Reading and Writing a Letter of Intent

Letters of Intent 101

A letter of intent (LOI), also known as a term sheet or an expression of interest, is an informal offer made by a strategic or financial buyer of, or investor in, a business. A LOI is drafted in the preliminary stage of a business sale and can be a useful method for expressing, in plain English and summary fashion, an offer to purchase. LOIs are typically non-binding, which means that, with limited exceptions, the most important of which is exclusivity, either party can walk away at any time for any reason. The term sheet provides an overview of a prospective buyer’s intentions and sets the stage for what the ultimate definitive agreement will be.

The Buyer’s Opening Move

The merger and acquisition process typically starts with a representative of the seller (an investment banker, business broker, or some similar intermediary) approaching a group of potential buyers in writing via a Confidential Information Memorandum about their interest in some form of a transaction (sale of equity, sale of assets, merger, or investment) with the seller. Basic narrative and financial information about the seller is shared after the potential buyer has signed a non-disclosure agreement.

From the seller’s perspective, this communication invites these potential buyers to make an offer at a price the buyer is willing to pay. Most times, transaction advisors representing a seller request a LOI as early as possible in the sales process so that the seller can narrow the number of potential buyers with whom it will engage in further discussions.

Stated another way, a term sheet is a prospective buyer’s first volley, expressing an interest in such a transaction in writing. The primary purpose of a letter of intent is to suggest a price or valuation range that a buyer is willing to pay to the seller. A LOI is typically delivered after a prospective buyer reviews the Confidential Information Memorandum, if one exists, but prior to meetings with management and initiating any other form of due diligence.

What’s in a Letter of Intent?

Putting forth a valuation range helps a seller evaluate whether proceeding with a potential buyer makes sense. A term sheet typically proposes other key terms of an offer. For example:

• The anticipated timing for closing the transaction.
• The acquisition rationale.
• The transaction structure.
• The sources and use of funds.
• Length of time the seller may be required to remain with the business and in what capacity.
• How the price will be paid, i.e., cash, stock, promissory notes, etc.
• Whether any portion of the payment will be held in escrow, and if so, under what terms, i.e., length of escrow, release conditions, etc.

The most critical, particularly to sellers, and legally significant provision in LOIs is the provision entitled exclusivity, also referred to as a lockup. This provision requires the seller to negotiate only with the potential buyer for a specified period of time, generally around 30 to 180 days, but, in practice, usually somewhere in the middle.

It may even require the seller to report any expressions of interest the seller receives from other interested parties to the potential buyer. It is critical that the seller believes 1) the buyer is a good and likely match for a potential transaction and 2) the seller is unlikely to receive superior terms from the buyer or another party.

While the seller can merely wait for such a time period to lapse before renewing conversations with other potentially interested parties, momentum for a transaction may be lost in the interim, so it is critical the seller feels fairly confident before signing the LOI. This is all the more true since the buyer typically isn’t directly giving the seller anything in exchange for the buyer’s signature.

We think you’ll also like:

1. Anticipating Contract Disputes Before You Sign
2. Cash is King: Prepare Your Balance Sheet for a Business Sale
3. When Should a Seller Sign a Letter of Intent?

[Editors’ Note: To learn more about this and related topics, you may want to attend the following on-demand webinars (which you can view at your leisure, and each includes a comprehensive customer PowerPoint about the topic):

1. Structuring and Planning the M&A Transaction
2. Selecting the Right Valuation Expert
3. What Every Founder/Entrepreneur Must Know

This is an updated version of an article originally published on September 27, 2021. This article was most recently updated by the Financial Poise Editors.]

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