If you own a small business, there might come a time when you need to negotiate a business transaction. For example, you may want to merge with another company, buy another business, or launch a joint venture. Or, you may have your eyes set on retirement and want to sell your business. These are instances where you need more than a handshake and verbal agreement. You also need a letter of intent (LOI), a written document containing the basic terms of the transaction.
A letter of intent is not a substitute for a legally enforceable contract; it provides both parties a roadmap for a proposed transaction. This Balboa Capital blog article explains what a letter of intent is, why you need one, and what it should include.
Overview: Letters of intent.
A letter of intent is a non-legally binding document that outlines the intention, scope, and general terms of a potential business agreement. It is drafted when one party proposes to another party to start negotiations for a deal. For example, the letter of intent can be used when one party wants to buy from the other, sell to the other, merge with the other, or do some other type of business with the other party.
In most cases, this document will outline all of the initial terms necessary for both parties to negotiate before reaching an agreement on a business-related transaction. Terms may include business price/valuation, asset descriptions, and limitations. One of the key benefits of an LOI is that it can be used as leverage for negotiations and does not obligate the parties in any way.
In short, a letter of intent is the preliminary step to get acquainted with each other and for both sides to make sure they are on the same page regarding the potential transaction.
What to include in a letter of intent.
As mentioned above, a letter of intent is a document that outlines the intentions of two parties to enter into a business agreement. It is usually written by one party and sent to the other party, who then responds with an agreement or disagreement. Before you pen to paper, make sure you understand what needs to be included in your letter and how it should be written.
There are three main parts of a letter of intent: the introduction, the body, and the conclusion. The introduction should include information about who you are writing to and include the names of both parties and their respective job titles. You may also include a brief bio of your company, including its history and mission statement. Some business owners go a step further and include more confidential information like year-over-year (YOY) growth, but it is not always necessary.
The body of the letter contains the details of the proposed transaction and timeframes. For example, if you are interested in buying a small business, describe what each party will be responsible for in the proposed transaction. You can include the purchase price, but you may indicate that it is negotiable. Contingencies should also be included in this section of your letter.
Contingencies need to occur for the proposed transaction to move forward. Common contingencies in business transactions include drawing up legal agreements that need to be signed by both parties and securing a loan or financing by the buyer who wants to purchase a business. In addition, if the seller or buyer has business partners, the partners will need to provide written approval before the transaction can be finalized.
Some of the additional information to include in this section include:
- Due diligence – this involves checking the business’s financials and verifying its tax records and legal documents.
- Public announcements – before the transaction’s closing date, the two parties cannot publicly disclose any news or information about the proposed transaction.
- Non-solicitation – this prevents the two parties from contacting their respective workers, vendors, and customers with the purpose of stealing them.
- Exclusivity clause – this does not allow either party to engage in similar negotiations with other businesses for the same proposed transaction during a specific time frame.
Finally, the conclusion should summarize your offer and request that they respond with their decision as soon as possible, or by the established deadline that you include in the letter. Setting deadlines can help ensure the entire process is completed promptly.
Who writes a letter of intent?
Consider hiring a business attorney or financial advisor to write your letter of intent. They are uniquely trained and qualified to provide you with a letter that follows best practices and protects you from potential legal issues.
For example, the phrasing in the letter needs to convey that you are proposing a business transaction, not committing to anything that is outlined. In addition, a business attorney or financial advisor will include the necessary disclaimers and information about exclusivity, transaction-related expenses, and confidentiality, among others.
Before you begin the journey of buying a business, merging with another company, or selling your business, you need to do your due diligence and gather as much information as possible. Once you are ready to start negotiating a deal, it is crucial to communicate the proposed transaction in a non-legally binding document with the other party. Doing so shows that you are serious about your intentions and have taken the time to outline everything in detail. Having a letter of intent can also increase your proposed transaction’s chance of materializing.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.