So you’ve found someone who’s interested in buying your online business. Congrats!
You know an LOI is typically the next step… but what does that mean, exactly? What should you expect to see in a letter of intent, and how can you ensure it’s written in your favor?
A letter of intent is the first step toward a successful acquisition. So it’s worth taking the time to understand all the ins and outs of this document.
What does LOI stand for, anyway?
What is an LOI in a business sale? The acronym stands for “letter of intent.” Or more fully, a letter of intent to purchase.
A buyer is interested in buying your business…but they need to know more, so they can make a final decision. The LOI is an agreement by the seller to consider a sale to this buyer.
Signing an LOI starts the purchase process and enables the buyer to learn all they can about your business. Then, they’ll make a final decision on whether to buy it.
So what’s in this legal document that opens the doors to letting strangers scrutinize your business’s financials?
Terms spelled out in the letter of intent may include:
- Payout schedule
- Proposed closing date
- A list of assets included in the sale
- A transition plan for key staff, including whether you’ll be required to stay on for a period of time
If this is the first time you’ve dealt with an LOI, you might mistaken this document for a casual expression of interest. In practice, it’s far more important than that, because it spells out the terms under which you’d sell your business if the deal goes through.
If your figures check out, there won’t be a reason to change the sale price. It’ll be what’s spelled out in the LOI, so make sure you’re happy with that number.
Buyers refer to the period after signing an LOI—when the buyer reviews the business in detail—as doing “due diligence.” They’ll learn the ins and outs of your business model and review your financials, to make sure you’re not fudging your numbers. (If the buyer uncovers anything unexpected during due diligence, they might have a reason to suggest a price and terms that differ from what you agreed to in the LOI.)
There’s one more big point to signing the LOI: It defines an exclusivity period for this buyer. During this time, you have to stop marketing your business to other possible buyers, so they have plenty of time to review it and make a decision on whether to purchase.
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How legally binding is an LOI?
While an LOI is a legal document you should review carefully, on the whole, it’s not legally binding. It is an expression of interest in buying your business, not a commitment to buy it.
The main clause that’s legally binding in an LOI is the exclusivity period. You could be sued if you market your business to other buyers, or try to make a deal to sell to a different buyer, during this buyer’s exclusive review time.
However, don’t make the mistake of signing an LOI and thinking you’ll change the details later. While it’s not a legally-binding commitment, if you make promises to your interested buyer about the price or what’s included in the sale, it’ll be hard to change those later.
That’s why you want to review your LOI closely before signing.
How to create a letter of intent
Now that you know what an LOI is, the next question is: How do you write an LOI?
Usually, as the seller, you won’t have to.
Most knowledgeable buyers will have their attorney draft the LOI and send it over for your review. If for any reason your buyer doesn’t present you with an LOI and wants you to draft it, you can find free LOI templates online to get you started, or ask your lawyer for help creating one.
So far, you’ve learned what an LOI is, how legally binding it is, and how it serves as a stepping-stone to your business sale. Now, what could go wrong? Plenty.
9 LOI mistakes to avoid when selling your business
Here are some common problems you might run into as a seller with a letter of intent, plus tips on how to avoid them.
These tips come from Andrew Ritter, an attorney who specializes in small-to-mid-market sales at New York-based Wiggin and Dana, as well as business broker Joe Hogg, managing director at business-brokerage firm Global Wired Advisors in Charlotte, N.C.
You’re not ready to sell
- You’re not emotionally ready. Selling your business is a huge life change. You’ve been your own boss, perhaps overseen a team, and enjoyed the excitement of building something valuable. Are you prepared to let all that go? Some sellers feel pressure to sell simply because they have an offer, but in reality it’s just one of your options. Think carefully about this before an LOI puts you on the road to selling.
- You haven’t built up revenue. Before signing an LOI, you should have spent recent months or even years building up your business so revenue is as high as possible. To get the best sale price, you need to show buyers the business is growing. “Buyers pay for future performance,” says Hogg. “Not current performance.”
- Your papers are not in order. You should also have all your business documentation assembled before you sign an LOI. Don’t have monthly profit-and-loss statements? That’s one of the first things buyers will request.Gather income statements, tax returns, your operations manual, customer lists—everything that explains how your business makes money and documents your revenue. If you sign an LOI before assembling these documents and have to scramble to create them on the fly, those delays may cause the buyer to lose interest.
You don’t take the LOI seriously enough
Because it’s mostly non-binding, some sellers take a casual attitude toward the LOI. Excited at the idea of hitting a big payday, they give it a quick read and sign on the dotted line.
Remember: the terms of your sale to this buyer are defined in the LOI, and they won’t be easy to change later.
For that reason, it’s highly advisable to hire an attorney to review your LOI before you sign. Don’t wait until you get to the sale contract to get a lawyer’s input.
You haven’t tried to find multiple buyers
If you’ve only had one offer—particularly if that offer was unsolicited—you have no idea whether your buyer’s offer is fair, or if they’re lowballing you, notes Hogg. Smart sellers try to attract more than one interested buyer before selecting an offer and moving to create an LOI. The ideal situation is to get into a bidding war, where motivated buyers bid against each other and raise the asking price.
