Why Use a Nonbinding Letter of Intent?

There are many tools available to help move a transaction forward, ranging from a simple handshake agreement to a formal purchase agreement with contingencies. We have found one of the most useful tools for moving the M&A process along is the nonbinding letter of intent.

To further understand the advantages of the nonbinding LOI, we’ve outlined below a list of the most commonly available tools to express and agreement between buyer and seller.

  • Handshake Agreement. In the old days, two businesspeople could shake hands on a deal with the understanding that “my word is my bond.” This is the least formal level of commitment, and may mark the beginning of a transaction process.
  • Memorandum of Understanding. An MOU is a written version of a handshake agreement.
  • Term Sheet. A term sheet is a document, usually about a page long, that identifies the basic parameters of the proposed transaction and the likely financial picture.
  • Indication of Interest. This form of agreement is most commonly used with for-sale transactions where prospective buyers need to give some indication of their credibility and seriousness about moving forward with the transaction.
  • Nonbinding Letter of Intent. As you can see, nonbinding LOIs are near the middle of the pack when it comes to transaction agreements. They are the focus of this article.
  • Binding Letter of Intent. A legally binding version of an LOI, bringing you closer to a contract.
  • Purchase Agreement with Contingencies. These are typically used when sophisticated buyers and seller seek to complete a transaction with the caveat that certain things, such as due diligence, need to be done first.
  • Purchase Agreement without Contingencies. A purchase agreement without contingencies is the most formal and binding type of agreement. In essence it says, “This is a firm offer. We want to close this transaction now!”

With the nonbinding LOI, there is a tremendous marketing opportunity in addition to the legal aspects of moving the transaction along. You could spend a year – or even two or three – having discussions back and forth only to discover that there’s really no deal at all. The Nonbinding LOI is one of the best ways for people to understand the parameters of the deal are and how close – or how far – apart you are. It helps determine if you’ll move the transaction forward and how without locking you into a binding agreement to acquire.