Buy a Business

The Significance of Signing A Letter of Intent

Signing A Letter of Intent in A South Florida Business Sale

At some point in the process of selling a business, a buyer may submit a Letter of Intent (frequently referred to as an LOI).

The Typical Sales Process for A Business Sale

Once a typical buyer signs a non-disclosure agreement and (if qualified) is given the confidential listing material, the buyer (if interested) will typically want to meet the seller to get their questions and concerns answered.
After that occurs, the buyer is normally ready to make an offer.
This offer may consist of a proposed purchase agreement which governs all facets of the transaction and is the formal contract used at closing.
Or a buyer may first offer an LOI for the seller’s review.

Letter of Intent not a Legally Binding Contract But Still Critical

An LOI is a much simpler version of the purchase contract that only covers the essential points of the deal (such as the price, terms, closing date, non-compete clause, and any other terms the deal demands to be agreed upon ahead of time). Although not legally binding, the signing of the LOI is critically important to many deals and to a successful closing.

Many Buyers Prefer Submitting an LOI

Buyers frequently prefer submitting an LOI rather than a proposed purchase agreement for the simple reason that formulating an LOI does not need the costly services as an attorney. Signing a letter of intent is still very significant because it expresses in writing the framework of the deal, it gives buyers a certain timeframe of exclusivity, and it is the instrument by which buyers and sellers conduct formal due diligence.

An LOI Binds the Buyer and Seller to the Terms of the Deal

Having a written and agreed upon framework of the deal through the letter of intent should signal the end of negotiations over the critical aspects of the deal (such as price, terms, the non-compete clause, and post-closing transitional-related matters). Again, even though the LOI is not legally binding, it does bind the parties as a practical matter to what is agreed upon in the LOI itself.

Selling A Salon As An Example

For example, if a salon is being sold and the LOI says that the seller give 60 days of free training to the buyer after the closing, then the purchase contract should also reflect this critical term. If the purchase contract has terms that differ from the LOI, then the party who made the changes must be willing to explain why the changes were made and must be agreed upon by the buyer. This can be a very difficult hurdle and would probably kill the deal since the term in question was agreed upon in the LOI.

Consistent and Clear Communication During the Negotiation

Both parties should understand the ramifications of changing critical terms of the deal. While it is true that discoveries during the formal due diligence period (after the LOI is signed) may give a buyer valid reasons for changing the LOI’s terms, a seller still may not agree to change what has been agreed upon in the letter of intent. An experienced business broker that facilitates clear and consistent communication between the parties is the real glue that holds a deal together.

Giving Buyer Exclusivity When Selling Your Business

The second critical component of signing a LOI is that it gives the buyer a certain timeframe of exclusivity – typically for 30 -60 days.
Exclusivity simply means that the seller is prohibited from signing another deal with another buyer during the exclusivity period.
A buyer wants as long an exclusivity period as possible.
A seller should want (and with the guidance of Five Star Business Brokers of South Florida always asks for) as short an exclusivity period as possible because one never knows what other buyer may emerge.
A buyer typically needs to have this peace of mind (of exclusivity) in order to be sufficiently motivated to spend the resources necessary on an accountant to assist with formal due diligence and on a lawyer to help draft the proposed purchase agreement. This outside assistance can frequently amount to several thousand dollars.
Conversely, the seller will also have to spend resources on their accountant and lawyer in answering the due diligence request list and with negotiating the purchase agreement.
So the seller will also need peace of mind that the buyer has signed a letter of intent and that an agreeable framework of the deal is in writing and will be abided by both parties.

Getting to the Due Diligence Phase During the Business Sales Process

Signing a letter of intent is the typical instrument governing the formal due diligence process and without signing an LOI (or of course a purchase agreement), formal due diligence can not and should not occur.

Terms of the Due Diligence Should Be Expressed in LOI

The letter of intent itself should spell out the commencement date of due diligence, and what sort of information the buyer will require during the formal due diligence process. It should also give a timeline as to when due diligence will be completed.

Importance of A Written Agreement Before Formal Due Diligence

In practical terms, a seller will not (and should not) engage in the formal due diligence process absent an agreed upon letter of intent. In fact, Five Star Business Brokers of South Florida advises all its clients never to engage in a formal due diligence process without some sort of an agreed written framework (such as an LOI) of the deal. A buyer should propose its formal due diligence request list either contemporaneously with the signing of the LOI or within a few days after its signing. However, if there are any surprises as to the content of the due diligence request list, they should be spelled out ahead of time in the LOI.

Selling A Restaurant in Palm Beach County: An Example

For example, if a prospective buyer of a restaurant wishes to physically observe the customer count and revenues of a restaurant over the course of a week as a part of their formal due diligence, such a request should be contained in the proposed LOI. The last thing there should be is any surprises – in any deal!

The Letter of Intent Should Be Used with Help of Expert Business Brokers

A letter of intent is not typically legally binding in any way, but it does and should bind the parties to the framework of the deal. A signed LOI gives both the buyer and the seller the peace of mind and confidence to engage with outside assistance and to put forth their own efforts in order to complete the deal. It can serve as the foundation of a successful closing and should be viewed as such by both buyer and seller.

Give Martin at Five Star Business Brokers of Palm Beach County a call today with questions about valuing your business and how to steer the sale of your business to a successful conclusion.