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.

Comments

[Greg Kells]

Use of an LOI or a standard offer form containing all of the standard clauses with many condistions for the benifit of the buyer and enough for the seller to opt out will substantially reduce the legal costs of finding the appropriate business and will save a lot of time for the buyer and seller. The LOI needs to outline the terms of sale and is used as the negotiating document. It needs to be accompanied by a meaningfull, refundable, deposit payable to the Broker (In Trust)and needs to have easy outs for both buyer and seller. Diligence should involve the purchasers lawyer and accountant but the drafting of the Agreement of Purchase and Sale should be undertaken after diligence has been completed. The diligence should address operations, financials, legal, and marketing. The drafting of the Agreement of Purchase and Sale should be done by the buyers lawyer with the drafting of the security documentation done by the sellers lawyer. You will not know enough prior to diligence to draft an effective Agreement of Purchase and Sale and will be wasting your time, the time of the Lawyers, and your money. I have sold hundreds of businesses and know that if at the closing we do not have a seller who wants to sell and a buyer who wants to buy no amount of documentation is going to make the deal work. Generally the seller needs to provide a training and transition program for the buyer and is providing some of the financing of the transaction. An LOI will get them to the point that they each know what they should know before signing tha Agreement of Purchase and Sale

[Marc]

Have you ever been hurt by using a LOI instead of a PA? Obviously a LOI can be great to use if you don't know much but are intrigued by the company, but I wonder about the cons of using it over a PA.

FROM RICHARD: Never been hurt by it except when a seller is expecting a full purchase agreement. Personally, I prefer a full PA but it is not always feasible and an LOI can often tie up the business for the buyer early on