Before You Sign an LOI to Buy or Sell a Business
By Lee A. Mangum, Partner, Cook Pearce Litchford Rector, PLLC
Before signing a letter of intent to buy or sell a business, the parties should identify what is being purchased, evaluate the business at a preliminary level, and agree on the major economic and legal terms. Complete due diligence usually occurs after the LOI, but waiting until the purchase agreement to address deal structure, financing, real estate, liabilities, or price adjustments can lead to expensive renegotiation.
A well-drafted LOI creates a practical roadmap. It should give the parties enough certainty to invest in diligence and documentation without prematurely locking them into a transaction that has not been fully investigated.
What should a buyer investigate before signing an LOI?
The buyer does not need to complete every diligence task before the LOI. The buyer should, however, obtain enough reliable information to decide what it is willing to buy, how the price will be calculated, and what requires further investigation.
An initial review commonly includes:
- The seller's exact legal name, ownership, organizational status, and authority;
- Financial statements, tax returns, revenue sources, expenses, debt, and owner compensation;
- Major customer, supplier, equipment, software, financing, and service contracts;
- Real estate ownership or lease terms, assignment rights, and consent requirements;
- Required licenses, permits, certifications, and regulatory approvals;
- Employees, contractors, compensation arrangements, benefits, and restrictive covenants;
- Liens, litigation, threatened claims, warranty obligations, and insurance history; and
- Intellectual property, trade names, websites, telephone numbers, customer data, and other assets important to continued operations.
The U.S. Small Business Administration's acquisition guidance likewise emphasizes contracts, leases, cash flow, inventory, licenses, zoning, and environmental concerns. The final diligence list should be tailored to the business and its industry.
Is the transaction an asset purchase or an ownership-interest purchase?
One of the first decisions is whether the buyer will acquire selected assets or the stock, membership interests, or other ownership of the operating entity.
In an asset purchase, the agreement identifies the assets being acquired and liabilities being assumed. This may allow a buyer to exclude certain obligations, but it does not eliminate every potential successor-liability issue. Contracts, permits, leases, and other rights may also require assignment or third-party consent.
In an ownership-interest purchase, the buyer acquires the entity itself. Operational continuity may be easier because the entity remains in place, but the buyer generally acquires the company with its existing history and liabilities. Contracts may still contain change-of-control provisions.
Tax treatment can be materially different. Legal counsel and the parties' accountants should coordinate before the LOI fixes a structure or price that creates an unintended result.
What terms should the LOI address?
An LOI should do more than state a purchase price. Depending on the transaction, it may address:
- Whether the deal is an asset or ownership-interest purchase;
- The assets included, assets excluded, and liabilities assumed;
- Cash at closing, seller financing, earnouts, or contingent payments;
- Treatment of inventory, accounts receivable, debt, cash, and working capital;
- Financing and due-diligence contingencies;
- Access to records, employees, facilities, and advisers;
- Treatment of owned or leased real estate;
- Seller transition services and employee matters;
- Restrictive covenants and protection of goodwill; and
- The target closing date and conditions to closing.
The LOI should also identify which provisions are binding. Although many proposed deal terms are nonbinding, confidentiality, exclusivity or "no-shop" obligations, access rules, expenses, and governing-law provisions may take effect immediately.
Why do price allocation and adjustment terms matter?
The headline price does not explain how value will be allocated among equipment, inventory, receivables, restrictive covenants, goodwill, and other assets. Allocation can affect taxes and the parties' economic results. For qualifying asset acquisitions, buyer and seller generally report the allocation on IRS Form 8594.
If price depends on working capital, collections, inventory, an earnout, or post-closing performance, the documents need objective definitions, reliable accounting rules, and a process for resolving disagreements.
How does due diligence shape the purchase agreement?
The LOI is not a substitute for the definitive purchase agreement. Diligence findings help determine the representations, warranties, covenants, closing conditions, and indemnification provisions in that agreement.
An unresolved customer contract may require consent before closing. A lien may require a payoff. Uncertain receivables may justify a collection-based adjustment. A known claim may require a specific indemnity, escrow, or holdback. The parties should also negotiate liability caps, deductibles or baskets, survival periods, and claim procedures. These provisions can be as important as the purchase price.
What should a seller do before going to market?
A seller can reduce delays by organizing corporate records, financial statements, tax returns, contracts, employee information, licenses, insurance policies, and real estate documents before accepting an LOI. Missing signatures, expired contracts, liens, ownership discrepancies, and consent requirements should be identified early.
Most transactions also require coordinated legal, tax, financial, lending, and insurance advice. Bringing that team together before the LOI often produces clearer terms and a more efficient closing.
Frequently Asked Questions
Is a letter of intent legally binding?
It depends on its language. Many LOIs make the proposed transaction nonbinding while making selected provisions—such as confidentiality, exclusivity, access, expenses, and governing law—binding. The entire document should be reviewed before signature.
How long does business-acquisition due diligence take?
There is no universal period. The appropriate timeline depends on the business's size, records, contracts, regulation, real estate, financing, and identified risks. The LOI should provide a realistic period and address possible extensions.
Is an asset purchase always safer for the buyer?
No. It can help define which liabilities are assumed, but some obligations may follow the assets by law, and important contracts or permits may not transfer automatically. The best structure depends on legal, tax, operational, and financing considerations.
Can the parties change terms after signing the LOI?
Usually, nonbinding terms can still be negotiated. Binding provisions may restrict a party, however, and major changes can disrupt financing or expectations. Clear preliminary diligence reduces that risk.
The Law Office of Lee Mangum, a trade name of Cook Pearce Litchford Rector, PLLC, advises business owners on acquisitions, sales, contracts, financing, and related business matters from its Carrollton and Chattanooga offices. Lee Mangum is licensed in Georgia, Tennessee, and Florida.
This article provides general information and is not legal or tax advice. Reading it does not create an attorney-client relationship.
