What this chapter covers
How a letter of intent or term sheet frames price, due diligence, exclusivity and financing before any definitive contract exists.
Key takeaways
- “Non-binding” wording still shapes what can realistically be renegotiated later.
- A price stated without structure — debt, cash, working capital — says very little.
- Diligence scope and timetable belong in the letter so the process stays bounded.
- Exclusivity and confidentiality clauses are usually binding even inside a non-binding document.
- Financing assumptions set out early reduce execution risk later.
After confidentiality has been addressed and the first discussions have taken place, an M&A process usually reaches a point where conversations need to become more concrete.
What is the buyer proposing to acquire? At what valuation? How will the price be paid? What needs to happen before a definitive agreement can be signed? And, perhaps most importantly, are both sides sufficiently aligned to justify the time and cost of moving into full due diligence and documentation?
This is where the Letter of Intent (LOI), term sheet, memorandum of understanding or heads of terms enters the transaction.
The terminology varies between jurisdictions and markets, but the underlying function is broadly similar: to record the principal terms on which the parties are prepared to continue negotiating before committing themselves to a definitive acquisition agreement.
An LOI is therefore an unusual document.
It is often described as non-binding, yet it can have a major influence on everything that follows.
Why have an LOI if it is not the final contract?
The purpose of an LOI is not to complete the acquisition.
It is to establish whether there is enough agreement on the fundamental commercial and structural points to justify moving forward.
A typical M&A LOI may address:
- the proposed purchase price or valuation framework;
- whether the transaction will be structured as a share or asset acquisition;
- the form of consideration, such as cash, shares or a combination;
- possible purchase price adjustments;
- the intended due diligence process;
- conditions to the transaction;
- financing assumptions;
- the anticipated timetable;
- exclusivity;
- confidentiality; and
- transaction costs.
The value of the exercise is therefore partly legal and partly commercial.
It allows the parties to identify major disagreements before committing significant resources to a process that may have little prospect of completion.
"Non-binding" does not mean irrelevant
The central characteristic of most M&A LOIs is that the parties do not intend the principal transaction terms themselves to create an obligation to complete the acquisition.
A buyer stating that it is prepared to acquire a company for EUR 50 million does not normally become legally obliged to pay EUR 50 million simply because the seller signs the LOI.
The transaction remains subject to negotiation and execution of the definitive agreement and commonly to due diligence, corporate approvals, regulatory matters and other conditions.
However, that does not mean the entire LOI is non-binding.
Certain provisions are frequently intended to have immediate legal effect, particularly those dealing with confidentiality, exclusivity, expenses and governing law.
This distinction should be made explicit.
The drafting should clearly identify which provisions are intended to bind the parties and which merely record their current commercial understanding.
Otherwise, a document intended as a roadmap for negotiations can create uncertainty about whether the parties have already assumed obligations they did not intend to undertake.
The precise legal consequences will, of course, depend on the governing law. In some jurisdictions, concepts such as intention to create legal relations, certainty of terms, pre-contractual good faith or liability for breaking off negotiations can materially affect the analysis.
For that reason, calling a document "non-binding" is not a substitute for careful drafting.
The LOI sets the negotiating perimeter
Although its principal commercial terms may not be legally binding, an LOI can become extremely important in practice because it establishes the reference point for the definitive negotiations.
Suppose the LOI provides for an enterprise value of EUR 100 million on a cash-free, debt-free basis with a normalized level of working capital.
The definitive SPA will contain the detailed mechanics required to translate those few words into an actual purchase price.
But it would be commercially difficult for either side simply to ignore the agreed framework and introduce a fundamentally different pricing methodology later in the process without a reason.
The same applies to deal structure, earn-outs, rollover equity, escrow arrangements or other major economic terms.
This is why an LOI must strike a careful balance.
If it is too vague, difficult issues are merely postponed and may reappear after substantial diligence costs have been incurred.
If it is too detailed, the parties can spend excessive time negotiating a document that was supposed to facilitate the negotiation of the real agreement.
From an advisory perspective, the right question is therefore not:
"How much can we put into the LOI?"
It is:
"Which issues need to be settled now to determine whether this deal is worth pursuing?"
Price: the headline number is rarely enough
One of the most important functions of an LOI is to establish the initial economics of the transaction.
But stating a purchase price alone may be misleading.
A proposal of "EUR 100 million" can mean very different things depending on whether that amount refers to enterprise value or equity value, how debt and cash will be treated, what level of working capital is assumed, and whether part of the consideration is deferred or contingent.
