Letter of intent when selling an SME: what are you really agreeing to before you sign?

When a potential buyer shows serious interest in an SME, one of the first documents that may reach the business owner is a letter of intent.

It is often seen as a preliminary step, used to put the main terms of the transaction on paper before due diligence begins and the definitive agreements are negotiated. In practice, however, the letter of intent can have a significant impact on everything that follows.

Price, payment structure, transaction perimeter, conditions, timing, exclusivity and the business owner’s role after closing may already be outlined at this stage. Even where many of these terms are not yet final, changing an approach that has already been agreed can become increasingly difficult later in the process.

For this reason, signing a letter of intent should not be treated as a formality. It is the point at which both seller and buyer need to confirm that they are, in fact, negotiating the same transaction.

What a letter of intent actually defines

A letter of intent, commonly referred to as an LOI, sets out the main terms on which the parties intend to continue negotiations.

Its content can vary considerably from one transaction to another. In the sale of an SME, it may cover the value attributed to the business, the scope of the acquisition, payment terms, any purchase price adjustments, due diligence, conditions to closing and the period during which the seller agrees to negotiate exclusively with that buyer.

The LOI does not replace the definitive sale and purchase agreement. Its importance comes from the fact that it establishes the framework from which the rest of the negotiation will develop.

The clearer that framework is, the lower the risk of reaching the contractual stage only to discover that the two parties have very different expectations.

The price in the LOI is not necessarily what you will receive

The figure that naturally attracts most of the business owner’s attention is the price.

The problem is that the number stated in the letter of intent may only represent one part of the equation.

It is important to understand, for example, whether the proposed value refers to the enterprise value before taking net debt and cash into account, how working capital will be treated and which adjustments may be made at closing.

The payment structure matters just as much.

An offer paid entirely at closing is very different from one that includes deferred consideration, an earn-out linked to future performance or a rollover investment by the seller into the new ownership structure.

Two letters of intent may therefore show the same overall value while producing very different financial outcomes for the seller.

Before signing, it should be sufficiently clear not only what value is being attributed to the company, but also how that value is expected to translate into the amount ultimately received by the shareholders.

Due diligence can affect the negotiation

After the letter of intent is signed, the buyer will normally begin a more detailed due diligence process covering the company’s financial, tax, legal, commercial and operational position.

This is a normal part of an M&A transaction.

If the review identifies material issues that differ from the information on which the offer was based, the buyer may ask to revisit some of the agreed terms.

The situation becomes more sensitive when the LOI leaves completely open the basis on which due diligence findings may affect the price or transaction structure.

A buyer must be able to verify the assumptions behind its offer. From the seller’s perspective, however, it is equally important to avoid turning due diligence into an opportunity to reopen every element that has already been negotiated.

This becomes even more relevant when the letter of intent also includes an exclusivity clause.

Exclusivity changes the seller’s position

Requests for exclusivity are common in M&A transactions.

The buyer is about to commit time and resources to due diligence, involve advisers and begin negotiating the definitive agreements. It is therefore understandable that the buyer may ask the seller not to continue parallel negotiations with other parties during this period.

For the business owner, however, granting exclusivity means temporarily giving up other options.

Other potential buyers are put on hold and the competitive tension created during the sale process is reduced. If the transaction does not reach closing, those discussions may need to be restarted after other interested parties have already moved on or lost momentum.

Exclusivity should therefore normally be granted only once the main terms of the transaction are sufficiently clear.

Price, payment structure, key conditions and the buyer’s ability to complete the transaction should all have been considered before agreeing to negotiate with one party only.

The length of the exclusivity period also matters. It should reflect the time genuinely required to complete due diligence and negotiate the agreements, without leaving the seller tied to a process for an unnecessarily long period if there is no meaningful progress.

The amount offered is not the only thing that matters

When reviewing an LOI, it is easy to focus primarily on the economics.

The probability that the transaction will actually reach closing is just as important.

A buyer may still need to secure financing, obtain internal approvals or satisfy other requirements before being able to complete the acquisition. Each of these conditions affects deal certainty.

