What Is a Letter of Intent (LOI) For Buying a Business?
Updated on June 30, 2022
A letter of intent is designed to protect a buyer and seller of a business as they go through the sale process. Letters of intent are custom-made for each business transaction. The terms of an LOI dictate what type of experience you have when going through the process of buying or selling a business.
This is why it’s important to understand what an LOI is, how and when it’s used, and what to expect when using an LOI.
What Is An LOI?
A signed LOI is a preliminary commitment from a business buyer and seller to a future purchase agreement.
Usually, the buyer will produce the LOI and set the terms for the seller to review.
The buyer and seller will negotiate terms that will ensure both parties act in good faith. Together they will iterate on the LOI to arrive at a definitive agreement for a fair business deal.
What Is the Purpose of a Letter of Intent?
The purpose of an LOI is to set the precedent of how the buyer’s due diligence process is going to work and to outline a potential future deal.
Due diligence is the process of evaluating a business. When carrying out due diligence on a business, a buyer will analyze its financials, assets, and liabilities.
An LOI protects the buyer because it allows them access to business information they need to confirm the legitimacy and overall health of the business before making an offer. It protects the seller because the terms of the contract forbid the buyer from sharing or manipulating their business’ data.
Both parties agree to commit to the due diligence process that usually lasts for 30 days. During this time, the seller isn’t allowed to accept an LOI from another buyer. This quality of an LOI is beneficial to buyers as it allows them to deal one-on-one with the seller, without other buyers competing for the business.
Are Letters of Intent Legally Binding?
An LOI usually doesn’t include any legally-binding terms in the agreement. It will include a clear statement that the buyer isn’t obligated to fulfill the preliminary deal exactly as it is proposed. But in most cases, the buyer will only change the deal terms if they notice any glaring flaws with the business.
When Will An LOI Be Used?
A buyer will issue an LOI after they’ve carried out their surface checks on the business and confirmed that it meets their acquisition criteria.
If the seller is going to allow the buyer to carry out due diligence on their business, they need a serious commitment from the buyer. They need to verify the legitimacy of the buyer by confirming they have the funds to buy the business.
What Are the Common Terms For An LOI?
The basic terms of an LOI will outline the proposed due diligence process. This includes a timeframe to completion, the participation requirements of both parties, the preliminary purchase offer, and some information about the proposed transaction.
To protect both parties, a non-disclosure agreement (NDA) is usually included in the terms. This is a contractually-binding element that prevents the disclosure of confidential information as defined in the terms.
There will also be a non-solicitation provision. This is another contractually-binding agreement that prevents employee poaching.
What Are Some LOI Red Flags I Should Be Aware of?
Out in the business mergers and acquisitions (M&A) world, most business owners and buyers act in good faith. However, like in all industries, there are some who don’t act in a fair manner.
As a business owner, it’s important to keep an eye out for savvy business buyers who want to undercut the value of your business or steal its data.
One way some buyers manipulate letters of intent to their advantage is by creating terms that lock the seller into an exclusivity agreement, but not the buyer. In this scenario, the buyer could be looking at multiple businesses at once while the seller isn’t allowed open their business to other potential buyers.
In rare cases, a phony buyer will steal a business’ information. This could be analytics data from a content site or product sales data from an ecommerce store. They’ll sell this information to competitors or use it for other nefarious purposes.
But the most common way we see buyers manipulate an LOI to their advantage is by sending an unsuspecting business owner an offer and attaching a deadline for them to accept.
When a business owner receives an official letter outlining a buyer’s intent to purchase their business for what seems like a huge sum of money, they get excited.
Feeling pressured to avoid missing out on the offer, they accept. But as the buyer goes through their due diligence process, they will pick out flaws with the business and significantly reduce their offer.
In the end, the business owner ends up selling their business for less than its worth.
The moral of the story is when you receive an offer for your business, you should seek professional advice to get an accurate valuation.
How One Amazon FBA Owner Almost Lost $700K on the Sale of Their Business
We had an Amazon FBA owner reach out to us for advice after they had received an offer of $1,400,000 for their business.
We knew their business was worth more than that, so we told them that if they listed with us they would earn a higher sale price.
When we listed the business for sale on our marketplace and connected it with the right buyers, the seller ended up walking away with $2,100,000.
Whatsmore, the initial offer wasn’t for $1,400,000 cash upfront. It included terms where a lower upfront amount would be paid and the rest would be paid over a period of time. The purchase price they secured through us was for $1,800,000 upfront and they got a 5% revenue share for the next 2 years of the business’ earnings after the sale.
This is why we always recommend business owners get a professional valuation from a trusted broker before stepping into the selling process.
Why Using a Trusted Broker is the Best Way to Buy or Sell a Business
The process of acquiring or selling a business is long and laborious. Especially when you do it privately.
As a buyer, you need to draft up an LOI for every business you’re interested in. When you’re searching for businesses, there’s no efficient way to filter out ones that don’t match your criteria.
As a seller, you’re on your own dealing with buyers who want to acquire your business for the lowest price possible.
When you buy or sell a business through Empire Flippers, you transact in a secure environment.
We’ve created an Unlock system that conceals the details of business listings on our marketplace. To see a business’ website and sensitive data, a buyer must first verify their identity and liquidity to confirm they have the funds needed to purchase the business.
This system protects sellers from phoney buyers and tire-kickers. It also makes it easier for buyers to find acquisitions. With other brokers, buyers must file an LOI just to see a business’ website.
This can delay the sale of a business as most letters of intent are valid for a minimum of 30 days. Meaning that if the seller deals with multiple buyers, they have to wait months for their business to be sold.
In our 10 years as a brokerage, we’ve handled over 1,900 business transactions. We have teams and systems in place to make buying or selling a business as efficient as possible.
For buyers, the process starts by creating a free account and using our search filters on our marketplace to narrow in on your ideal business in minutes.
For sellers, the process starts by submitting your business for sale in just a few minutes.
If you’d like any free advice from a professional, then give us a call!
