What Is a Letter of Intent?

Businesses exist to interact with other businesses as well as their customers. Whenever two companies do business together, they need a contract. Before they have a contract, they need something to memorialize their agreement. This is a "letter of intent."

A letter of intent is sometimes called an "agreement to agree." It is a documentation of the understanding between the parties about their business transaction. A letter of intent, or "LOI," is not a binding agreement but can serve as the basis for a contract. The LOI, if properly written, has everything you need to write your contract.

Letters of Intent Defined

LOIs are often seen during mergers or business acquisitions. The companies meet to agree on the basic terms of the business purchase before coming to a final agreement. An LOI must include enough concrete details to show a "meeting of the minds" between the parties but make it clear this it is not meant to be a full contract.

LOIs are also used for joint ventures, as companies lay out their expectations for themselves and the other parties. Letters of intent may be part of grant applications, showing how the applicant intends to reach out to additional funders or how the project will proceed.

The structure of a letter of intent is like a contract and may contain similar clauses. However, they must be non-specific. An LOI can become a contract if it is too specific and appears to be a final statement of intent.

Outlining a Letter of Intent

The purpose of a letter of intent is to give the parties a starting point for the due diligence process. When businesses begin a venture, they start by investigating the possibilities of the venture. They then need to perform their due diligence on the company they're doing business with to be aware of its track record and benefits.

An LOI is a business letter, not a contract, written without boilerplate clauses. It should contain some key paragraphs, including:

• Statement of purpose. The LOI should open with an explanation of the reason for the document and the effective date. Key terms should be defined.
• The governing law used for the transaction, whether federal or state, should be identified in case of litigation.
• Parties to the proposed transaction. The primary parties need to be clearly labeled if this is a merger or acquisition.
• The type of transaction and a general timeframe agreed to by the parties. For instance, a merger that announced in two weeks and completed in about six months.
• Confidentiality agreements are frequently included in LOIs. Mergers and joint ventures are often confidential information. It is reasonable to keep them under wraps until the official announcement. A non-disclosure agreement may be part of the ordinary course of business.
• Restrictive covenants are not required, but many businesses use them. Non-compete agreements are used when the due diligence process may reveal customer information to the other party. LOIs regarding real estate may include a requirement for an escrow before the discussion can proceed.
• The parties should include a closing date or deadline and state that the agreement will be void if not finalized by that date.

If the agreement is straightforward, business owners can use a letter of intent template. These are available online. If the deal exposes them to any liabilities or involves anyone besides the two parties, it's best to have an attorney draft the LOI.

Unintended Contracts

A letter of intent is not a legal contract, but it is a legal document and can become a definitive agreement if the parties are not careful. Some things to watch out for in a letter of intent include:

• Ambiguous or unclear disclaimers. If you have a disclaimer stating "except as otherwise provided," your LOI is not intended to be binding; it's best to state which provisions are not binding.
• Stating you are negotiating "in good faith." Courts have coupled this with other statements to create a final agreement you did not intend.
• Mandatory phrases like "must" or "shall," which are contractual statements. Use permissive phrases like "may" or "could."
• Partial performance or detrimental reliance on the LOI that can convert it into a contract. If one party must open an escrow account before the agreement becomes final and the deal falls through for some other reason, you may still have a deal if the escrow is not refundable.
• Subsequent language referring to a "final agreement" or "final contract" in emails or other correspondence, as they may be evidence of a contractual obligation. Be careful how you discuss your pending transaction.

In cases of real estate purchases, less is better. An LOI should contain the bare minimum of interest in purchasing the property. Otherwise, the courts may find it is a purchase agreement, not a letter of intent. If your LOI contains the purchase price, a property description, a closing date, and the terms of the deal for payment, it is not an LOI. It is a contract for sale, and the courts will enforce it.

Term Sheets and Memorandum of Understanding

A term sheet is a non-binding bullet-point document listing the terms and conditions of a business sale or negotiation. A term sheet is like an LOI, but it contains only the terms of the deal. It is a standardized format that allows investors and entrepreneurs to compare the aspects of multiple deals.

A memorandum of understanding (MOU) is a document that emerges after a letter of intent. The MOU formalizes the terms of the LOI before the parties write the contract. Use an MOU to get numerous approvals before signing a contract. When the negotiation process is nearly at an end and the business deal is complete, the MOU memorializes the agreement.

Consider Seeking Professional Legal Advice

Making a mistake on a letter of intent could become a disaster for you. If your small business is preparing for a major transaction like a merger or acquisition, it's wise to consult a good business lawyer first. To get legal help with all stages of business transactions, including drafting a letter of intent, consult an attorney specializing in mergers and acquisitions.