The letter of intent — commonly called the LOI, and sometimes referred to as a term sheet or memorandum of understanding — is the document that memorializes the parties’ preliminary agreement to move forward with a transaction on specified economic and structural terms. It is signed after the seller has selected a preferred buyer but before the definitive purchase agreement is negotiated. The LOI is not the deal; it is the framework for the deal. But because it shapes the negotiation of the definitive agreement and because certain of its provisions are legally binding, it deserves far more attention than many business owners give it.
What the LOI Covers
A typical M&A letter of intent addresses purchase price and the method of payment (cash at closing, deferred consideration, rollover equity, or earnout components), deal structure (stock purchase, asset purchase, or merger), the treatment of existing indebtedness and working capital, the proposed timeline to signing the definitive agreement and closing, the conditions that must be satisfied before closing, key representations and warranties the seller will be expected to make, the general framework of indemnification, any employment or equity arrangements for continuing management, and the exclusivity period during which the seller agrees not to negotiate with other buyers.
Most of these terms are stated to be non-binding — they reflect the parties’ current intentions but impose no legal obligation to consummate the transaction or to agree to specific terms in the definitive agreement. The typical LOI contains explicit language stating that the parties do not intend to be legally bound except with respect to specifically enumerated provisions. This structure gives both parties the flexibility to walk away if the definitive agreement negotiation produces irreconcilable differences, while still creating a common understanding of where the deal stands at the time of signing.
Which Provisions Are Binding
The binding provisions in an LOI typically include the exclusivity or no-shop obligation, the confidentiality agreement (if not separately documented), expense allocation (including whether the parties will bear their own costs or whether one party will pay the other’s costs under defined circumstances), governing law, and any break-up or reverse break-up fee arrangements. These provisions are singled out for binding treatment precisely because they are most likely to be invoked if the transaction does not proceed to closing.
The binding nature of the exclusivity provision is particularly important and will be discussed in detail below. The binding nature of the confidentiality provision is also significant: sellers routinely share highly sensitive financial and operational information with prospective buyers during due diligence, and a binding confidentiality obligation ensures that information cannot be misused if the deal does not close.
Exclusivity and No-Shop Provisions
The exclusivity provision — sometimes called a no-shop clause — is one of the most strategically significant provisions in the letter of intent. It obligates the seller to negotiate exclusively with the signing buyer for a specified period, typically 30 to 60 days, and prohibits the seller from soliciting, discussing, or entering into any agreement with any other potential acquirer during that period. For the buyer, exclusivity is an essential pre-condition to investing the time and resources necessary for full due diligence and definitive agreement negotiation. For the seller, exclusivity represents a surrender of leverage that should be given only after careful consideration.
Sellers should resist open-ended or automatically renewable exclusivity provisions. The exclusivity period should be defined, and it should expire automatically if the buyer fails to proceed in good faith or if a definitive agreement has not been signed within the period. Some sellers negotiate for a “walk-away” right if the buyer fails to meet defined milestones during the exclusivity period, such as completing due diligence by a specified date or delivering a first draft of the definitive agreement within a stated timeframe.
The scope of the no-shop obligation is also a point of negotiation. Buyers typically want a broad prohibition on any contact with other potential acquirers, including any discussion that could be characterized as soliciting interest. Sellers, and particularly those with boards of directors that have fiduciary duties to shareholders, may want a fiduciary out that permits the board to respond to an unsolicited superior proposal if one emerges during the exclusivity period. Private company sellers without institutional investors rarely insist on this carve-out, but sellers with minority shareholders or outside investors often do.
The LOI as a Precedent-Setting Document
One of the most important — and most underappreciated — functions of the LOI is its role in establishing precedent for the definitive agreement negotiation. Once a seller agrees to a specific economic term or structural point in the LOI, it is very difficult to walk it back in the definitive agreement without giving the buyer grounds to argue that the seller is renegotiating an agreed term. Buyers routinely exploit this dynamic by treating the LOI as a floor for their position on any given issue and by seeking additional concessions on top of what the LOI already provides.
For this reason, experienced M&A counsel consistently advise sellers to negotiate the LOI as carefully as if it were the definitive agreement, including on issues that might seem like secondary concerns at the time. The indemnification cap stated in the LOI — whether 10 percent or 30 percent of the purchase price — will be the starting point for the definitive agreement negotiation, and moving the buyer off that stated position after exclusivity has been granted is an uphill battle. The basket (the threshold of losses the buyer must absorb before indemnification obligations kick in) will be treated similarly. Even the framing of which seller representations are described as “fundamental” in the LOI can have downstream consequences for how strenuously the buyer argues for enhanced indemnification protection for those representations.
