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Why are letters of intent so important in M&A deals?

Bob Wolter

Bob Wolter is a mergers and acquisitions advisor for Cornerstone Business Services, Green Bay,
Wisconsin. He contributes this column exclusively for Cheese Market News®.

In mergers and acquisitions (M&A), a letter of intent (LOI) isn’t simply a preliminary document that gets the deal process started — it’s a strategic negotiating document that establishes the economic expectations, allocation of leverage and framework for everything that follows.

In this column, I outline why LOIs are so important in M&A deals.

• ‘It’s just non-binding’

If I had a dollar for every time I’ve heard someone say, “Don’t worry about it, the LOI is non-binding,” I could probably skip the deal and retire.

Here’s the thing. Technically, they’re right. Most of a letter of intent isn’t legally enforceable. You can walk away. The other side can walk away. Nobody gets sued over the purchase price in a three-page LOI.

But “non-binding” and “doesn’t matter” are two very different things. The LOI is the first time both sides put the deal in writing. It’s the document everyone points back to for the next 60, 90, sometimes 120 days. It’s where expectations get set, and in M&A, expectations are everything.

Get the LOI right, and the rest of the process feels like filling in details. Get it wrong, and you spend months renegotiating things you thought were already settled. Those fights don’t stay small. They follow you all the way to the closing table.

• Why the LOI carries so much weight

Think of the LOI as an anchor. Once a number or a term is on paper with both signatures under it, it becomes the baseline. Anything that moves away from it later looks like a concession or, worse, a re-trade.

That cuts both ways. If you’re the seller and you agree to vague language about working capital, don’t be surprised when the buyer’s definition shows up in the purchase agreement and quietly takes a few hundred thousand dollars off your proceeds. If you’re the buyer and you commit to a clean price with no room for what diligence might uncover, every adjustment you ask for later will feel like bad faith to the seller.

There’s also the leverage problem. Before the LOI is signed, the seller usually has options. Maybe there are other bidders. Maybe they can just keep running the business. The moment they sign an LOI with an exclusivity clause, that leverage shifts hard toward the buyer. The seller stops talking to anyone else, starts spending money on lawyers and accountants, and gets emotionally invested in a closing date.

So whatever the seller didn’t nail down before signing gets a lot harder to win afterward. Buyers know this. Good sellers know it, too.

• Where LOIs usually go wrong

Most LOI problems aren’t dramatic. They’re small gaps that nobody thought were worth arguing over at the time. A few show up again and again:

• The headline price without the structure: “$20 million” sounds clear until you ask how much is cash at close, how much is an earnout, how much is a seller note and how much gets held back in escrow. Two people can sign the same LOI and picture completely different checks.

• Working capital left as “to be determined:” This is probably the most common source of late-stage fights. If the LOI doesn’t say how the target will be set, or at least what method you’ll use, you’re setting up a negotiation for the worst possible moment — right before closing, when everyone is tired and nobody wants to walk.

• Exclusivity that’s too long or too loose: A 120-day no-shop with no milestones gives the buyer all the time in the world and the seller no way out. Shorter windows, or extensions tied to real progress, keep both sides honest.

• Diligence scope nobody defined: If the buyer can dig into anything, for as long as it wants, the deal timeline belongs to the buyer. And open-ended diligence has a way of turning up “issues” that conveniently justify a lower price.

• The people stuff: Will the owner stay on? For how long, and at what pay? Who gets employment agreements? Leaving these out because they feel awkward is how you end up with a key employee threatening to leave two weeks before closing.

• How to get it right

None of this means your LOI needs to be 40 pages. It shouldn’t be. But it should be specific about the things that move money and the things that tend to blow up deals.

A few habits make a big difference:

• Spell out the structure, not just the price: Cash at close, escrow, earnout terms, seller financing and any rollover equity should all be on the page.

• Agree on a working capital approach now: Even if you can’t land on an exact peg, agree on the method, like a trailing 12-month average.

• Put guardrails on exclusivity: Pick a reasonable window and tie extensions to milestones like a draft purchase agreement or completed quality of earnings.

• Define the diligence process: List the major areas, set a timeline and name what would actually be a deal-changer.

• Address key people early: If the owner’s role after closing matters to the buyer, say so now.

• Bring your advisors in before you sign: An M&A advisor or attorney who’s seen a hundred LOIs will spot in 10 minutes what you’d otherwise discover in month three.

The extra week you spend tightening the LOI almost always saves you a month later. And it saves you something harder to get back: trust between the two sides.

• The tone you set is the tone you get

The best deals I’ve seen weren’t the ones with the highest price. They were the ones where both sides walked into diligence already agreeing on what the deal was. The LOI did its job. It turned a handshake into a shared picture, and everything after that was execution.

The worst deals were the opposite. Every step reopened something from the LOI. Every draft of the purchase agreement started a new argument. By closing, people who had started out excited about working together could barely sit in the same room.

The LOI may be non-binding on paper. In practice, it binds you to a way of doing the deal. So treat it like the foundation it is. Ask the uncomfortable questions early, write down the answers clearly and make sure everyone signing it is picturing the same deal.

Because whatever you leave fuzzy at the start, you’ll be paying for at the finish.

CMN

The views expressed by CMN’s guest columnists are their own opinions and do not necessarily reflect those of Cheese Market News®.

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