What it means
An LOI exists because full contracts are slow and expensive to draft. Before spending money on lawyers, accountants and due diligence, both sides want to know they agree on price, structure and timing, and the letter captures that understanding on two or three pages.
The document typically covers the headline number, what is being bought or supplied, the conditions that must be met, an exclusivity period and a target completion date. It reads like a contract but usually states plainly that it does not create a binding obligation to complete.
That non-binding framing is the source of most confusion. Certain clauses are almost always binding even when the commercial terms are not, most commonly confidentiality, exclusivity, governing law and who bears their own costs if talks collapse.
In practice an LOI does real work beyond the legal position. It gives a buyer permission to spend money on due diligence, gives a seller a reason to stop talking to rival bidders, and gives both sets of advisers a written brief to draft against.
The nuance worth carrying into any negotiation is that a badly drafted LOI can bind you by accident. Courts look at substance as well as labels, so language such as "the buyer shall pay" in a document called non-binding invites argument later.
In practice
Real-world examples
Example 1
A software company and a potential acquirer sign a two-page LOI stating an indicative price range and a 60-day exclusivity period. The exclusivity clause is binding, so the seller must stop responding to other approaches while the buyer runs due diligence. The price itself is expressly subject to that diligence and is later adjusted downwards when recurring revenue proves lower than reported.
Example 2
A manufacturer and a large retailer sign a letter of intent for a three-year supply arrangement ahead of a full framework contract. The LOI lets the manufacturer order long-lead-time components and begin tooling, with a clause confirming the retailer will reimburse documented tooling spend if talks fail. That single binding clause turns a soft agreement into something the manufacturer's bank will lend against.
Example 3
Two engineering firms planning a joint bid for a public infrastructure contract sign an LOI covering how they will split scope, costs and any eventual profit. It is non-binding on the commercial split but binding on confidentiality, protecting each firm's pricing model. When the tender is won, the LOI becomes the skeleton of the formal joint venture agreement.
Think of it
An LOI is like booking a wedding venue and agreeing on the date and cost before you send out formal wedding invitations. It secures your intent and dates, but you can still cancel if the venue floods before the big day.
Formula
Calculation
Indicative enterprise value in an LOI = adjusted EBITDA x agreed multiple, with equity value = enterprise value - net debt
A logistics group signs a letter of intent to buy a regional courier business. Adjusted EBITDA for the last twelve months is $4,000,000, and the parties agree an indicative multiple of 6.5 times, giving an enterprise value of $4,000,000 x 6.5 = $26,000,000. The target carries $3,000,000 of net debt, so the indicative equity value payable to shareholders is $26,000,000 - $3,000,000 = $23,000,000. The LOI also proposes that 20% of that equity value, which is $23,000,000 x 20% = $4,600,000, is deferred for two years as protection against warranty claims, leaving $23,000,000 - $4,600,000 = $18,400,000 payable at completion.Case study
Seen in the real world
Bellweather Diagnostics is a fictional laboratory group used here to show how an LOI shapes a deal. It received an approach from a larger healthcare operator and, after three meetings, agreed to a letter of intent valuing the business at 6.5 times adjusted EBITDA of $4,000,000, or $26,000,000 on an enterprise value basis.
The letter ran to four pages. It fixed a 90-day exclusivity window, confirmed the buyer would bear its own advisory costs, set out the deferred consideration structure, and listed the six conditions the buyer considered essential, including the retention of two senior clinical staff.
In this illustrative case the final signed contract landed at $24,800,000 rather than $26,000,000, because diligence found a lease renewal that had been assumed rather than agreed. Bellweather's board accepted the reduction without drama, precisely because the LOI had said in plain terms that the price was indicative and subject to verification.
Watch out
Common mistakes
- Treating an LOI as a done deal and telling staff, customers or lenders that the transaction is agreed. Deals signed at LOI stage frequently change or collapse, and premature announcements damage the business if they do.
- Skimming the binding clauses because the document is labelled non-binding. Exclusivity, confidentiality and cost-sharing provisions typically do bind and can be expensive to breach.
- Leaving the price mechanism vague, for example agreeing a multiple without defining how EBITDA is adjusted. Every undefined term becomes a negotiation you will have again with less leverage.
Questions
People also ask
Is a letter of intent legally binding?
Generally not on the commercial terms, but specific clauses within it usually are, and careless drafting can make more of it binding than intended.
How long should exclusivity last?
Sixty to ninety days is a common range, long enough for meaningful due diligence but short enough that a stalled buyer cannot lock a seller out of the market indefinitely.
What is the difference between an LOI and a term sheet?
Very little in substance, as both summarise headline terms before a full contract, though term sheet is the more usual label in investment and financing situations.