On this week’s Tuesday Tax Take, we are looking at a document that often gets dismissed as “just a formality” but can have a major impact on a transaction: the letter of intent, commonly called an LOI. Whether a deal is large or small, a well-drafted LOI helps set expectations, identify key terms early, and reduce the risk of misunderstandings as the parties move toward a definitive agreement. While a letter of intent is usually nonbinding, that does not mean it is unimportant.
What Is a Letter of Intent?
A letter of intent is a preliminary agreement that outlines the basic terms of a proposed transaction before the parties invest significant time and money in drafting final documents. LOIs are commonly used in business sales, real estate transactions, joint ventures, and other commercial deals. The LOI acts as a roadmap for negotiating the final agreement. An LOI typically addresses issues such as:
- Purchase price or pricing framework
- Deal structure, such as asset sale or stock sale
- Assets or interests to be transferred
- Timing and key milestones
- Due diligence period
- Exclusivity or no-shop provisions
Nonbinding Does Not Mean Risk Free
Most letters of intent state that they are nonbinding, except for certain provisions. However, courts often look beyond labels and examine the language and conduct of the parties. Provisions that are commonly binding include confidentiality obligations, exclusivity or no-shop clauses, governing law, and expense allocation. If these provisions are not carefully drafted, a party may find itself locked into obligations it did not fully anticipate. In some cases, unclear or overly detailed LOIs have led to disputes over whether a binding agreement was formed.
Why LOIs Are Especially Important in Smaller Deals
In smaller transactions, parties are more likely to rely on informal discussions or handshake agreements. This can create confusion when expectations differ or memories fade. An LOI helps ensure that both sides are aligned on the major points before legal and accounting costs increase. It can also identify deal breakers early, saving time and resources. For small deals, an LOI does not need to be lengthy or complex. It simply needs to be clear.
LOIs Help Shape the Final Deal
A well-drafted LOI influences how the rest of the transaction unfolds. It can set the tone for negotiations and reduce the likelihood of major changes late in the process. For example, an LOI may establish the assumed deal structure, allocate responsibility for taxes or liabilities, or outline post-closing obligations. These early decisions often carry through to the definitive agreement. Without an LOI, parties may discover late in the process that they had different assumptions all along.
Common Pitfalls to Avoid
Because an LOI is often drafted early, it is easy to underestimate its importance. Some of the most common LOI issues include:
- Using vague or inconsistent language
- Failing to clearly identify which provisions are binding
- Including too much detail without adequate legal review
- Agreeing to exclusivity periods that are too long
- Overlooking tax or regulatory considerations
Letters of Intent and Due Diligence
LOIs frequently establish the framework for due diligence. They may set deadlines, identify access rights, or allocate responsibility for costs. Clear due diligence provisions help keep the transaction on track and prevent disputes over timing or scope. They also reinforce that the deal remains subject to further review and approval.
Final Thoughts
A letter of intent plays a critical role in bridging the gap between early discussions and a final, binding agreement. Even though it is usually nonbinding, it shapes expectations, allocates risk, and influences how a transaction moves forward. Taking the time to thoughtfully prepare an LOI can make the rest of the deal smoother, faster, and more predictable.
This article is provided for general information purposes only and should not be construed as legal advice. Those requiring legal advice are encouraged to consult with their attorney.
