Letter of Intent (LOI)

A Letter of Intent (LOI) is a preliminary, typically non-binding agreement that outlines the fundamental terms and conditions of a proposed business acquisition. Think of it as a roadmap for the deal — it establishes the framework for negotiations while preserving both parties' ability to walk away before signing the definitive purchase agreement.

Why LOIs Matter in SMB Acquisitions

In the small business acquisition world, an LOI serves as crucial relationship currency. Sellers receive dozens of inquiries but only 2-3 serious LOIs, making a well-crafted letter your primary differentiation tool against competitors.

Statistical reality: Deals with signed LOIs close at a 78% rate versus 12% close rate for verbal agreements, according to business broker industry data.

Essential Components of an Effective LOI

Purchase Price and Valuation Method

Headline price: Clear statement of enterprise value
Valuation basis: Asset purchase vs. stock purchase structure
Earnout provisions: Performance-based price adjustments (if applicable)
Working capital mechanisms: How inventory, receivables, and payables are handled

Deal Structure and Financing

Cash at closing: Down payment amount and source of funds
Debt financing: SBA loan, bank financing, or seller note components
Contingencies: Financing approval, due diligence satisfaction, lease transfers
Closing timeline: Target date (typically 60-90 days from LOI execution)

Due Diligence Framework

Scope and duration: Financial, operational, legal review (usually 30-45 days)
Access requirements: Books, records, customer lists, employee agreements
Exclusivity period: Buyer's exclusive negotiation rights (60-90 days typical)
Information confidentiality: Non-disclosure and non-solicitation terms

Example LOI structure for $3M EBITDA services business:

Purchase Price: $12M enterprise value (4.0x EBITDA)
Structure: Asset purchase
Cash at Closing: $9M
Seller Note: $3M (6% interest, 7-year term)
Working Capital: $500K adjustment at closing
Due Diligence: 45 days, full financial and operational review
Exclusivity: 90 days
Closing: 75 days from LOI execution

Strategic Elements That Make LOIs Compelling

Personal Connection and Vision

Seller's legacy: How you'll preserve company culture and employee relationships
Growth strategy: Specific expansion plans that demonstrate business understanding
Industry expertise: Relevant experience that reduces execution risk for seller

Financial Strength Indicators

Proof of funds: Bank statements or financing pre-approval letters
Track record: Previous acquisition experience or relevant operational background
Speed to close: Compressed timeline demonstrating preparedness and seriousness

Risk Mitigation for Seller

Employee retention: Commitments regarding key personnel and compensation
Customer relationships: Transition plan for maintaining client relationships
Operational continuity: Gradual ownership transfer with seller consulting period

Common LOI Negotiation Points

Price Adjustment Mechanisms

Working capital pegs: Typical range $200K-$800K for sub-$10M businesses
EBITDA adjustments: Quality of earnings findings that impact valuation
Earnout terms: Performance milestones and measurement periods (usually 2-3 years)

Risk Allocation

Representations and warranties: Seller guarantees about business condition
Indemnification: Claims coverage and escrow amounts (10-15% of purchase price)
Insurance requirements: D&O, general liability, cyber security coverage

Operational Transition

Management consulting: Seller availability for 6-12 months post-closing
Non-compete agreements: Geographic and temporal restrictions on seller
Key employee agreements: Retention bonuses and employment contracts

LOI Red Flags for Both Parties

Buyer Warning Signs:

Financing contingencies beyond 30 days: Suggests inadequate preparation
Extensive carve-outs from purchase price: Cherry-picking valuable assets only
Aggressive earnout terms: >50% of consideration tied to future performance
Unrealistic closing timelines: <45 days without demonstrated financing readiness

Seller Concerns:

Lowball initial offers: >20% below asking price without justification
Extensive due diligence scope: Fishing expeditions rather than focused review
Weak buyer financing: Inadequate personal liquidity or unproven lending relationships
Complex deal structures: Overly sophisticated terms that mask buyer inexperience

Legal Binding vs. Non-Binding Provisions

Typically Binding Elements:

Confidentiality obligations: Protect proprietary business information
Exclusivity provisions: No-shop periods during due diligence
Expense reimbursement: If deal fails due to buyer default
Good faith negotiation: Requirement to proceed reasonably toward closing

Typically Non-Binding Elements:

Purchase price and terms: Subject to due diligence findings
Financing arrangements: Contingent on formal loan approval
Closing conditions: Material adverse change qualifications
Final agreement execution: Definitive purchase agreement supersedes LOI

Industry-Specific LOI Considerations

Professional Services Businesses

Client contract assignments: Transferability of key service agreements
Professional licensing: Individual vs. entity-based credential requirements
Non-solicitation scope: Client and employee restriction terms

Manufacturing and Distribution

Equipment valuations: Third-party appraisals for significant machinery
Supply chain continuity: Vendor relationship transfer agreements
Environmental assessments: Phase I environmental studies for real estate

Technology and Software Companies

Intellectual property transfers: Patents, trademarks, proprietary technology
SaaS metrics validation: Customer churn, lifetime value calculations
Developer transition: Key technical personnel retention requirements

Post-LOI Success Factors

Due Diligence Excellence (30-45 days)

Financial verification: Three years audited statements, monthly P&L trends
Customer concentration: Top 10 customer analysis and contract review
Operational assessment: Process documentation and key person dependencies
Legal compliance: Permits, licenses, employment law adherence

Relationship Management

Seller communication: Weekly update calls during due diligence period
Employee engagement: Early introduction to key personnel (with seller approval)
Customer transition planning: Joint meetings with top 5 customers pre-closing

Financing Execution

SBA loan processing: 45-60 days typical timeline with complete documentation
Appraisal coordination: Business valuation and real estate assessments
Legal documentation: Purchase agreement, promissory notes, security agreements

LOI Success Metrics and Benchmarks

Industry averages for signed LOIs:

Time to close: 73 days median (range: 45-120 days)
Close rate: 78% for deals with signed LOIs vs. 12% for verbal agreements
Price adjustment: 5-15% reduction from LOI price after due diligence (quality of earnings findings)
Deal breakdown causes: Financing issues (35%), due diligence findings (25%), seller remorse (20%), buyer cold feet (20%)

Best-in-class performers:

Close rate: >90% for experienced buyers with demonstrated financing capacity
Timeline compression: 45-60 days for all-cash or pre-approved financing deals
Price stability: <5% variance from LOI to closing (indicates thorough upfront analysis)

Key Takeaways for Buyers

An effective LOI accomplishes three objectives: demonstrates seriousness, establishes fair terms, and creates momentum toward closing. The most successful buyers invest 10-15 hours crafting compelling LOIs that tell a story about why they're the right owner for this specific business.

Common mistake: Using generic templates without customization for the target company. Sellers can immediately identify copy-paste LOIs, which destroys credibility.

Success strategy: Reference specific details from preliminary conversations, demonstrate industry knowledge, and present a clear vision for the business's future under your ownership.

Negotiation approach: Start with reasonable terms rather than extreme positions. Small business sellers prioritize certainty of close over maximizing the last 5% of purchase price.

The LOI represents your first formal step from "looking at businesses" to "buying a business." Get it right, and you've significantly increased your probability of successful closing. Get it wrong, and you've likely lost the opportunity permanently.