TL;DR
A letter of intent is not just an expression of interest. Exclusivity and confidentiality clauses are legally binding from the moment you sign, and the commercial terms you agree to set the baseline for everything that follows. Know what you are agreeing to before you put your name on it.
A letter of intent is not a binding purchase agreement. Buyers will often tell you that. What they say less often is that several clauses inside it are legally binding, and that the commercial terms you agree to in the LOI form the baseline that the final agreement is negotiated from. Understanding what you are signing matters more than it might appear at first glance.
What an LOI Is and What It Does
An LOI, sometimes called a term sheet or memorandum of understanding, is a document that sets out the key terms of a proposed transaction before the parties invest in full legal documentation. It signals mutual intent and gives both sides a framework for the due diligence and drafting process that follows.
Most of the commercial terms in an LOI are non-binding. The price, structure, and conditions are all subject to negotiation and to the results of due diligence. But some provisions are explicitly binding from the moment you sign.
The Clauses That Are Actually Binding
Exclusivity. Also called a no-shop or standstill clause. This provision prohibits you from soliciting or entertaining other offers during a defined period, typically 30 to 90 days. Exclusivity is almost always binding and it hands leverage to the buyer. They have time to complete diligence while you are locked out of exploring other options. Negotiate the length carefully and understand what triggers an early termination.
Confidentiality. If the LOI contains a confidentiality or non-disclosure provision, it is binding. This restricts what you can say about the deal and to whom, including your employees, advisors, and other potential counterparties.
Governing law and dispute resolution. These provisions specify which province's laws govern the agreement and how disputes will be resolved if the transaction falls apart. They are usually binding and worth reviewing.
The Commercial Terms You Need to Understand
Purchase price and structure. Is the price a fixed number or is part of it contingent on future performance, called an earnout? Earnouts sound like upside but they are often harder to collect than sellers expect. If part of your consideration is contingent, understand exactly what metrics trigger payment and who controls those metrics after closing.
Asset sale versus share sale. These are fundamentally different transaction structures with different tax consequences for the seller and different risk profiles for the buyer. Which one is proposed in the LOI will shape everything that follows. This is a conversation to have with your accountant and lawyer before you sign, not after.
Representations and warranties. The LOI will often describe the scope of the representations and warranties you will be required to make in the final agreement. These are statements about the condition of your business that, if inaccurate, can expose you to post-closing liability. The narrower you can negotiate these at the LOI stage, the better positioned you are in final drafting.
Working capital adjustment. Many LOIs specify a target working capital level as part of the price calculation. If the business delivers more or less working capital than the target at closing, the price adjusts accordingly. Understand how working capital is defined in the LOI and whether the target is realistic given your business's seasonality and operations.
What Owners Get Wrong
The most common mistake is signing an LOI without professional advice because it does not feel like a real agreement yet. The exclusivity period locks you out of other buyers at the exact moment the buyer has maximum information asymmetry. If the deal falls apart during due diligence, you have lost months and potentially damaged your negotiating position with the next buyer.
The second mistake is accepting the buyer's first LOI without negotiating. LOIs are drafts. The buyer expects negotiation. The terms they open with are not the terms they require to close.
What to Do About It
- Do not sign an LOI without a lawyer reviewing it first. The review does not need to take weeks. A business lawyer can turn around a summary of the binding provisions and key commercial risks in a day or two. That is worth the cost relative to what you are agreeing to.
- Negotiate the exclusivity window down. Buyers ask for 60 to 90 days as standard. Push for the shortest period they will accept, and include a mechanism to terminate exclusivity if the buyer is not progressing diligence in good faith.
- Clarify the earnout structure before you sign. If any portion of the consideration is contingent, model out scenarios where you do and do not hit the targets. Understand who controls the decisions that affect whether you collect.
- Involve your accountant on the asset versus share structure question. The tax impact to you as a seller can be significant depending on which structure is used and whether your shares qualify for the lifetime capital gains exemption.
- Read the definition of working capital carefully. Confirm whether cash is included or excluded, how receivables are treated, and whether the target number reflects how your business actually operates at close versus at a seasonal high or low.
The LOI is where deals are shaped, not just where intent is stated. The owners who protect themselves most in a sale are the ones who treat the LOI negotiation with the same seriousness as the final agreement. If you are looking at an LOI and want a financial read on the terms, book a free call at peterxiacpa.com/book.
Frequently Asked Questions
- Is a letter of intent legally binding?
- Partially. Most commercial terms in an LOI such as the purchase price and conditions are non-binding and subject to negotiation. However, specific clauses including exclusivity, confidentiality, and governing law are typically stated to be binding from the date of signing. Always have a lawyer identify which provisions are binding before you sign.
- What is the difference between an asset sale and a share sale?
- In a share sale, the buyer purchases the shares of your corporation and takes on all of the company's assets and liabilities. In an asset sale, the buyer purchases specific assets of the business and typically does not assume existing liabilities. The tax treatment for the seller differs significantly between the two structures. This is a question to work through with your accountant before agreeing to a structure in the LOI.
- What is an earnout in a business sale?
- An earnout is a portion of the purchase price that is contingent on the business achieving specific financial targets after closing, typically over one to three years. It is used when a buyer and seller disagree on the value of future performance. Earnouts can be difficult to collect because post-closing, the buyer controls many of the decisions that affect whether the targets are met. Review the earnout metrics and control provisions carefully before agreeing to them.
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