Letter of Intent (LOI) Meaning

Key Takeaways

  • A letter of intent is a preliminary contract signed by two or more parties willing to involve in a business deal. It contains the key terms of the prospective definitive purchase agreement.It first goes through drafting for the parties to negotiate and make modifications as needed. The final LOI draft is prepared and signed after they agree to the terms mentioned.The parties must execute an LOI before entering into a mergerMergerMerger refers to a strategic process whereby two or more companies mutually form a new single legal venture. For example, in 2015, ketchup maker H.J. Heinz Co and Kraft Foods Group Inc merged their business to become Kraft Heinz Company, a leading global food and beverage firm.read more, sale or purchase, or joint ventureJoint VentureA joint venture is a commercial arrangement between two or more parties in which the parties pool their assets with the goal of performing a specific task, and each party has joint ownership of the entity and is accountable for the costs, losses, or profits that arise out of the venture.read more agreement.A well-drafted LOI identifies and describes all the parties involved in the proposed business transactionBusiness TransactionA business transaction is the exchange of goods or services for cash with third parties (such as customers, vendors, etc.). The goods involved have monetary and tangible economic value, which may be recorded and presented in the company’s financial statements.read more, the type of the contract, financial terms and details, due diligence information, a closing date, etc.

How Does Letter of Intent for Business Work?

For any business deal to work out, the parties must trust each other to guide the collaboration. A letter of intent for business puts forth what the parties intend to do and achieve, along with what they expect from each other.

An LOI is similar to a Memorandum of UnderstandingMemorandum Of UnderstandingA memorandum of understanding (MOU) is an initial level of consent shown by the involved parties in a document to proceed with certain mutually agreed objectives. For example, two countries sign an MOU to outline the terms of their upcoming trade partnership terms.read more or MoU signed by two or more individuals or entities looking forward to collaborating on a future contract. As such, it outlines the contract terms agreed upon by both parties and their commitment to finalize the definitive agreement. It makes it easier for them to enter into a business transaction without any doubts or confusion.

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Excluding a few provisions, the overall letter is non-binding. However, the LOI should maintain both exclusivity and confidentiality –

  • Exclusivity means that until the LOI expires, neither party will seek another possible buyer or seller for the same agreement.Confidentiality is an assurance that the parties involved would not disclose any detail or information related to the deal with any external or third-party individual or entity.

The document, listing the contract terms, non-disclosure provisions, intentions, and expectations of the parties, should necessarily be prepared when:

  • Leasing a real propertyPurchasing or selling a real propertyBuying or selling stocks or assets of a businessAgreeing to the merger of businessesCreating a joint venture

Letter of Intent Format

The contract, which precedes a proposed definitive agreement, must be written in a specified letter of intent format, which:

  • Identifies all the partiesContains detailed information about the prospective dealHighlights obligations of the partiesDescribes the business transaction and its termsOutlines contingenciesStates financial terms and detailsAllows for due diligenceMentions closing date

Due diligence allows the parties to check for financial and legal activities or risks associated with the business deal in question. It lets the parties exit the negotiation phase at any point if they observe something suspicious. Similarly, mention of an expiry date ensures smooth processing of the business transaction.

Letter of Intent Examples

Let us look at the examples below to see how an LOI might make a potential business deal go smoothly.

Example 1

Gary and Jennifer decided to start a joint venture. Hence, they prepared an LOI to make sure it clearly states contract clauses. They both read through the letter draft and suggested modifications based on their intentions and expectations.

The LOI had a due diligence clause and date of expiration, enabling both parties to withdraw their involvement upon finding any issues with the deal. Thus, they prepared the final LOI.

Meanwhile, Jennifer was doubtful of Gary’s efforts. So she started to look for someone she could blindly trust and found a business partner in Rob. As the LOI was not binding, Jennifer withdrew from the contract before the closing date.

Example 2

Recently, electric semi-truck manufacturer Nikola Corp. has received an LOI from the port trucking company Total Transportation Services Inc. (TTSI). Nikola is all set to launch its first electric trucks by the end of 2021. And the letter from TTSI would lead to the purchase and trial of 100 Nikola Tre semi-trucks in daily operations starting in 2022-2023.

Template

Below is a letter of intent template to initiate a 50-50 joint venture between two businesses:

SOURCE

Purpose

Besides stating the terms of the proposed definitive purchase agreement for negotiation, an LOI can serve many other purposes. These include:

  • Protecting interested parties in case the deal does not work outBinding both parties through confidentiality and exclusivity provisionsDefining the type of the contract, such as sales or purchase, merger, or joint ventureAllowing inclusion or modification of clauses before entering a definitive agreementPermitting due diligenceDeclaring ongoing negotiation processVerifying transaction issuesMentioning the deadline saves both time and money for parties involved

This has been a guide to Letter of Intent and its meaning. Here we discuss how the letter of intent for business works, along with examples, format, and template. You can learn more from the following articles –

An LOI is a preliminary contract documenting the key terms of a proposed business deal between two or more parties. It shows their intentions, expectations, and commitment to execute the binding or definite agreement. Though considered non-binding, provisions like confidentiality and exclusivity make the letter binding to parties.

The purpose of an LOI is to give the parties involved in prospective business deal clarity about what they intend to do and what they expect from each other. If everything goes as planned, they proceed with the proposal.

An LOI may or may not be legally binding. In most cases, an LOI is non-binding, which means the parties involved can withdraw their participation before the expiration date. However, non-disclosure provisions form the basis for a binding agreement.

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