When Should a Seller Sign a Letter of Intent?

A letter of intent (LOI) is used in the purchase and sale of a business to set forth the framework for the negotiation of definitive transaction documents and closing of a transaction. Normally, a letter of intent does not create a binding contractual obligation to purchase or sell the business.

However, a non-binding letter of intent does impose upon the parties the obligation to negotiate, in good faith, transaction documents that contain the material terms set forth in the letter of intent. If one party breaches its obligation created by the LOI, the other party will have a claim to recover transaction expenses incurred but will not have a right to the “benefit of the bargain.” This would occur only if there were a binding obligation to purchase or sell the business.

Buyer Advantages of a Letter of Intent

Strategically, it is advantageous for a buyer to execute an LOI  as early in the process as possible because a properly drafted letter of intent will grant the exclusive right to a buyer to complete due diligence and to negotiate definitive transaction documents.

Why Exclusive Right to Negotiate Benefits a Buyer

This exclusive right to negotiate is a binding provision, exposing the seller to contractual damages if they breach it. It gives tremendous bargaining power to the buyer because, during the exclusivity period, a seller is required to negotiate exclusively with the buyer and cannot leverage one buyer against the other with respect to price and deal terms.

Timing of the Letter of Intent

For this reason, a seller will want to delay the execution of an LOI as long as possible and, if the company is in high enough demand, attempt to avoid executing a letter of intent altogether. A buyer, however, often requires exclusivity before they will spend the funds necessary to complete due diligence. The seller will not proceed with a transaction if a letter of intent is not signed.

Buyer and Seller: Differing Objectives for LOI Content

The differing objectives of the buyer and seller impact not only the timing of the execution of the letter of intent but also its content.

The Buyer’s Perspective on LOI Content

From the buyer’s perspective, the exclusivity provision is the primary motivation for moving forward with a letter of intent. Therefore, the buyer wants to include as few material terms as possible because once a letter of intent with an exclusivity provision is signed, the deal will only improve for the buyer.

As due diligence is completed, issues come to light and transaction documents are negotiated. From the buyer’s perspective, the best possible position would be to enter an exclusivity agreement without terms. While a shrewd buyer might propose this, a seller should never enter a “naked” exclusivity agreement.

The Seller’s Perspective on LOI Content

A well-represented seller will recognize that the high-water mark for its bargaining power is before the execution of a letter. Therefore, unlike a buyer, who would like to keep the letter of intent as minimal as possible, the seller will want to include the material terms of the deal as well as any terms which the seller views as critical to a successful transaction.

A seller does not benefit strategically from waiting until after the letter of intent is signed before raising critical deal terms. A good example is indemnification. A buyer will want to avoid the topic to the extent possible. At the same time, a seller will want to clearly delineate any caps on indemnification and other limitations on indemnity such as, possibly, baskets and de-minimis claim requirements.

Consult with Your Lawyer Before Executing an LOI

Careful consideration of the strategic underpinnings of a letter of intent with experienced corporate counsel will assist the buyer and seller in determining the optimal content and time to execute it in any particular transaction.

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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. The Letter of Intent-In Detail
2. Structuring and Planning the M&A Transaction
3. The M&A Process

This is an updated version of an article originally published in April 2015 and revised on June 24, 2019.

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