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Negotiating the 'Letter of Intent' When Buying a Business

Cliff Ennico on

"I am looking to buy a local business. The owner and I have agreed on a purchase price subject to my reviewing his books and records. I was expecting the owner to send me a sales contract for the business, but he sent me something called a 'letter of intent' instead.

"I read over the letter, and there are several things in there that I don't like. At the bottom of the letter, though, it says it is 'not legally binding' and subject to legal contracts that I assume will be prepared later.

"I don't want to antagonize the owner, but I don't want to sign up for anything I can't change later. Should I negotiate this now or wait until we do the legal contracts?"

A letter of intent is a "term sheet" describing the purchase price and other terms and conditions under which you will buy the business. There is usually no "legal language" in the LOI, and it is technically "nonbinding" -- you and the owner both have the right to walk from the deal if you do not agree on a "definitive" (binding) sales contract later on.

But.

While the LOI is only a "blueprint" for the binding sales contract, if something is spelled out in an LOI, it is generally considered a "good faith" agreement on that specific point and will be difficult to change later. You should show this LOI to your attorney right away and change anything you don't like before you sign it.

 

Here are some of the things you should watch out for.

"Nonrefundable" Deposits: It is customary for the buyer of a business to put up a "good faith" deposit -- sometimes as much as 5 to 10% of the total purchase price -- when the contract of sale is signed (never earlier). The seller is taking the business off the market while he's negotiating with you in good faith and wants to be sure you are committed to doing the deal.

If the deposit is "nonrefundable," that's a problem. A "nonrefundable" deposit means you never, ever get it back under any circumstances whatsoever. There could be good reasons why you may change your mind later about buying this business. For example, the seller may have "cooked the books" by inflating his revenues and profits. Or perhaps the owner's landlord won't let you take over the lease of the business' storefront location. Or perhaps you suffer a stroke and can no longer run the business.

In such situations, which are beyond your control, you should not only be able to walk from the deal but get your deposit back. If the deposit is "nonrefundable," you're out of luck. The fact that the LOI is "nonbinding" will not help you; the owner will keep the money and force you to sue him to get it back.

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