Letter of Intent or Full Purchase Agreement?

When the time comes to make an offer on a business, there are two choices for the type of  agreement you can present. You can either submit a Letter of Intent (LOI) or Offer to Purchase Agreement (PA).

There are substantial differences between the two and the situation will generally dictate what is best.

What’s the Difference?

An LOI is generally a “non-binding” agreement that simply lays out some initial conditions of the transaction such as price and terms and the timing for future steps of the transaction. It will also refer to subsequent documentation to be presented. Additionally, it can, and should, present a “no-shop” clause which prevents the seller from accepting other offers as long as all of the milestones are met along the way to closing.

LOIs are standard in larger transactions. In smaller deals, the seller and broker can perceive them as not being a serious agreement and may resist tying up the business for any unreasonable length of time. While there is some validity to this perception, it’s not always accurate.

A “full-blown” Offer to Purchase is far more detailed, and will include all of the material deal terms, conditions, representations, warranties. It will also cover non-compete conditions, inventory, financing, training, leases and contracts, etc.

Which One to Use?

Personally, I prefer and recommend that a detailed Offer to Purchase Agreement is used whenever possible. Doing so allows you to set forth all of the terms you are prepared to offer, and eliminates a lot of the ambiguity that can surface later on.

On the other hand, there are times when an LOI makes more sense. This can be when:

• You have not yet received adequate information to present an offer on all points.
• The business has attracted a lot of interest and you want to tie up the deal quickly
• There are certain conditions that still need to be negotiated
• The buyer does not believe the seller is serious and wants to get them to play their hand
• The buyer and seller are far apart on their individual valuations and you want to learn if there is any possibility of a deal before spending substantial legal fees

On the last point above, regardless if you use an LOI or PA, you must have it reviewed by an attorney.

Although an LOI is a non-binding document, a buyer should not look at it as anything less than a true commitment and the seller should address it as a serious initiative. Both parties should use it as a platform to demonstrate their mutual sincerity to getting a deal done together.

Buyers should familiarize themselves with the contents of both of these agreements so they are properly informed and can utilize the most effective document for the particular situation.

While both agreements have their place, if an LOI is used, it should simply be a short-term solution. In other words, once you have an LOI signed, everyone should move expeditiously to finalize all other deal points and memorialize the terms in a bona fide Offer to Purchase Agreement.