If you’re in business or thinking of selling your business, you might hear the term “letter of intent”, or LOI. You might not know what a letter of intent is or how it can help your business. A letter of intent can be a contract, and it can also just be a statement of the future intent of the parties. It’s a written document executed by two parties that may or may not be binding. Here’s how to know when you need a letter of intent and how a letter of intent can help you in the business world:
What is a letter of intent?
A letter of intent is a written document between two parties. It can help you prepare or finalize a business deal. It outlines the major components of a business deal. A letter of intent is different from a contract because it’s often written in shorthand, and it may not be complete. Generally, it outlines the major points of a business deal between the parties so that the parties can work out the details at a future date.
What is the purpose of a letter of intent?
A letter of intent allows the parties to finalize some terms while they negotiate the remaining details of an agreement. If the parties want to begin conducting business without waiting for a complete contract, a letter of intent can give them some binding terms. In the absence of an agreement, the court might imply a contract between the parties. That can leave the terms of their business open to interpretation and uncertainty. A letter of intent allows the parties to formalize the terms they agree to right away. It allows them to state what they agree to now in hopes of negotiating a more complete agreement in the future.
How are letters of intent used in the business world?
There are multiple ways that letters of intent are typically used in the business world. First, the parties might use a letter of intent to make some of the terms of an agreement binding while they iron out the rest of the details. For example, a business might agree to merge with another company but need time to figure out details like a timeline for sale, transfer of assets and salaries for employees. The parties might use a letter of intent to memorialize their agreement and even state a selling price while leaving time for the parties to work out a timeline and other specifics.
A letter of intent might also be used to give the parties time to negotiate whether they want to enter into a deal. The parties might agree to exclusive and confidential negotiations for a period of time. They might use a letter of intent to state their intent to negotiate and also state their agreements regarding confidentiality and exclusivity. These terms can be binding. One letter of intent might look very different from another depending on the purpose of the letter.
You might use a letter of intent when you need fast performance from another party. You might use it when you have a complicated deal and you want some agreement in place before you iron out the details. A letter of intent can give you time to raise capital or do due diligence in order to decide if you want to complete a business deal.
What are the benefits of a letter of intent?
A letter of intent can be beneficial for business by giving each party the confidence to negotiate in good faith and motivation to invest resources in the negotiations. It can be a psychological boost for each party knowing that the other is serious enough about creating a deal that they want to continue negotiations. When a letter of intent helps the parties begin business quickly, it can help the parties avoid the uncertainty that comes from doing business without certain terms.
What are the drawbacks of a letter of intent?
Because of their ambiguous nature, a letter of intent is often vague. If the parties can’t agree on the final terms of the agreement, the deal might fall apart. They might engage in long negotiations for a deal that ultimately doesn’t end up happening. Alternatively, they might lock in terms that they later determine are unfavorable. The parties may also disagree on the enforceability of some or all of the letter of intent. Finally, leaks or publicity of the letter of intent may attract competing buyers or sellers.
What does a letter of intent typically contain?
A letter of intent may contain any of the following:
- The basics – Most letters identify the parties and contain a brief statement of the deal that they hope to negotiate.
- Confidentiality – The parties agree not to talk about the negotiation with third parties. The purpose of confidentiality is to prevent third party buyers or sellers from trying to compete.
- Exclusive negotiations – If the parties want to negotiate only with each other, they might put an exclusivity requirement in a letter of intent. An exclusivity term can give each party confidence that the other party is present to negotiate in good faith.
- A fee for backing out – A buyer might want a fee if the seller backs out. That can ensure that the seller negotiates in good faith and that the negotiations and due diligence that the buyer undertakes is worth their time.
- Good faith negotiations – A requirement that the parties negotiate in good faith can encourage both parties to put their best effort into negotiations.
- Choice of law – In a letter of intent, a choice of law provision states what state or federal law applies if the parties disagree about any terms of the letter of intent. If there’s a choice of law term, that’s the body of law that the court applies in order to decide the dispute.
Is a letter of intent enforceable?
Whether the letter of intent is enforceable comes down to the intent of the parties. In the event of a dispute, the court looks at the letter and the actions of the parties in order to determine if the parties intended for the letter of intent to be binding. One major factor the court considers is whether any terms in the letter are conditional. That is, if one of the parties only has to perform if an event occurs, the agreement likely isn’t enforceable unless the event happens. For example, if the sale of a business is conditional on the approval of shareholders, and the shareholders don’t approve, the agreement likely isn’t enforceable.
How can I make sure that my letter of intent is good?
To make sure your letter of intent does what you want it to do, it’s important to be clear on what’s enforceable and what’s not. Clearly state whether the entire agreement is enforceable or whether none of it’s enforceable. If you want only some parts of the letter to be enforceable, it’s important to clarify what parts you want to be binding. It’s also important to state what penalties you want to apply to either party if the deal falls through.
Done correctly, a letter of intent can help your business by formalizing agreeable terms and allowing the parties to move forward. If you’re considering selling your business, or if you’re looking at buying one, contact our team of experienced M&A attorneys to schedule a consultation.