Letter of Intent (LOI): How to Draft & Negotiate

The Letter of Intent is the pivotal document in any search fund acquisition. It marks the transition from the search phase to the deal phase and sets the framework for everything that follows — due diligence, acquisition financing, and the definitive purchase agreement. A well-drafted LOI protects the buyer, reassures the seller, and establishes the commercial terms that will govern months of negotiation.

What an LOI is and why it matters

An LOI (also called a term sheet or indication of interest) is a document that outlines the proposed terms of an acquisition before both parties commit to the expense and effort of full due diligence and legal documentation. It is primarily non-binding, meaning neither party is legally obligated to complete the transaction. However, certain provisions — exclusivity, confidentiality, and expense allocation — are typically binding.

The LOI matters for several reasons. First, it forces both parties to agree on the material terms before investing significant time and money. Second, the exclusivity provision prevents the seller from shopping the deal while you conduct diligence. Third, it gives your investors and lenders confidence that a deal is progressing, which is essential for lining up acquisition financing. Fourth, it establishes the negotiating dynamic — the tone and structure of the LOI often set the pattern for the entire deal process.

Key sections of an LOI

1. Purchase price and valuation

State the proposed enterprise value and how you arrived at it (e.g., a multiple of trailing twelve months adjusted EBITDA). Specify whether the price is fixed or subject to a working capital adjustment at closing. Many search fund LOIs express the price as a range (“€5.0M-€5.5M, subject to confirmatory due diligence”) to preserve negotiating flexibility while giving the seller a clear indication.

2. Transaction structure

Specify whether you are proposing an asset purchase or a share purchase. Asset purchases are more common in the US (favorable tax treatment for buyers, ability to select assets and exclude liabilities). Share purchases are more common in Europe, particularly in France and Germany, where asset transfers can trigger complex employment and contract assignment issues. Include the anticipated form of consideration: cash at closing, seller notes, earn-outs, or a combination.

3. Exclusivity (no-shop period)

The exclusivity clause is arguably the most important binding provision. It prevents the seller from soliciting or entertaining competing offers during the due diligence period. Typical exclusivity periods range from 60 to 120 days. Push for 90-120 days — search fund acquisitions require extensive diligence, financing arrangements, and investor coordination. Include an extension mechanism (e.g., automatic 30-day extension if diligence is proceeding in good faith) to avoid the pressure of an arbitrary deadline.

4. Due diligence

Outline the scope and process for due diligence. Specify that the buyer will have full access to financial records, contracts, employees (typically after a certain milestone), customers, and facilities. State that the transaction is contingent on satisfactory completion of due diligence — this gives you an exit ramp if you discover material issues. Be explicit about what “satisfactory” means: it should be at the buyer's sole discretion.

5. Conditions to closing

List the conditions that must be satisfied before the transaction can close:

• Financing contingency: The acquisition is subject to the buyer securing adequate debt and equity financing. This is standard in search fund deals.
• Board/investor approval: For traditional search funds, the acquisition requires approval from search fund investors.
• Regulatory approvals: Anti-trust clearance, industry-specific licenses, or foreign investment approvals as applicable.
• No material adverse change: The business has not suffered a significant deterioration between LOI signing and closing.
• Key employee retention: Certain critical employees must agree to remain with the business post-closing.
• Seller transition: The seller agrees to a post-closing transition period (typically 6-12 months).

6. Seller note and earn-out terms

If part of the consideration is deferred, specify the terms. For seller notes, include the principal amount, interest rate, maturity, amortization schedule, and subordination terms (the seller note is almost always subordinated to senior bank debt). For earn-outs, define the performance metrics (revenue, EBITDA, customer retention), measurement period, and payout formula. Earn-outs are notoriously difficult to negotiate — keep the metrics simple and objectively measurable.

7. Confidentiality and announcements

Both parties agree to keep the transaction confidential until closing. No public announcements without mutual consent. This protects the business from employee anxiety, customer uncertainty, and competitor opportunism during the diligence period.

Binding vs. non-binding provisions

Understanding this distinction is crucial. The LOI should explicitly state which provisions are binding and which are not:

• Typically binding: Exclusivity, confidentiality, expense allocation (each party bears its own costs), governing law, and dispute resolution.
• Typically non-binding: Purchase price, transaction structure, closing conditions, representations and warranties, and indemnification terms.

Be cautious about making the purchase price binding. While sellers may push for this, a binding price before due diligence is complete removes your ability to renegotiate if you discover material issues. The standard practice is to keep the price indicative and non-binding, with the definitive purchase agreement setting the final terms.

Negotiation strategies

• Anchor with a fair offer: Unlike venture capital, ETA deals involve personal relationships with owner-operators. Lowball offers damage trust. Start with a fair valuation based on comparable transactions and clear methodology.
• Prioritize exclusivity: Exclusivity is more valuable to you than a slightly lower price. If the seller is reluctant, offer a shorter initial period with extension options tied to milestones.
• Use structure to bridge price gaps: If the seller's price expectation exceeds your valuation, bridge the gap with seller notes, earn-outs, or a management consulting agreement during the transition period. These tools reduce your upfront cash outlay and align incentives.
• Keep the LOI simple: Resist the urge to over-negotiate the LOI. It is a framework, not a definitive agreement. Over-lawyering the LOI signals distrust and can kill deals. Save the detailed provisions for the purchase agreement.
• Protect your exit ramps: Ensure the due diligence contingency and financing contingency are clearly worded and at your sole discretion. These are your protection against overpaying or acquiring a problematic business.
• Address the seller's concerns proactively: Most SME owners care about their employees, their legacy, and certainty of close. Address these directly in the LOI — commit to employee retention, describe your operating philosophy, and demonstrate that your financing is credible.

EU-specific formats and considerations

France: Lettre d'intention

In France, the LOI (lettre d'intention) carries particular legal significance. French courts have interpreted overly detailed LOIs as creating binding obligations, even when labeled as non-binding. Keep the language conditional and avoid specific commitments. The LOI should reference “sous réserve de” (subject to) due diligence and financing. Employee information rights under the Hamon Law (for businesses with fewer than 250 employees) must be observed — employees have a right to be informed of a potential sale and may make a competing offer.

Germany: Absichtserklärung

German LOIs (Absichtserklärung or Letter of Intent) typically follow a structure similar to Anglo-Saxon practice. However, German law imposes a duty of good faith (Treu und Glauben) during negotiations, and breaking off talks without legitimate reason after a signed LOI can trigger liability for reliance damages (culpa in contrahendo). The share purchase agreement (SPA) for a German GmbH acquisition must be notarized by a German notary (Notar), which adds time and cost to the process.

Spain and other EU markets

In Spain, the carta de intenciones follows similar principles. Spanish law also recognizes pre-contractual liability, so be careful about creating expectations you may not fulfill. In the Netherlands and the Nordics, LOI practices closely follow Anglo-Saxon conventions, making them generally more familiar to international investors.

From LOI to closing

Signing the LOI is a milestone, not the finish line. The typical path from LOI to closing takes 3-6 months and involves confirmatory due diligence, negotiation of the definitive purchase agreement, securing acquisition financing, obtaining regulatory approvals, and coordinating the closing mechanics. Maintain momentum by setting clear deadlines, communicating frequently with the seller, and managing your professional advisors (lawyers, accountants, lenders) actively. Deals die in the gaps between milestones.