Evaluating a Letter of Intent
Compare price terms, expected closing cash, retained risks and the buyer’s ability to complete a transaction.
Overview
A letter of intent sets out proposed economics and process before definitive agreements are completed. Review the amount, timing and conditions of payment with the buyer’s ability to close.
An LOI is often largely nonbinding, but selected provisions, commonly confidentiality and exclusivity, may bind the parties. Language and applicable law determine its effect, not its title. Have counsel review it before signing.
Three takeaways
- Move from headline value to proceeds. Clarify enterprise versus equity value, included assets or entities, cash, debt, seller expenses and working capital adjustments.
- Separate closing cash from escrow, seller financing, rollover equity and earnouts. Record each amount, date, condition and ranking; contingent amounts are not closing cash.
- Test financing, diligence, approvals and definitive-document milestones before agreeing exclusivity.
Considerations
- Agree working capital target methodology, included accounts, seasonality and disputes. A shortfall may reduce proceeds; avoid counting the same item in working capital and debt.
- Compare proposals using the same date, financial information and assumptions. Distinguish agreed amounts, estimates and performance-dependent consideration.
- An earnout depends on negotiated metrics, calculation methods, measurement periods and post-closing operating decisions. Rollover remains an investment; escrow release is conditional.
Outcomes depend on the business, market conditions and negotiated documents. Consult your legal and tax advisers about your circumstances.
From enterprise value to closing cash: an illustration
A $30 million enterprise value, plus $1 million of qualifying cash, less $6 million of debt and $1 million of seller transaction expenses, produces $24 million before personal taxes and other adjustments. If $5 million is rolled into equity and $1 million held in escrow, cash released at closing is $18 million.
Illustrative arithmetic only. The example assumes cash is credited to the seller and the working capital adjustment is zero. Actual definitions may differ. Escrow release remains conditional; rollover equity is not closing cash.
Financing, exclusivity and progress
Ask who provides equity and debt, what is committed rather than indicative, and which investment committee, lender, regulatory or third-party approvals remain. Review financing conditions and what happens if funding changes.
Discuss exclusivity duration, permitted contacts, extensions and termination rights with counsel. Agree a timetable, named decision-maker and milestones. Be cautious about extending exclusivity without a clear explanation of remaining work.
Role, liability and closing conditions
Clarify owner responsibilities, transition, compensation, time commitment, rollover, incentives and retention. Restrictive covenants need legal review.
Identify indemnities, escrow or holdbacks, potential insurance, major closing conditions and customer or landlord consents. Ask what can change price, prevent closing or leave you paying expenses if the deal fails.
For information only. This material is not an offer or solicitation, or legal, tax or investment advice. Structures and terms depend on the business, counterparties and definitive documentation.