Avoid Common LOI Mistakes
Written By Adam Yohanan
When you do M&A deals — i.e., buying or selling a business — you inevitably get involved with letters of intent, also known as LOIs.
LOIs are essentially summaries of the key terms of big deals. They outline the deal so the parties can move forward with diligence and drafting. LOIs are legally non-binding, except for certain parts, so many people do not take them seriously. This is a big mistake.
LOIs might not be legally binding but they are morally binding and difficult to contradict in practice. Backtracking on LOI terms later can erode the other party’s trust in your credibility and hurt your negotiating position.
Today’s newsletter is about how to approach LOIs before and after you sign them.
The first key mistake in an LOI is over-promising and changing deal terms after signing the LOI.
For example, the LOI promises a 15-mile non-compete but the purchase agreement demands 40 miles, or the LOI specifies a stock sale but you push for an asset sale. These changes can feel like broken promises to the other party, undermining trust and credibility.
The second key mistake in an LOI is being silent or too vague on critical points.
LOIs are not meant to be comprehensive, but not mentioning essential terms can lead to friction later. You don't want to invest too much time and money into a deal process that might get blown up later because the parties are not aligned on key terms.
When you draft your LOI, sort the key terms of the final document into three categories:
Terms you must address in the LOI.
Terms you should address in the LOI.
Terms you could address in the LOI.
In the M&A context, the three categories of LOI terms can be split up as follows:
1. Essential LOI Terms (Must Be Addressed)
Price: The purchase price must be clearly stated, including how it will be calculated. For example, if it is a flat cash payment, say that. But if you expect an annuity or an earn out, say that instead.
Binding Terms of the LOI: Clearly define any provisions that are legally binding, such as confidentiality and exclusivity.
2. Important Terms (Should Be Addressed)
Deal Structure: Is the deal an asset sale or stock sale? While detailed mechanics can be addressed later, identifying the structure early avoids surprise tax implications.
Existence of Key Terms: Clarify whether critical provisions will be included in the final deal:
• Working capital adjustments.
• Escrow holdback amounts.
• Indemnity obligations.
But don't necessarily address every detail of those terms. You can save the details for the full agreement.
3. Optional Key Terms (Can Be Addressed in LOI)
Specifics of Working Capital Adjustments: Detailed formulas or benchmarks for adjustments.
Escrow Holdback Details: Exact percentage or timeline for release.
Indemnity Cap and Basket: Precise limits and thresholds for indemnity claims.
By focusing on the existence of these terms in the LOI rather than their specifics, you leave flexibility to negotiate later while avoiding the perception of backtracking.
Adam Yohanan is a transactional business lawyer with extensive experience representing companies, investors, and entrepreneurs in a wide range of high stakes business transactions.
Adam handles the small and large transactions in the life of a businesses, including mergers & acquisitions, entity formations, partnerships and joint ventures, investing and fundraising, commercial contracts, and dissolutions. His office can be reached at 212-859-5041.
Haley Kopp is a corporate lawyer focused on representing start-ups and small companies in formations, venture capital, angel investor financings, mergers and acquisitions, and general corporate matters.
Haley's diverse experience gives her a practical approach to solving complex business issues, whether guiding companies through financing rounds or corporate transactions. Her office can be reached at (619) 512-3652.
This guide is meant for educational and informational purposes only and should not be considered legal advice. It is essential to consult with an attorney or other advisors regarding all legal and other important matters.