An LOI may therefore need to indicate the basic pricing architecture even if the detailed calculation will only appear in the SPA.
For example:
EUR 100 million enterprise value, on a cash-free, debt-free basis and subject to a normalized working capital adjustment
provides considerably more information than:
purchase price: EUR 100 million.
The legal drafting is important because it avoids ambiguity. The advisory contribution is equally important because the drafting must correctly reflect the economic understanding reached between the parties.
This is one of the earliest points in the transaction where lawyers, financial advisers and the parties need to be speaking precisely the same language.
Due diligence should not become an unlimited option
Most LOIs contemplate further due diligence.
For the buyer, this is essential. The indicative valuation and structure may have been developed using limited information and will need to be tested against the target’s financial, legal, tax, commercial and operational position.
From the seller’s perspective, however, opening a data room creates cost, disruption and information risk.
The LOI can therefore help define the expected scope and timetable of the diligence process and make clear that the proposed transaction remains subject to satisfactory completion of that review.
Advisers should also consider the sequencing of the process.
A bidder that has not yet resolved fundamental questions about valuation or financing should not necessarily receive the same degree of access as a bidder that has demonstrated a credible path to closing.
As with the NDA, information access can be staged according to the maturity of the transaction.
Exclusivity: where the LOI becomes immediately consequential
Perhaps the most commercially significant binding provision in many LOIs is exclusivity, often referred to as a no-shop provision.
The seller agrees, for a defined period, not to solicit or negotiate competing transactions while the buyer conducts due diligence and works toward a definitive agreement.
From the buyer’s perspective, the rationale is clear.
Due diligence requires time and money. Lawyers, accountants, advisers and financing sources may all become involved. A buyer will often be reluctant to incur those costs if the seller remains free to use its offer to solicit a better bid elsewhere.
For the seller, however, exclusivity has a real opportunity cost.
Once granted, competitive tension may be reduced. If the buyer delays the process or attempts to renegotiate important terms after obtaining exclusivity, the seller may find itself temporarily unable to pursue alternatives.
The duration and structure of the exclusivity period therefore matter considerably.
A seller may seek a relatively short period, clear milestones or the ability to terminate exclusivity if the buyer does not progress the transaction as expected.
The buyer, conversely, will want sufficient time to complete diligence, arrange financing and negotiate definitive documentation.
This is a good example of why an LOI should not be regarded as a ceremonial document. Even where the acquisition itself remains non-binding, exclusivity can immediately change the parties’ negotiating leverage.
Financing assumptions matter early
A buyer’s offer also needs to be understood in the context of how the acquisition will be funded.
Is the proposal fully funded from available cash? Does it depend on acquisition financing? Is a private equity sponsor involved? Will the seller receive shares or deferred consideration?
An LOI does not need to reproduce the financing documentation, but material financing assumptions should normally be identified early enough for the seller to assess execution certainty, not just headline valuation.
A slightly higher offer that depends on uncertain financing may be commercially less attractive than a lower offer with a clear and credible funding path.
This is where the advisory analysis goes beyond simply reading the price written on the page.
In M&A, the best offer is not necessarily the offer with the highest number. It is often the offer with the best combination of price, conditionality and probability of closing.
How much detail is enough?
There is an inherent tension in every LOI.
The parties want enough detail to establish meaningful alignment, but not so much that they effectively negotiate the SPA twice.
The most useful LOIs therefore focus on matters capable of becoming genuine deal breakers: valuation, structure, consideration, major price mechanics, financing, diligence, exclusivity, timetable and significant conditions.
More detailed questions — extensive warranties, indemnification mechanics, disclosure standards or detailed closing deliverables — will generally belong in the definitive agreement unless a particular issue is already known to be fundamental to the transaction.
The objective is not completeness.
It is clarity on the points that justify continuing the deal.
More than a preliminary document
An LOI sits in an unusual position in the M&A process.
It is not normally the agreement that transfers ownership, and its principal economic terms are often expressly non-binding.
Yet by the time it is signed, the parties may already have agreed the valuation framework, transaction structure, diligence process, exclusivity period and principal conditions around which the rest of the transaction will develop.
That makes the LOI more than a statement of intention.
It is the document that converts an initial discussion into a structured transaction process.
And although the parties may remain legally free not to complete the acquisition, the choices made at the LOI stage can define the negotiating position from which the rest of the deal will be built.