Decoding the Purpose of the Letter of Intent in Mergers & Acquisitions

In mergers and acquisitions (M&A), the Letter of Intent (LOI) is often heralded as a pivotal milestone. Many practitioners and dealmakers focus intensely on “getting to the LOI,” sometimes treating it as the ultimate objective in the early stages of a transaction. However, this approach risks misrepresenting the LOI’s true function and may inadvertently distract from the broader, more critical phases of the deal process. This article seeks to decode the real purpose of the LOI in M&A transactions, dispel the overemphasis on its significance, and provide a comprehensive, fact-based perspective on its role as a transitional, not terminal, step on the path to a successful deal.

What is a Letter of Intent (LOI)?

A letter of intent (LOI) is a largely non-binding agreement that describes the key financial and legal terms of a proposed transaction. It often also outlines a timeline for a buyer’s or investor’s due diligence and the path to closing. An LOI is a preliminary agreement between parties before they invest significant time and money in due diligence and definitive agreements. An LOI is a roadmap on how the parties will proceed together; it’s not a definitive agreement. It is generally non-binding, except for exclusivity and venue of law provisions. In many M&A transactions, the parties work toward the LOI as a key milestone.

What is Typically Included in an LOI?

LOIs include the agreed economics of the transaction, usually including:

• The purchase price (often known as consideration)
• Components of that price: cash versus stock, rollover equity, earn-out, seller note, etc.
• The anticipated structure of a transaction, including, for example, whether it is an asset purchase, stock purchase, or a merger
• How an acquirer will finance the deal (may also be included)
• A timeline for a buyer to complete due diligence and negotiate a definitive agreement
• An exclusivity provision that says that a seller is not allowed to talk to other buyers or investors for the term of the provision

Whom Does an LOI Benefit?

An LOI unquestionably benefits the buyer. A properly crafted LOI can also protect the seller to an extent (more below), but the primary beneficiary is the buyer. The exclusivity provision prevents the seller from “shopping the deal” to other buyers or investors. Competing bidders tend to drift away, and if they are re-engaged after that period, they will know that something went wrong and they have negotiating leverage. In short, the buyer gets time for due diligence without competition. There is an asymmetry of actionable provisions in an LOI: the only meaningful binding term is the exclusivity provision. The buyer can typically walk away, change the price, or alter the terms at any time, often without any penalty.

Sellers can gain some protection by including milestones in the LOI. A seller has a few points of leverage with a buyer in this situation. For example, a seller can always simply say “no” to any changes of price or terms, and is not required to accept any proposed changes. It is often straightforward to include in an LOI a provision that waives the exclusivity clause if the price or terms change.

The second point of sellers’ leverage is that buyers spend real money on due diligence. Milestones can include completing specific elements of due diligence by set dates, finalizing a definitive agreement by a set date, or providing evidence of financing, among other items. Exclusivity becomes void if any of these milestones are missed. There are indeed other tricks of the trade to balance out the LOI in favor of sellers, but fundamentally, they benefit buyers.

Sellers often sign LOIs because they must. Many acquirers simply will not invest time and resources into due diligence without an LOI with an exclusivity provision. This is particularly true in the middle market and even more so in the lower-middle market. Financing is often more difficult for smaller transactions.

There are sometimes other reasons for an LOI, as well. There may be rare occasions when a public announcement is warranted, but the LOI can serve as a general overview of the deal for public communication. In certain cases, a pre-transaction antitrust filing with the Federal Trade Commission may be required under the Hart-Scott-Rodino Act; the LOI can start the review process when and if necessary.

A Clear Point of View on the LOI

LOIs are often a necessary step in an M&A process. They advantage buyers and disadvantage sellers. Any seller who enters an LOI must include milestones and police them carefully; it is important to act in good faith, but buyers must know they are being held accountable to reach the finish line in the transaction. They must know there is a risk of losing their exclusivity provision, putting their due diligence costs at risk, and risking the deal. However, it is a mistake to consider the LOI the object of the process. Instead, the objective of the process is to reach a definitive agreement with no “outs” for the buyer (on the agreed terms and conditions), and ultimately to close and complete the wire transfer.

It should be noted that the LOI is non-binding except for the exclusivity provision. Buyers typically enter into an LOI after reviewing an information memorandum, meeting management, and receiving additional information as part of cursory due diligence. At this point, they are rarely able to meaningfully contract terms before some level of detailed due diligence is completed.

Therefore, it is often meaningless to include contract terms such as survival of “reps & warranties,” indemnification provisions, working capital adjustment targets, etc. Hours, days, and months can be spent negotiating these non-binding provisions (lost time and momentum), which must be addressed again in a definitive agreement after a buyer has completed due diligence. If an LOI is required, it is better to “get on with it” and let a buyer get to work to move things along.

In short, an LOI is a waystation to a transaction. The objective is not the LOI itself, but rather to reach a definitive agreement and ultimately close the transaction.