Letter of Intent to Buy a Business: What Goes In It and What to Negotiate

A letter of intent (LOI) is the bridge between "we'd like to buy your business" and a signed purchase agreement. It sets out the main terms, gives the buyer a period of exclusivity to do diligence, and usually becomes the blueprint for the final legal documents. It's mostly non-binding, but don't let that fool you. Once signed, the terms in an LOI are very hard to change.

This guide covers what goes into an LOI for a private business acquisition, which terms matter most and how to approach the negotiation from either side. It's general information, not legal advice. Use an experienced M&A lawyer.

What an LOI does

• Aligns expectations on price and key terms before both sides spend money on lawyers and diligence.
• Grants exclusivity, so the seller stops talking to other buyers for a set period.
• Sets the diligence process and timeline.
• Signals seriousness, which helps the buyer secure financing and the seller plan.

Some terms are binding, typically exclusivity, confidentiality, governing law and sometimes expense allocation. The economic terms are usually non-binding until the definitive agreement is signed.

The key terms

1. Purchase price

Usually expressed as a headline enterprise value on a cash-free, debt-free basis. Many LOIs also show how the price was derived, such as a multiple of adjusted EBITDA. See our guide to valuing a business with EBITDA multiples.

If the price is based on a specific EBITDA figure, say so. That makes it clear the price may change if diligence finds a different number. Sellers sometimes resist this, but transparency at LOI stage avoids nasty surprises later.

2. Form of consideration

How the price is paid. Common components:

The mix matters as much as the headline number. A $10 million offer with $9 million cash at closing is very different from one with $6 million at closing and $4 million in earn-outs.

3. Deal structure: asset vs share purchase

• Asset purchase: the buyer acquires selected assets and liabilities. Buyers often prefer this because they avoid unknown liabilities and may get tax benefits from stepping up asset values.
• Share (or stock) purchase: the buyer acquires the company's shares, including all liabilities. Sellers often prefer this because of tax treatment and a cleaner exit.

Tax consequences can be significant for both sides and differ by country. Get tax advice before agreeing to a structure. In Canada, for example, the lifetime capital gains exemption on qualifying small business shares often makes a share sale much more attractive to sellers.

4. Working capital

The LOI should state that the business will be delivered with a normal level of working capital, and ideally how that level (the "peg") will be calculated, such as the average over the trailing twelve months. If actual working capital at closing is higher or lower, the price adjusts.

This is one of the most commonly disputed items in small business deals. Getting the method agreed in the LOI saves a lot of argument later.

5. Financing

Sellers want to know the buyer can actually pay. Buyers should describe their sources of funds: equity commitments, lender discussions, seller financing. A financing contingency, where the deal depends on the buyer getting a loan, makes the offer weaker. If you can remove it, your offer is stronger.

6. Due diligence

Describe the scope of diligence (financial, legal, tax, commercial, operational, environmental where relevant) and the expected timeline. Many buyers commission a quality of earnings report as part of financial diligence.

7. Exclusivity

The seller agrees not to solicit or negotiate with other buyers for a period, commonly 45 to 90 days for smaller deals. This is usually binding.

• Buyers want enough time to finish diligence and arrange financing.
• Sellers want it short, with the right to terminate if the buyer changes the price or misses milestones.

8. Employment and transition

Will the owner stay on? For how long, in what role and at what pay? Will key employees receive retention bonuses or new contracts? These terms affect the seller's life directly and are often as important to them as price.

9. Representations, warranties and indemnities

The LOI may outline the general approach: the size of any escrow or holdback, caps and baskets on indemnity claims, and whether representations and warranties insurance will be used. Detailed negotiation happens in the purchase agreement, but setting expectations early helps.

10. Non-compete and non-solicit

Buyers usually require the seller not to compete or poach employees and customers for a period after closing. The enforceability of these clauses varies by jurisdiction, so local legal advice is important.

11. Conditions to closing

Typical conditions include satisfactory diligence, financing, third-party consents (such as landlord or key customer consent to assignment), regulatory approvals and signing of employment agreements.

Tips for buyers

• Be specific. Vague LOIs feel attractive to sellers at first and lead to disputes later. Spell out the basis of your price, the working capital method and the payment structure.
• Don't over-promise. Re-trading the price after diligence damages your reputation with sellers and intermediaries. Offer what you can actually pay.
• Explain your plan for the business. Owners care about their employees and legacy. A short paragraph on how you'll run the company can win a deal at a similar price.
• Keep the timeline realistic. Allow enough exclusivity to finish properly.

Tips for sellers

• Compare offers on cash at closing, not headline price.
• Limit contingent consideration like earn-outs to amounts you'd be comfortable never receiving.
• Negotiate the working capital peg early.
• Keep exclusivity short and tied to buyer milestones.
• Check the buyer's track record. Ask for references from owners they've bought from before.
• Get advisers involved before signing, not after.

A simple LOI outline

1. Parties
2. Transaction overview (asset or share purchase)
3. Purchase price and basis of valuation
4. Consideration (cash, seller note, earn-out, rollover, escrow)
5. Working capital target and adjustment method
6. Sources of financing
7. Due diligence scope and timeline
8. Key conditions to closing
9. Employment and transition arrangements
10. Non-compete / non-solicit
11. Exclusivity period (binding)
12. Confidentiality (binding)
13. Expenses
14. Governing law
15. Non-binding nature (other than specified sections)
16. Expiry date of the offer

After the LOI

Once signed, the buyer runs diligence and both sides' lawyers draft the purchase agreement. Expect questions, requests for documents and negotiations over representations and indemnities. If diligence uncovers material issues, the buyer may propose changes. Handled honestly and early, most issues can be resolved. Handled late, they can kill deals.

Earn-outs: getting the details right

Earn-outs are among the most disputed terms in private company deals. If you include one, the LOI should at least outline:

• The metric: revenue, gross profit or EBITDA. Revenue is simpler and harder to manipulate. EBITDA aligns better with value but depends on how the buyer runs the business.
• The period: commonly one to three years after closing.
• The calculation: including which accounting policies apply and how integration costs are treated.
• Payment mechanics: all-or-nothing thresholds, or sliding scales that pay partially for partial achievement. Sliding scales usually lead to fewer disputes.
• Operating covenants: any commitments by the buyer on how the business will be run during the earn-out period.
• Acceleration: what happens if the buyer sells the business or integrates it so fully that the metric can't be measured.

Common LOI mistakes

• Leaving the working capital method undefined, leading to large price disputes at closing.
• Agreeing a headline price without specifying the EBITDA it's based on.
• Accepting long exclusivity without milestones.
• Not addressing key employees, only to discover late that the deal depends on someone who won't stay.
• Skipping tax advice on asset versus share structure until after signing.