Letter of Intent

A letter of intent (LOI) is a preliminary, typically non-binding agreement that outlines the key commercial terms of a proposed acquisition: purchase price, structure (all cash or stock), seller financing, earnout provisions, exclusivity period, and timeline to closing. It is a framework document—less detailed than a binding definitive merger agreement, but detailed enough to commit both buyer and seller to a path forward.

Why deals need an LOI

A large acquisition is a months-long process. Before investing USD 10 million in diligence, legal reviews, and management time, both buyer and seller need confidence that they are genuinely aligned on price, structure, and timing. The LOI provides that checkpoint. It says: “We agree on the basic deal. Here is the price, here is how we will pay, here is when we expect to close. Now let’s dig deeper.”

The LOI also establishes exclusivity: the target agrees not to shop itself to rival bidders during a defined window (typically 30–90 days). This is critical to the buyer’s willingness to invest in diligence and financing. Without exclusivity, the buyer is often competing against multiple bidders simultaneously, driving up costs and uncertainty.

For the target, the LOI signals a credible buyer with real intent. If the buyer walks away after signing an LOI, the target may have lost weeks or months of opportunity to approach other bidders. This imbalance is one reason LOIs typically include reverse termination fees or expense-reimbursement provisions to compensate the target if the buyer terminates without cause.

The anatomy of a typical LOI

A letter of intent usually includes:

Parties and definitions – The buyer, the target (or its owner), and sometimes an advisor (e.g., the investment bank representing the seller). Definitions clarify what “EBITDA,” “material contract,” and “closing condition” mean for the deal.

Purchase price – A fixed price per share, or a total enterprise value range with a formula to narrow it. Price is often stated in multiple forms:

• Equity value – What the buyer pays for the business
• Enterprise value – Equity value plus assumed debt, minus cash (used when debt levels are uncertain)
• Implied valuation multiples – E.g., “7.5x EBITDA” or “12x earnings,” signalling reasonableness and benchmarking against comps

Consideration and structure – How the buyer will pay:

• All cash (funded by balance sheet, debt, or equity raise)
• All stock (target shareholders receive buyer stock)
• Mixed (e.g., 60% cash and 40% stock)
• Seller financing (the buyer may pay part of the purchase price by issuing a promissory note due over 3–5 years, common in smaller deals)

Earnouts – Contingent payments tied to post-closing performance. For example, if a software-as-a-service company is valued at USD 100 million upfront, the buyer might agree to pay an additional USD 20 million if the company hits 30% revenue growth in year one post-closing. Earnouts are common when the target’s future is uncertain or when buyer and seller disagree on valuation.

Sources and uses of funds – The buyer’s planned financing: debt financing, equity from the buyer’s balance sheet, equity raise, etc. If the buyer is a private equity firm, this section typically shows the equity commitment from its fund and the debt it expects to raise (usually 4–6x EBITDA for a buyout).

Representations and warranties outline – A high-level sketch of what the target will represent in the definitive agreement. The LOI does not list detailed reps; instead, it flags categories: “The target will represent that its financial statements are accurate, its contracts are valid, and it has no undisclosed litigation.” The full reps are negotiated later in the definitive agreement.

Conditions to closing – Major hurdles that must be cleared:

• Regulatory approval (antitrust clearance, industry-specific approvals)
• Shareholder approval (target shareholders must vote yes, sometimes buyer shareholders too)
• Financing certainty (if the buyer is financing with debt, it must secure commitment letters from lenders)
• No material adverse change (MAC clause; the target must not suffer unexpected deterioration)
• Due diligence satisfaction (buyer reserves the right to walk away if diligence reveals material problems, though LOI language often softens this to “no material adverse effect”)

Exclusivity period – The duration for which the target is bound not to solicit or entertain other offers. Typical windows are 60–90 days; longer periods (6+ months) may be negotiated if detailed diligence is required.

Diligence timeline and schedule – A rough roadmap:

• When the target will provide financial records, tax returns, contracts, and employee information
• When the buyer’s advisors (accountants, lawyers, operations consultants) will access the data room
• When preliminary findings and questions will be exchanged
• Target closing date (e.g., “within 120 days of signing this LOI”)

Public announcements and confidentiality – Agreement on how the deal will be announced (joint press release, timing, key messages). Also, a commitment to keep deal terms confidential unless required by law or SEC disclosure rules.

Expenses and costs – Each party bears its own advisor fees, legal costs, and diligence expenses, unless the deal fails and one party is deemed at fault. Some LOIs include provisions that if the buyer terminates for non-diligence-related reasons, it reimburses the target’s costs up to a cap (e.g., USD 250,000).

Governing law and dispute resolution – Usually the law of Delaware, New York, or the state where one party is incorporated. Many LOIs include a “no litigation” commitment: if disputes arise before closing, they are resolved through mediation or arbitration, not court (to avoid public filings that might disrupt the deal).

Binding vs. non-binding terms

The genius of the LOI is that it can be partially binding. A common structure:

Binding – Exclusivity, confidentiality, expenses, governing law, dispute resolution, and timeline. These terms are enforceable; breach can result in injunctive relief or damages.

Non-binding – Price, structure, earnouts, and detailed conditions. If the buyer and target cannot agree on the definitive agreement, either can typically walk away without penalty. The exclusivity window expires, and the target is free to shop the deal elsewhere.

Some LOIs, however, are entirely non-binding except for confidentiality and exclusivity. Others impose reverse termination fees on the buyer if it walks away for reasons other than diligence findings—a way to compensate the target for lost time and opportunity.

The transition from LOI to definitive agreement

Once the LOI is signed, the legal and financial teams take over. Over the next 6–12 weeks, the buyer’s accountants, lawyers, and operational advisors conduct detailed diligence:

• Financial diligence – Auditing revenue recognition, gross margins, customer concentration, working capital, historical cash flow
• Legal diligence – Reviewing all material contracts (customer, supplier, debt, real estate leases), litigation files, intellectual property registrations, regulatory filings
• Tax diligence – Examining tax returns, identifying exposure to audits or assessments, reviewing structuring options for the acquisition
• Operational diligence – Interviewing management, assessing sales pipelines, supplier relationships, manufacturing capacity, IT infrastructure

As diligence progresses, issues often emerge. A customer loss, a litigation hold, a key employee departure, or an unexpected liability may require renegotiating price or terms. The LOI’s exclusivity period gives the parties time to resolve these issues before signing the definitive agreement. If diligence reveals a major problem, the buyer can usually walk away (though the target may dispute whether diligence findings justify termination versus a price adjustment).

Once diligence is substantially complete and both parties are satisfied, the legal teams draft the definitive merger agreement—a detailed, lengthy document incorporating representations, warranties, covenants, indemnification, and closing mechanics.

The stakes of the LOI

For the buyer, the LOI is a gateway to exclusive access to the target’s financial records and management team. For the target, it is a statement that the buyer is credible and committed—though the non-binding nature of price means the target is not yet assured of the deal.

Disagreement often arises over what “diligence satisfaction” means. If the buyer finds a major customer loss, can it walk away citing a material adverse change? Or must it renegotiate price? The LOI’s language on this—vague or specific—often predicts future disputes. Sophisticated targets insist that material adverse change clauses are narrow and specific; buyers push for broad carve-outs that let them reprrice if anything material changes.

The LOI is also a forcing function for disciplined thinking. By committing to price, structure, earnout formulas, and closing conditions in writing, both parties expose their assumptions to scrutiny. Disagreements that seem small in conversation often become large when written down—a sign that more negotiation is needed before signing the definitive agreement.

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