What exactly is a Business Purchase Letter of Intent or LOI?

What exactly is a Business Purchase Letter of Intent or LOI?

This seems like a very scary document but actually it's not.  Technically, a business purchase letter of intent is really a non-binding agreement that says "I would like to buy your business for an asking price of $XXXX with contingency stipulations A, B, and C but first I want to take a closer look at your business".

Again, it seems complicated but it's really a very simple semi-legal looking document that gets the ball rolling.

You should be aware that before a seller signs the LOI, they have the right to ask for proof of funds. If the seller is holding a note, the funds would be the down payment. If you are getting a bank loan, then proof of a contingent approval is often required. If you can't show the funds needed to make the deal work, it will be a waste of time for them to sign.

WHEN DOES THE LOI COME INTO PLAY?

The business purchase letter of intent comes into play once you have decided that you like what you have seen so far and are seriously considering buying the business.

This document should be provided by the buyer, since it has a lot of buyer related requests in it for the seller to adhere to for due diligence. If a broker is involved, they will help with putting this together. There is no need for a lawyer when dealing with this document.

You may want to get a business buying savvy accountant involved though to make sure you are asking for all of the necessary financial documents you may need for due diligence.

WHAT'S THE TRUE PURPOSE OF AN LOI?

The purpose of an LOI has a few sides to it. First, it tells the seller that you have a genuine interest in the business. Next, it technically holds the seller up from entertaining another buyer by setting in motion a due diligence period.

The due diligence period allows you to dig deep into the business and also "prove" the seller's claims about the revenue, expenses and operations of the company.

The business purchase letter of intent presents a written offer of the purchase price that has been excepted by both the buyer and seller along with the agreed upon seller financing terms (if any) and any other formally verbal agreements such as how inventory will be handled and if any liabilities will be assumed.

In addition, the contingencies to the sale that the buyer has established will be in this document. These contingencies vary based on the industry, but basically spell out what type of documents the buyer needs to see, what financial factors need to be "proven" true (such as weekly revenues) the ability to obtain a new lease for the property, the ability to transfer any licenses and so on.

Put it all together and this 2 to 4 page document spells out the basis for the final contract should the buyer and seller decide to move to the contract phase.

WHY IS IT NOT "LEGALLY BINDING"

An LOI is a non-binding agreement regarding being completely committed to buying the business with no way out. It's not so much a legal document as it is a blueprint of what will eventually be a legal document at the end of the due diligence period.

DO NOT mistaken the LOI as something that is not taken seriously by the seller and broker. That is why a deposit is taken.

A "good faith" deposit is required with the LOI and is usually from $1000 to $5000 but may vary. This is especially true when working with a broker. This fee is fully refundable if at the end of due diligence (or during it) the seller has a change of heart or the buyer finds that the contingencies in the LOI were not met.

WHY BOTHER WITH AN LOI?

A business purchase letter of intent is truly a necessary document in the buy/sell process.  It sets the tone for the final contract but also lines the buyer and seller up for a smoother transaction. It spells out exactly what is expected from the seller so the buyer can perform the due diligence as well as lays out the major stipulations on paper so there are no mistakes. things such as offer price, note structure, down payments the deposit figure and other important things that need to be part of the deal in order for it to make sense to the buyer.

Also, without it, you may end up getting information very slowly, or not at all. And without it, the seller is wide open to entertain as many other offers as he wants and allow others to perform due diligence as well. This causes an unnecessary rat race to finish as fast as possible doing your due diligence, which is not a good idea at all.

It doesn't need to be, and shouldn't be, an over complicated document as this may turn a seller off but it's also a good barometer. If a seller refuses to acknowledge things you may have verbally agreed to as well as use it as a list of things they need to give you for due diligence, it's a good indicator that the seller has been less than honest with you already and is possibly hiding more. If that's the case, good riddance to the deal.

THE LOI IS SIGNED, NOW WHAT?

Once the business purchase letter of intent is signed, the game is on. The agreement should state that the due diligence period starts as soon as you get all of the requested documents from the seller. After the due diligence process is completed, it's time to adjust your offer price or stick to your guns and move on to the contract phase.

I personally use for myself and clients I represent on the buy side of a deal a simple 2 page LOI. You are better off getting a template like this than trying to make one up yourself or going to a lawyer for something that may be over complicated. 

ONE LAST NOTE

Some attorneys like to convince clients that going straight to the purchase agreement and starting due diligence when it's just about completed is the way to go. This all depends on the deal, the business, the industry and the general complexity of the whole things. Personally, I steer people away from this as bringing in lawyers at this stage can start trouble that's unnecessary as negotiations and details should be worked on with you, the seller, the listing broker and the advisor(s) you are using. Not an accountant or attorney who know nothing of what is going on.

Skipping the LOI doesn't usually speed anything up as now you are putting the timing into the hands of attorneys when you could have just gotten it signed and started due diligence. Honestly, at this point it's a non-binding agreement that also gives you the right to back out or change your offer and you haven't paid a dime in attorney fees. I think most people feel this would be a wiser and less costly process. Don't you?