What a letter of intent is
A letter of intent sets out the price and shape of the transaction before counsel write the definitive agreement. The element first-time sellers find counterintuitive is that the price is usually non-binding while the seller's obligations usually are binding. The buyer is not yet committed to buying; the seller is committed, from signature, to negotiating only with that buyer.
Exclusivity is what is being granted
The binding clause is exclusivity: for a set period, the company is taken off the market while the buyer verifies everything. It is a reasonable request from a serious buyer. It is also the moment leverage transfers to the buyer, because the alternatives have agreed to stop for the duration.
The consequence is one of the few simple rules in this process: every term that matters is negotiated before the LOI is signed, while alternatives exist. Anything left vague is resolved during exclusivity, and during exclusivity vague terms tend to resolve in the buyer's favor.
The same price, four different deals
The same headline price can arrive in any of the following forms, and they are not worth the same:
- All cash at closing. The cleanest form and the rarest, and typically worth accepting a somewhat lower headline to obtain.
- Most at closing, the rest as an earnout. The last part arrives only if the company meets targets after closing, under an owner who is no longer the seller. The deal is best judged at its cash at closing, with the earnout as possible upside.
- Most at closing, the rest as a seller note. The seller lends part of the price to the buyer, repaid over time and secured by a company the seller no longer controls. Sound when the buyer is strong; the seller may ask for the same evidence a bank would.
- The full price, with part held in escrow. Standard mechanics, but the amount and the duration are negotiable, and the working capital peg beside them can move the price materially in either direction.
Questions to ask before signing
- How much is cash at closing, as opposed to earnout, note and escrow?
- Is the buyer's financing committed, or still to be arranged? An LOI contingent on financing that does not yet exist is an aspiration with an exclusivity clause attached.
- How is the working capital peg calculated, and by whom?
- What happens if diligence runs past the exclusivity period: does it extend automatically, or does the seller regain leverage?
- How long must the seller stay after closing, and on what pay?
None of these questions offend a serious buyer, who answers them routinely. The parties the questions inconvenience are the ones the questions exist to reveal.
Where this fits: the offers step, before anything is signed, which is where comparing offers side by side on their terms matters most. Next in the series: what happens after signing.