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Letter of Intent: What is it and Why Do You Need It

signing a letter of intent to buy or sell a business

Toronto business and technology lawyer, Sukhi Hansra,  of Hansra Law, provides some insight into a Letter of Intent to purchase when it comes to buying and selling a business.

A Letter of Intent in a business acquisition is typically the first step towards buying or selling a business. The Letter of Intent helps prepare both the buyer and seller for the transaction and their negotiations.

What is a Letter of Intent to Purchase?

Once you know that it is the right time to buy or sell your business you are ready to start the transaction – and the first step is to prepare a Letter of Intent. The Letter of Intent is a short document outlining the intentions of the parties and the basic elements of the proposed transaction. It can be thought of as an offer to purchase the business or a summary of the negotiations between the parties. This document is typically prepared by the Buyer and provided to the Seller.

Some key items that are typically negotiated and inserted into a Letter of Intent include a list of assets or shares being purchased, the purchase price and how it will be paid (full cash buyout, bank loan or monthly instalments), the proposed closing date, negotiation and investigation periods (often called due diligence periods), assumption or termination of employees, and non-competition and non-solicitation agreements.  

What is the Difference Between a Binding and Non-Binding Letter of Intent?

A Binding Letter of Intent will be treated as a legally binding contract that can be enforced in court. This means that both Parties to the transaction will be bound to follow the conditions within the Binding Letter of Intent. If one person breaks the agreement or any binding clause in the Letter of Intent, he or she may face legal consequences by being forced to fix the breach of contract or pay monetary damages to the other person.

A Non-Binding letter of intent is more of an offer or informational document that helps clarify the basic details of the transaction. When drafted properly, a Letter of Intent is a great way to negotiate an agreement without making any formal commitment to the other party. However, it is important to remember that you will have little power with a non-binding letter of intent to seek a remedy, such as monetary damages, if the other party breaks the agreement.

Sometimes a Letter of Intent will generally be Non-Binding, but it will include some Binding clauses. For example, this is typical where the Buyer and Seller are still negotiating but they want to ensure that the Confidentiality clause is binding on both parties. The binding confidentiality clause will help the buyer and seller negotiate and share information without worrying about losing sensitive business information.

Why Do You Need a Letter of Intent?

Not everything has to be agreed upon and final to prepare a letter of intent. Think of it as an informational document to keep track of your negotiation with the buyer or seller. The key advantage to having a Letter of Intent is that issues that might be deal breakers can be identified early on in the negotiations and resolved. 

Resolving significant issues early on in the process can help buyers and sellers reach a final agreement sooner. This saves both time and money for the buyer and seller, while ensuring that the transaction closes on time.

Once the Buyer and Seller have agreed on the basic items in the Letter of Intent, the next step will be to prepare an Asset Purchase Agreement or a Share Purchase Agreement (depending on what is being purchased exactly) to reflect the final terms of the transaction.

If you are buying a business, selling a business or merging your business with another, these considerations should be discussed with your advisors – legal and accounting before you begin negotiating the price and terms. For sellers, it is best to seek the advice of a business lawyer as soon as you receive a Letter of Intent to make sure you are not accidentally committing to Binding clauses. The cost of a 1-hour meeting to discuss should provide the answers needed to maximize your interests in any transaction.

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