When navigating a business acquisition or merger, the Letter of Intent (LOI) serves as one of the most critical documents in the process. It outlines the key terms of the proposed transaction and establishes a framework for negotiations between the buyer and the seller. Although not always legally binding in its entirety, the LOI sets expectations, provides structure, and significantly influences how the deal progresses from preliminary discussions to final closing.
This guide examines the role of the LOI, distinguishes between binding and non-binding provisions, explains the essential deal points typically included, and reviews the standard timeline from LOI to closing. It also provides an overview of potential red flags that both parties should recognize before committing to the transaction.
The Role of the Letter of Intent
The LOI functions as a roadmap for the transaction. It enables the parties to reach an agreement on major terms before devoting substantial time and resources to due diligence and drafting definitive agreements. By clarifying the framework at an early stage, the LOI minimizes uncertainty and helps avoid misunderstandings.
For sellers, the LOI clarifies the buyer’s intentions with respect to valuation, the nature of the acquisition, and the obligations that will remain in place after closing. For buyers, it creates an opportunity to negotiate protections such as purchase price adjustments, indemnities, and transitional support before making a full commitment. While the LOI is preliminary, it is far from a mere formality, as it establishes the foundation upon which the final agreements will be built.
Binding and Non-Binding Clauses
One of the most important distinctions in an LOI is between binding provisions and those that are not. In most cases, the substantive deal terms, such as price and structure, are non-binding. This means that signing the LOI does not legally obligate either party to close the transaction.
Nevertheless, LOIs usually contain provisions that are intended to be binding regardless of the outcome of the deal. These frequently include confidentiality commitments, which protect sensitive business information shared during negotiations, and exclusivity or “no-shop” clauses, which restrict the seller from soliciting or engaging with other potential buyers for a specified period. Binding provisions may also include governing law, jurisdiction clauses, and agreements about the allocation of transaction expenses. The LOI needs to specify which clauses are binding and which are not, since ambiguity at this stage can create significant legal and financial risk later.
Key Deal Points
Several major components of the transaction are typically outlined in the LOI. One of the most important is the purchase price and the structure of the deal. The LOI should state clearly whether the transaction will take the form of an asset purchase, in which specific assets and liabilities are acquired, or an equity purchase, in which ownership interests in the entity are transferred. Each option carries different tax and liability consequences, and clarity at this stage is essential.
Working capital requirements are another key issue. Buyers often insist that a business deliver an agreed level of working capital at closing to ensure its continued operations. The LOI should explain how this working capital will be measured, how adjustments will be handled, and whether there will be any post-closing reconciliation.
The treatment of accounts receivable is also significant. In some transactions, the buyer may insist on holding back a portion of the purchase price until certain receivables are collected. This protects the buyer from paying for accounts that may ultimately go uncollectible. The LOI should describe how receivables will be valued and the conditions under which holdback amounts will be released.
Non-compete provisions are often included to preserve the value of the acquired business. These clauses prevent the seller from competing in the same industry or geographic area for a specified period of time. While the enforceability of such provisions can vary, addressing them at the LOI stage ensures that the parties are aligned on this issue before moving forward.
Finally, many transactions require a transition period in which the seller assists the buyer to ensure a smooth handover. This may involve training staff, introducing clients, or remaining in a limited operational role for a defined period. Addressing the scope and duration of transition obligations in the LOI reduces the risk of future disputes.
Timelines from LOI to Closing
The process from signing the LOI to closing the transaction generally follows a structured path. First, the parties execute the LOI and confirm the principal deal terms. This is followed by a due diligence period, which usually lasts between thirty and ninety days, during which the buyer conducts a comprehensive review of the target’s financial, legal, and operational matters. Once due diligence is completed, the parties negotiate and draft the definitive agreements, including the purchase agreement and any ancillary contracts.
If the deal requires regulatory or third-party approvals, such as consent from lenders, landlords, or government agencies, these must also be obtained before closing. The transaction then concludes when all conditions are satisfied, final documents are executed, and funds are transferred. While most transactions proceed from LOI to closing within sixty to one hundred twenty days, larger or more complex deals may require additional time.
Recognizing Red Flags
Because the LOI sets the framework for the deal, both parties should carefully evaluate its terms for potential risks. Certain issues should raise concern if not addressed properly. For instance, vague or ambiguous purchase price language can create confusion about valuation. A lack of clarity on whether the deal is structured as an asset purchase or equity purchase may expose parties to unintended tax or liability consequences. Similarly, non-compete provisions that are overly broad may prove unenforceable, creating future uncertainty.
Other areas that warrant close review include the working capital provisions, particularly if the requirements or adjustment mechanisms are not well defined, and any accounts receivable holdbacks that lack clear release conditions. Transition obligations should be described with enough specificity to prevent future disputes, while exclusivity clauses must be proportionate in scope and duration. It is equally important to ensure the LOI clearly distinguishes between binding and non-binding terms, establishes a method for resolving disputes, and specifies how expenses will be handled if the transaction does not close.
The Letter of Intent is a critical milestone in any business transaction. It clarifies the structure of the deal, establishes expectations for both parties, and sets the stage for negotiations that follow. By addressing binding versus non-binding clauses, clearly defining purchase terms, and carefully reviewing all deal points, both buyers and sellers can significantly reduce the risk of future disputes. Taking time at the LOI stage to identify and address potential red flags ensures that the path from negotiation to closing is both efficient and productive.
How Leiva Law Firm Can Help You
At Leiva Law Firm, we understand the importance of structuring Letters of Intent with clarity and precision. Our attorneys have extensive experience in guiding clients through mergers, acquisitions, and business transitions, ensuring that every critical detail is addressed. If you are preparing to enter into a transaction, we can assist you in reviewing your LOI, identifying areas of risk, and safeguarding your interests throughout the process.
Contact Leiva Law Firm today at (818) 519-4465 to schedule a consultation with our Los Angeles lawyer and learn how we can support you in achieving a smooth and successful transaction.