Sellers should therefore resist the temptation to view the LOI as a quick preliminary document that can be revised later. The more detail that can be included in the LOI — and the more favorable that detail is to the seller — the better positioned the seller will be in the definitive agreement negotiation.
Price and Structure in the LOI
The purchase price stated in the LOI is typically an enterprise value or equity value number, stated as a range or as a specific amount that is subject to customary adjustments. The LOI should specify whether the price is enterprise value (which will be reduced by net debt and adjusted for working capital) or equity value (which has already incorporated those adjustments). This distinction matters enormously: a stated price of $50 million that is an enterprise value number could produce significantly different net proceeds to the seller than a $50 million equity value number, depending on the amount of the company’s debt and working capital at closing.
The LOI should also specify the deal structure — stock purchase, asset purchase, or merger — and any planned elections under Sections 338(h)(10) or 336(e) of the Internal Revenue Code. If the buyer is seeking a deemed asset sale election, the seller should ensure that the price in the LOI reflects the gross-up for the seller’s incremental tax cost, or at minimum that the LOI acknowledges the buyer’s obligation to negotiate that gross-up in the definitive agreement.
Earnout and Deferred Consideration
When the parties have different views on the value of the business — typically because the seller is projecting optimistic future performance that the buyer is not willing to pay for upfront — the LOI may include an earnout as part of the consideration. An earnout is a contingent payment that the buyer agrees to make after closing if the business achieves specified financial or operational milestones during a defined period. The LOI should describe the earnout structure in at least general terms: the total amount, the performance metric (revenue, EBITDA, or another measure), the measurement period, and the major covenants the buyer will be required to comply with in operating the business to give the earnout a fair chance of achievement.
Earnouts are discussed in detail in a separate article on this website, but at the LOI stage the key point is that sellers should resist accepting an earnout as a substitute for a higher upfront price without understanding the risks. Earnouts are frequently disputed post-closing, and buyers who control the operations of the acquired business have significant influence over whether earnout milestones are achieved. The LOI-level commitment to an earnout, including its governing terms, should be as specific as possible.
Break-Up Fees and Reverse Break-Up Fees
In some LOIs, particularly in larger transactions or those involving financial buyers, the parties agree to break-up fee arrangements that provide some economic protection if the deal does not close. A break-up fee (also called a termination fee) paid by the seller to the buyer protects the buyer against the risk that the seller walks away after the buyer has invested significant due diligence resources. A reverse break-up fee paid by the buyer to the seller protects the seller against the risk that the buyer fails to close — most commonly because of financing failure or regulatory clearance issues.
These fees are a particularly important negotiating point in deals where there is meaningful deal completion risk. Sellers who accept a reverse break-up fee in lieu of the right to seek specific performance should understand that the fee represents the ceiling on their recovery if the buyer fails to close, regardless of the actual damages they suffer. Conversely, buyers who pay a break-up fee should understand that in some courts, paying the fee may be the buyer’s sole obligation upon termination, even if the seller can demonstrate greater actual damages.
The Tactical Use of the LOI
The LOI is not merely a reflection of the current state of negotiations; it is a strategic tool. Sellers who are running a competitive process can use the existence of multiple LOIs or term sheets to create competitive pressure on their preferred buyer. Buyers who want to lock in favorable terms before the seller engages other parties will try to move quickly to LOI. Both sides use the LOI to establish anchoring positions on key economic terms that will be difficult to dislodge later.
From the seller’s perspective, the most important tactical use of the LOI is to resist the granting of exclusivity until the maximum number of issues have been resolved in the seller’s favor. Every additional term that the seller can get into the LOI before exclusivity is granted is a term that the buyer will have difficulty walking back once the competitive dynamic disappears. Sellers who are advised by experienced M&A counsel will use the pre-exclusivity period to negotiate as much specificity as possible into the LOI — not just on price but on indemnification framework, working capital methodology, key closing conditions, and the treatment of management equity — before agreeing to stop talking to other buyers.
Understanding the letter of intent for what it truly is — not a preliminary document but the foundational framework for the entire deal — is essential for any business owner navigating a sale process. The time and care invested in negotiating the LOI will pay dividends throughout the months of definitive agreement drafting and negotiation that follow.