This becomes particularly important once the seller has granted exclusivity.

Before temporarily giving up other alternatives, the business owner should therefore understand how committed the buyer is, what approvals or financing are still outstanding and whether the buyer has the resources required to complete the transaction.

The highest offer on paper is not necessarily the most certain transaction.

The business owner’s role after closing

Another point that should begin to take shape in the letter of intent is what happens after the sale.

In many transactions, the buyer may ask the business owner to remain involved for a transition period. In other cases, a longer commitment may be required, with operational responsibilities, specific performance targets or a continuing equity investment.

These terms can materially change the nature of the transaction.

Remaining for a few months to manage a handover is very different from continuing in an executive role for several years. In the same way, an earn-out linked to future results may leave part of the seller’s proceeds dependent on the performance of the business after control has passed to the buyer.

Leaving these issues entirely to the definitive agreement can mean discovering too late that the parties have fundamentally different expectations.

The LOI should therefore provide at least a clear indication of the intended relationship between the seller and the buyer after closing.

A non-binding LOI can still have real consequences

Many letters of intent state that the principal economic terms are non-binding until the definitive agreements are signed.

That does not necessarily mean that the entire document has no legal effect.

Provisions relating to exclusivity, confidentiality, information handling, transaction costs or other specific commitments may be expressly binding from the moment the LOI is signed. The actual legal effect will depend on how the document has been drafted and should be reviewed with the legal advisers involved in the transaction.

From the business owner’s perspective, the practical point is simpler: a preliminary document should not be confused with a document that can be signed without consequence.

The LOI is often the point at which some alternatives become restricted and the transaction begins to take a much more defined shape.

What should be clear before you sign?

A letter of intent does not need to anticipate every clause that will eventually appear in the definitive agreement.

It should, however, allow both parties to understand with reasonable clarity what transaction they are trying to build.

Before signing, the seller should understand what the buyer is acquiring, what value is being attributed to the company, how the final purchase price will be calculated, how much will be paid at closing and how much will remain deferred or contingent.

It should also be clear which due diligence findings could affect the offer, what conditions the buyer still needs to satisfy, how long exclusivity will last and what role the business owner will retain after closing.

If these points remain too vague, the risk is that the seller enters an exclusive negotiation while the most important elements of the transaction are still unresolved.

Conclusion

The letter of intent does not complete the sale of an SME, but it can shape much of the transaction that follows.

It is the point at which initial interest becomes a structured negotiation and, in many cases, a negotiation with one buyer only.

For this reason, the quality of an LOI should not be judged simply by the price stated on the first page. The transaction perimeter, payment structure, conditions, timing, implications of due diligence and commitments that continue after closing all matter.

A well-structured letter of intent does not eliminate the issues that will still need to be negotiated in the definitive agreements. It does, however, reduce the risk of reaching a late stage in the process only to discover that seller and buyer had been working towards two different transactions.

FAQ

Does signing a letter of intent mean I am committed to selling my company?

Not necessarily. In M&A transactions, many of the commercial terms in an LOI may be non-binding until the definitive agreements are signed. Certain provisions, including exclusivity and confidentiality, may nevertheless be binding from the date of signature.

Is the price stated in the LOI final?

Not always. It may still be subject to due diligence findings, adjustments for net debt or working capital and other conditions set out in the letter of intent.

What is exclusivity when selling a company?

Exclusivity is an undertaking by the seller not to negotiate with other potential buyers for an agreed period. It allows the selected buyer to complete due diligence and negotiate the transaction without competing discussions, but temporarily reduces the seller’s alternatives.

How long should an exclusivity period last?

There is no standard period that applies to every transaction. It should be long enough to complete the required due diligence and negotiations, but not so long that the seller remains unnecessarily tied to a process that is not progressing.

What happens after a letter of intent is signed?

The process will normally move into detailed due diligence and negotiation of the definitive transaction documents. If the review confirms the assumptions behind the offer and the parties agree the contractual terms, the transaction can then proceed towards signing and closing.