A letter of intent arrives after the first conversations and looks like a formality. It says it is non-binding, so it is read quickly and signed quickly, in the wish to move things along. In practice it is the document that sets the rules for the entire process that follows, and parts of it bind completely.
What it usually contains
The subject of the transaction and exactly what is being bought. A price or a range, with the assumptions behind it. The proposed payment structure. Conditions to be satisfied. The scope and deadline of diligence. A timetable to signing. Exclusivity. Confidentiality. Allocation of costs. Letters vary in length, but almost every one covers those nine items.
What binds and what does not
The price and the intention to transact do not bind. The buyer is not obliged to buy, the seller is not obliged to sell, and the price normally changes after diligence. That is why the letter carries its non-binding label.
What does bind, usually set out expressly in a clause near the end, are the provisions on confidentiality, exclusivity, costs, governing law and dispute resolution, and sometimes a fee if one side withdraws for a reason within its own control. Which provisions bind depends on the drafting and on the applicable law, so the letter goes to counsel before signature however harmless it looks.
Exclusivity is what the seller actually gives
By signing exclusivity the seller undertakes not to talk to anyone else for the agreed period. That removes the one thing that reliably holds a price up, which is the existence of another interested party. The buyer knows this. Once exclusivity is granted their negotiating position is materially better than it was before.
Exclusivity is therefore granted short, thirty to sixty days, and extended only where the buyer has genuinely progressed within it. An extension without completed steps is a sign the buyer is stalling. It also helps to state in the letter what the buyer has to achieve during that period for an extension to be considered at all.
A price that is not a price
The figure in the letter is indicative and conditional on diligence. The gap between it and the final price is where owners are most often disappointed, and it rarely arises from bad faith on the buyer’s side. It arises because the letter states only a number and not how that number becomes an amount in a bank account.
The letter should therefore fix the price mechanism and not just the price: whether a locked box or completion accounts apply and the reference date, what is treated as debt, and the basis on which the working capital target is calculated. Those three items are agreed easily while the buyer does not yet have exclusivity, and with difficulty afterwards.
What to insist goes into the text
- The price mechanism and the reference date, named expressly.
- The definition of net debt, including items the buyer intends to treat that way.
- The basis for calculating the working capital target.
- The scope of diligence and the date it ends, so it cannot expand indefinitely.
- The length of exclusivity and the conditions for extending it.
- Who bears which costs if the transaction does not happen.
- What happens to confidential material if the process stops.
The mistakes that cost money
The most expensive is exclusivity with no end date, or one that renews automatically. The second is a price agreed without a mechanism, because every later argument is fought over that. The third is allowing the scope of diligence to grow week by week, which drags the process out while the seller’s position weakens. The fourth is cutting off every other interested party rather than leaving the door open in case this buyer walks away.
Where to go next
- The sale agreement: warranties, escrow and price adjustments
- How to sell a company
- Due diligence: what buyers look for
- How long does it take to sell a company
This describes practice and is not legal advice; which provisions bind is assessed by counsel on the specific text. If a letter of intent has arrived, it is worth reading it as a document about the process rather than a document about price, because the price is negotiated afterwards under the conditions that letter has just set.