This might involve more marketing time on your part, reaching out to partners or competitors, or signing up on more than one business-sale website. There are also a growing number of business brokers who specialize in helping owners of smaller businesses to find a buyer. Brokers have a network of known buyers they can market your business to, improving your odds of finding more than one buyer. Of course, they also take a commission, so factor that in when you’re considering this option.
You don’t know what your small business is worth
If you’re selling your first business and have never dealt with the world of mergers-and-acquisitions, you’re probably unfamiliar with how businesses are valued for sale. This is another area where a business broker could help, especially if they specialize in selling business in your industry. They’ve helped sell many businesses, so they usually have a strong sense of what fair market value is for a business of your type and size.
Another option for learning what your business is worth is to hire a business valuation specialist. Yes, there are people who do nothing but scrutinize businesses and determine their sale value. Tap their expertise and make sure you get what you deserve in your business sale.
This sounds obvious, but it’s a mistake some entrepreneurs make: if you don’t know how much your business is worth, you shouldn’t be signing an LOI that names a sale price. You could be leaving hundreds of thousands of dollars on the table, and you’d never know it. The buyer certainly isn’t going to tell you your business could command a higher price!
The LOI’s exclusivity period is too long
How long should an exclusivity period be? Hogg likes a tight 45-60 days. If this buyer isn’t going forward with the purchase, it’s best you find out quickly, so you can resume marketing your business to other buyers.
An overlong exclusivity period takes the seller’s attention away from operations, which could cause performance to slump. Meanwhile, other potential suitors may lose interest and move on, motivating you to take whatever this buyer offers.
“We’ve seen LOIs where buyers ask for 180 days,” Hogg says. “This can create an ‘alligator roll,’ where you’re out of the market for so long, the buyer thinks they can lower the purchase price. You’re in a death grip.”
Information access isn’t well-defined
Your LOI should specify exactly what sorts of information the buyer can see during due diligence, says attorney Ritter. Otherwise, the exclusivity period can turn into a bottomless pit of demands for ever more data.
You can also define when in the exclusivity period the buyer can see specific types of information, Ritter notes. Your list of top customers or a buyer’s right to call on top customers, for instance, might be something you want to withhold until the very end of due diligence, when it’s become clear you’re finalizing the sale. Especially if your buyer is a top competitor, you don’t want to hand over your customer list only to see them walk away from the deal with that list in their pocket.
You don’t understand the risks
All sale transactions involve risk, Ritter notes. There may be things the seller or buyer don’t find out during due diligence and only discover after the acquisition.
Post-sale legal squabbles are fairly common. Ritter estimates between one-quarter and one-third of under-$1 million business sales end up with one party accusing the other of misrepresentation post-sale.
For instance, sellers may have an earn-out provision that relies on future sales revenue—but the buyer may not market the business as promised, making the payout lower. Or the seller may have assured the buyer that key customers have signed long-term contracts, but the buyer discovers they’ve expired, leading to lower revenue.
If the IRS audits the business after the sale and discovers the seller wrote off personal expenses as the business’s, whose problem is it, the seller’s or the buyer’s?
Sophisticated buyers understand these risks, and will put language in the LOI to protect their interests. Sellers should think through and anticipate possible risks, too, spelling out consequences of any failure to perform on the buyer’s part.
Material changes don’t kill the deal
What happens if the terms of the deal change during the exclusivity period? Say the buyer decides they want to offer a lower price after due diligence, or they insist the seller remain active in the business for longer than originally agreed in the LOI.
“If they say, ‘I want to pay you 20% less,” says Hogg, “Then the seller should be able to say, ‘Now, you have no exclusivity.’”
Both sides should have the option to walk away if deal terms change, says Hogg. But a buyer-drafted LOI may not spell out that right—another reason you need your own attorney to review it.
You fall prey to deal momentum
Signing an LOI and starting the due diligence process is a lot like hopping aboard a train, says Ritter. Once the train starts rolling, it can be hard to hop off. You’re hurtling towards signing a purchase contract.
What if you decide you don’t like the deal? It’s late in the game. It can seem overwhelming to start the marketing process again, and it might also feel too risky. After all, what if you never find another buyer?
Ritter advises sellers to trust their instincts. If you’ve decided a deal isn’t for you, don’t agree to a purchase at the wrong price or with the wrong buyer.
“Deal momentum is real,” Ritter says. “It’s hard to walk away–but if you don’t walk away from a bad deal, you could end up with seller’s remorse.
As you can see, mistakes in your LOI can impact the price and terms of the purchase. Knowing what you’re doing here, or hiring someone who does, can go a long way toward helping you get the best possible exit.
Before you sign on the dotted line, make sure you’re truly ready to take this important step on the road to selling your business.
We’re reporters, not lawyers. If you need help with a legal matter, please hire a lawyer. The information contained in this piece is provided for informational purposes only, and should not be construed as legal advice.