Non-Binding Letter of Intent to Purchase Business
A non-binding letter of intent to purchase a business conveys the intentions of people involved in a potential business sale agreement.3 min read
A non-binding letter of intent to purchase a business conveys the intentions of people involved in a potential business sale agreement. The letter starts the process towards a sale and makes it clear that the party is interested in purchasing the business. The document is also called a memorandum of understanding or a memorandum of agreement.
Because the letter of intent is non-binding and is simply an agreement to start moving towards a finalized sale, either party can walk away at any point without consequences.
When Do You Need a Letter of Intent?
A non-binding letter of intent explains what information the buyer needs in order to make an informed decision about whether or not to purchase the business. One of the main benefits of a letter of intent is that it grants the buyer “right of first refusal”. This means that the buyer is first in line to make the purchase, even if other interested buyers come out later. This is an advantage for the buyer because it prevents them from investing time and money into the sale only to have the seller choose someone else at the last minute.
It also shows the seller that the buyer is serious and allows them to see more details about the buyer's finances and business experience.
The letter of intent is typically written when both parties agree that they want to move forward with the deal and are ready to look at more specific details and information. The letter of intent starts things in motion to move towards a closing date.
Is a Letter of Intent Legally Binding?
Like the name states, a non-binding letter of intent doesn't bind either party to the deal. Either or both parties can cancel the agreement at any time and stop moving forward with the deal. The letter simply states how the deal will be completed.
However, some aspects of the letter could potentially be binding. An example of this is a clause allowing the buyer the right of first refusal, which would allow the buyer to dispute the letter if the seller doesn't follow the agreement and sells the business to someone else.
How to Write a Letter of Intent
A letter of intent is simply an outline of the process both parties will take to move towards a finalized sale. The situation can change as both parties proceed with due diligence and learn more about the financial status of the buyer and the business. Follow these tips to create an effective letter:
- Keep it short and simple; this isn't the time to go into details
- Avoid legal jargon
- Don't get too specific about any part of the purchase process
- Leave things open in case there are changes before the final sale agreement is finalized
The letter of intent should clearly be identified as such and make it clear that it isn't a binding contract to actually sell the business. In some cases a duty to negotiate in good faith is automatically applied; if not, then it should be included in the letter. This can be especially important in protecting the seller against someone creating the letter simply to collect information about them and their business with no real intention to actually purchase the company.
Both parties should agree and state in the letter if the deal is for stock or assets. Without this agreement, the deal could potentially fall apart if one party thinks they are buying assets and the other party thinks they are selling stock.
Included in the letter of intent could be a purchase price and what that price is based on. It is possible that the price could change as more information is gathered during the due diligence process. Including how the price was originally calculated helps both parties adjust the purchase price fairly.
For a deal involving the sale of assets, the parties should allocate the price of various assets on the balance sheet. How assets are allocated can greatly impact the tax ramifications of the sale. Taxes can make or break a sale, so this information is vital to the deal.
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