Letter of intent, explained simply
Most of an LOI is not legally binding. A few provisions usually are, most importantly exclusivity (the no-shop), which prevents the seller negotiating with other buyers for a fixed period, together with confidentiality and governing law.
The LOI sets the terms that financial due diligence must then test. If the price is expressed as cash-free, debt-free with a normal level of working capital, the diligence team must define and measure each of those.
How the LOI price is paid
IllustrativeAlder Creek, headline price $40.0 million, $ millions
The headline price is a combination of cash at closing, deferred consideration and contingent consideration.
Typical contents
| Term | What it records |
|---|---|
| Price | Headline value and the earnings basis on which it was calculated |
| Price basis | Usually cash-free, debt-free with a normal level of working capital |
| Form of payment | Cash at closing, seller note, earn-out, rollover equity |
| Structure | Asset purchase or stock purchase |
| Diligence | Scope and timetable |
| Exclusivity | No-shop period, commonly 30 to 90 days |
| Conditions | Financing, key employee agreements, approvals |
Worked example
A buyer offers $40.0 million for Alder Creek, based on EBITDA of $5.0 million, cash-free and debt-free with a normal level of working capital. Consideration is $32.0 million cash at closing, a $4.0 million seller note and up to $4.0 million of earn-out, with 60 days of exclusivity.
Diligence later supports adjusted EBITDA of $4.6 million. Because the LOI tied the price to $5.0 million of EBITDA, the buyer has a clear basis to renegotiate.
Alder Creek Manufacturing, Inc. is a fictional company. All figures are illustrative.
Why it matters in a deal
The LOI frames the negotiation. Vague wording on working capital or debt, or an unstated EBITDA basis, is a common source of later disputes.
Red flags
- No stated EBITDA basis for the price
- Undefined “normal” working capital
- Exclusivity too short for proper diligence