Letter of Intent (LOI) Meaning
A Letter of intent, also known as LOI, is a preliminary contract containing key terms of a prospective Business deal between two or more Parties. It is common in business transactions, for example, the sale, purchase, merger, or formation of a joint venture.
The agreement is usually non-binding and comes before a binding definitive purchase agreement. However, provisions like confidentiality and exclusivity make the letter binding to concerning individuals and entities. The drafting and signing of the contract occur during the negotiation process, allowing both parties to conduct due diligence. By signing the contract, both parties can learn about each other’s intentions and expectations before doing business to avoid disputes later.
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 merger, sale or purchase, or joint venture agreement.
- A well-drafted LOI identifies and describes all the parties involved in the proposed business transaction, 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 Understanding 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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Source: Letter of Intent (wallstreetmojo.com)
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 property
- Purchasing or selling a real property
- Buying or selling stocks or assets of a business
- Agreeing to the merger of businesses
- Creating 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 parties
- Contains detailed information about the prospective deal
- Highlights obligations of the parties
- Describes the business transaction and its terms
- Outlines contingencies
- States financial terms and details
- Allows for due diligence
- Mentions 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.
The purchase order includes 30 Nikola Class 8 battery-powered Tre trucks and 70 Tre trucks with hydrogen fuel-cell systems. The vehicle trials will begin with two battery and two fuel cell zero-emission trucks. By transitioning to sustainable transportation through Nikola Tre semi-trucks, TTSI expects a significant reduction in smog-causing nitrogen-oxide emissions at the ports of Los Angeles and Long Beach, California.
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 out
- Binding both parties through confidentiality and exclusivity provisions
- Defining the type of the contract, such as sales or purchase, merger, or joint venture
- Allowing inclusion or modification of clauses before entering a definitive agreement
- Permitting due diligence
- Declaring ongoing negotiation process
- Verifying transaction issues
- Mentioning the deadline saves both time and money for parties involved
Frequently Asked Questions (FAQs)
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.
Recommended Articles
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 –
- Forfaiting
- Credit Memo (Credit Memorandum)
- Articles of Association
This post first appeared on Free Investment Banking Tutorials |WallStreetMojo, please read the originial post: here
