Is a Letter of Intent Binding When Buying a Business?

What is a letter of intent when buying a business?

An LOI (sometimes called a term sheet or memorandum of understanding) summarizes the deal both sides intend to sign later in a definitive purchase agreement. A typical small business LOI covers price and how it is paid (cash, seller note, earnout), whether the deal is an asset or stock purchase, key conditions such as financing and landlord consent, a due diligence period, the seller's role after closing and a target closing date.

It also usually contains a few operative clauses: confidentiality, a period of exclusivity during which the seller will not negotiate with anyone else, who pays which costs, and which state's law applies. You can see how these fit together in the free letter of intent template, which separates the non-binding deal terms from the binding sections.

Which parts of an LOI are binding?

A well-drafted LOI says expressly which sections bind the parties and that everything else does not. The usual split looks like this:

Can a non-binding LOI still create a legally binding deal?

It can, if the document and the parties' conduct show they intended to be bound. Courts look at the language used, whether all essential terms were agreed, whether anything was left to negotiate, whether either side started performing, and whether the deal is the kind that is usually put in a formal written contract.

The best-known example is Texaco v. Pennzoil (Tex. App. 1987). Pennzoil and Getty Oil's major shareholders signed a memorandum of agreement and announced an agreement in principle; Texaco then bought Getty. Applying New York law, a Texas jury found the Pennzoil deal was binding and awarded more than $10 billion in damages. The document used firm language ("will") and the parties had agreed the essential terms.

Federal courts in New York, following Teachers Insurance & Annuity Association v. Tribune Co. (S.D.N.Y. 1987), recognize two kinds of preliminary agreement: one where all essential terms are agreed and the parties are bound to the deal, and one where they are bound only to negotiate the open terms in good faith. The labels in your LOI matter, but they are not the whole test.

What does a duty to negotiate in good faith really mean?

Some LOIs contain a binding promise that both sides will negotiate the definitive agreement in good faith on the terms set out. That can have teeth. In SIGA Technologies v. PharmAthene (2013), the Delaware Supreme Court held that a party that breaches an express obligation to negotiate in good faith can be liable for expectation damages (the profit the other side would have made) if the court finds the parties would have reached agreement but for the bad faith.

For a seller, this means you cannot sign an LOI with a good-faith covenant, then insist on completely different terms because a better offer arrived. For a buyer, it means retrading the price late in diligence without a real reason can carry legal risk. If you do not want that obligation, the LOI should say neither party is obliged to negotiate or to enter into any agreement.

How long should LOI exclusivity last?

Exclusivity is the binding term sellers most often regret. While it runs, the seller cannot talk to other buyers, and if the deal collapses after months, the seller may have lost its other prospects. Periods of 30 to 90 days are common for small deals, longer if the buyer needs SBA approval.

• Seller: tie exclusivity to a fixed end date, not to "completion of due diligence."
• Seller: let exclusivity end early if the buyer proposes a lower price or materially worse terms.
• Seller: require milestones, such as a lender term sheet within 30 days, to keep exclusivity alive.
• Buyer: ask for an extension right if the delay is caused by the seller's slow document production.
• Both: make sure the no-shop defines what counts as soliciting or negotiating with others.

Why do non-binding LOI terms still matter?

Even though the price and structure are not legally binding, they anchor the negotiation. Reopening an agreed point after the LOI is signed (known as retrading) damages trust and is often resisted. Sellers in particular should make sure the LOI spells out details that commonly shift later:

• Whether the price assumes a normal level of working capital or inventory at closing, and how that is measured.
• How much is cash at closing versus a seller note, earnout or escrow.
• The seller's post-closing role, its length and whether it is paid.
• The seller non-compete's length and geography.
• What happens to cash, receivables and the real estate.

LOI wording: risky vs clear

Risky: "The parties agree to the sale of the Business on the terms above and will sign a formal agreement." Firm language with no non-binding statement invites an argument that the deal is already done.

Clearer: "Except for Sections 9 to 13 (Confidentiality, Exclusivity, Expenses, Governing Law and Termination), this letter is a non-binding expression of intent. No party is obliged to complete the transaction unless and until a definitive purchase agreement is signed and delivered."

Also look for confidentiality obligations that run much longer than the deal process and for a non-solicit of the seller's employees and customers if the deal fails. Both are reasonable in a buyer's LOI, but they should be limited in time and scope.

Should an LOI include a deposit or break-up fee?

In large acquisitions, a break-up fee compensates one side if the other walks away for specified reasons. In small business sales they are relatively uncommon. More often, a buyer working through a business broker pays a good-faith deposit when the LOI or offer is accepted, held by the broker or an escrow agent.

If there is a deposit, the LOI should say exactly when it is refundable. A buyer wants it refundable for any reason during due diligence and if financing or landlord consent fails. A seller wants it to become non-refundable once diligence ends, so the seller is compensated for taking the business off the market. Ambiguous deposit language is a common source of small disputes, and it is easy to fix in a sentence.

Who should draft the LOI, and when should a lawyer see it?

Buyers usually prepare the first draft, sometimes from a broker's form. That gives the buyer control of the first framing of price, structure and conditions, so sellers should not treat the draft as the only option: a counter-proposal at the LOI stage is normal and far cheaper than renegotiating a full purchase agreement.

A lawyer's review is most valuable before the LOI is signed, while the important economic points are still open. Ask your attorney to confirm that the binding and non-binding sections are clearly separated, that exclusivity and confidentiality are limited, and that nothing in the letter commits you to terms you have not agreed. A short review at this stage usually costs far less than unwinding a binding term later.

An LOI feels informal, but it sets the shape of the deal and its binding clauses can be enforced. The Business Purchase analyzer is built for the definitive purchase agreement that follows, where the price split, seller note and indemnity are fixed in an automated review. For the LOI itself, use this short list:

• Does the LOI say clearly which sections are binding and which are not?
• Is exclusivity limited to a fixed number of days?
• Is there a good-faith negotiation covenant, and do you want one?
• Are price, structure, working capital and the seller's role described specifically?
• Does the confidentiality clause have an end date?
• Does the LOI terminate automatically on a set date if no agreement is signed?