What Is The Difference Between An LOI And A Purchase Agreement?
Comments & Replies
I typically use a Letter of Intent (LOI) to open negotiations with. This is similar to an offer in the sense that you will list the terms, conditions and contingencies that are immediately acceptable, along with your due diligence requirements. The seller will prefer the price listed on the LOI but I often go in stating "on price and terms acceptable following due diligence of the following items" and add a time line.
Why use an LOI?
It is difficult to get all of the information from a Seller. I use them to show the credibility of the Buyer and because I work with cash businesses and the stated income and expenses need to go through discovery to determine if the value will stand. I have found that a deposit is still necessary in order to prove the credibility of the buyer. In my transactions where an LOI is used a deposit is either placed into escrow or a statement is included into the body of the LOI, that a deposit will be placed into escrow following (some event stated here). Once all is agreed then the Buy Sell Agreement is created and placed into escrow.
This approach may take a little longer but the discovery is worth the time. The buyer will be easier to work with if all the facts are known going in. Surprises kill deals more readily with an offer acceptance format. It is easier to remind the buyer that this is why we started with the LOI. It is also better for the seller to see the outcome. If the business doesn't sell following the scrutiny, the seller will have gained knowledge that may allow for better preparedness for the next offer.
Would like to hear from other brokers and agents about their definition and thoughts . . .
An agreement for purchase and sale of a smaller business with a sub-$1 million value often can be completed using the standard language usually found in preprinted purchase offer forms / purchase agreements. The purpose of the letter of intent is to outline the basics of a deal and make sure the parties agree about price, payment terms and the assets included in the sale. But much of the detail is missing and is added later once the buyer and seller are on the 'same page' regarding essential elements of a transaction.
Besides price, terms and assets included, the issues related to a business sale involve covenant-not-to-compete, any training agreement, handling of inventory, receivables and payables, statements from both parties that the information they have provided is accurate and remedies available to each party should the other party not live up to the agreement. Unless the broker can offer a good reason to start with a LOI, you should propose writing an offer to purchase.
Once it is negotiated, amended as needed, and signed, it becomes the sales contract.
LOI can be as simple as having a price and terms to as complicated as 100 pages covering every aspect of the future sale. In some cases the LOI is almost as binding as a purchase agreement. This of course would be on bigger deals that justify spending over $5,000 in legal fees.
A purchase contract or agreement is exactly that. It is a legally binding contract, with a deposit attached.
This means that buyer has already done a lot of due diligence and is committed to buy the business, unless he discovers some important undisclosed fact. Purchase agreements should not be used until a few hours have been spent on financial due diligence studying the full financial statements for the last 3 years. Report from the seller or broker giving estimated or average expenses and profit are not full financial statements but fluff. Fluff is a term used in selling cars to excite the prospect to buy. The car salesman tells you the car has wings and drives itself. You cannot hold a car salesman's feet to the fire, when you sue him for false advertising.
Always use an LOI (Letter of Intent), for negotiations, based on fluff and only go to a purchase agreement after you and your CPA are 80% sure the deal will fly, subject to review of the full accounting records, tax returns, and lease.
There is a growing trend for brokers, under instructions from their sellers to want buyers to put up deposit checks in order to show the seller he is serious. This is not reasonable because the buyer is already going to hire an accountant or other expert to help with due diligence which is a real indication of seriousness. A buyer might respond by saying that I will write an offer, based on the sellers fluff if the seller will agree to cover the CPA review costs if the financials are not as represented by the seller before the offer was written. This allows both buyer and seller to show their seriousness.