contained in this letter of intent shall be binding on the parties in the long-form asset purchase and sale agreement.” If such a term is not included, then the LOI is not binding at all because the parties can say they don’t agree to the long form agreement later.
- Expiration of Offer. You may also include an expiration of offer in your LOI. It may say something like, “this offer shall terminate on August 1, 2020.” If you have multiple buyers you will likely want to have very short deadlines for offers to expire.