A letter of intent (LOI) is the roadmap for a business sale: it sets the price, the deal structure, and the timeline, and lets both sides agree on the big picture before anyone pays lawyers to draft a real contract. The definitive purchase agreement is the actual, binding contract that transfers the business — it's where the promises, the risk-shifting, and the fine print live. Sellers who treat the LOI as "just a handshake" are usually right about the price and terms, but wrong about a few specific clauses that bind them the moment they sign. Knowing which parts of each document matter, and when, is most of the battle.
What a letter of intent actually does
An LOI (sometimes called a term sheet) is a short document, often just a few pages, where a buyer and seller write down the price, how the deal will be structured (an asset purchase or an equity/stock purchase), the rough timeline to closing, and the major conditions — financing, a landlord's consent to assign the lease, a professional license transfer, and so on. Its main job is to get both sides aligned enough to justify the buyer's next step: due diligence, where the buyer digs into the real books, contracts, and operations before committing real money.
Most of an LOI is intentionally non-binding. The price you agreed to, the structure, the closing date — none of that is a promise either side can be sued over if the deal falls apart during diligence or negotiation of the final contract. That's normal and expected; it's why LOIs exist instead of jumping straight to a signed contract.
The part that surprises sellers: some clauses ARE binding
Here's what catches sellers off guard. Even though the deal itself isn't locked in, a handful of provisions inside the LOI usually are enforceable as soon as both sides sign:
Exclusivity / "no-shop": for a set period, the seller agrees not to negotiate with, solicit, or accept offers from any other buyer. This is the clause that changes everything — see below.
Confidentiality: both sides agree to keep the terms of the deal, and whatever financial and operational information gets shared during diligence, private.
Expenses: a clause specifying that each side pays its own legal, accounting, and advisory costs whether or not the deal closes — meaning a seller can walk away from a collapsed deal having already paid real legal bills.
Sometimes also a standstill or non-solicitation of employees clause, and a statement of which state's law governs the LOI itself.
A well-drafted LOI says explicitly, in its own section, which paragraphs are binding and which aren't. If it doesn't say so clearly, you're relying on a court to reconstruct what the two of you intended from the document's language and how you behaved afterward — and courts have found LOIs binding in whole or in part when the drafting was sloppy. That's rarely what either side had in mind. This is one of the clearest reasons to have a lawyer read the LOI before you sign, not after.
Why timing matters: negotiate before you sign, not after
Once a seller signs an LOI with an exclusivity clause, the seller's leverage largely evaporates. For the length of that exclusivity period — the buyer picked the number, and it's negotiable — the seller cannot shop the deal, solicit a better offer, or use a competing bidder to keep the buyer honest. If the buyer later tries to renegotiate the price downward during diligence (a common tactic, sometimes fair, sometimes not), the seller has little to counter with except walking away from months of work and the deal expenses already spent.
That's why the important terms — price, what's included and excluded, how working capital will be handled, who keeps which liabilities, whether there's an earnout or seller financing, the length of any seller non-compete — belong in the LOI itself, negotiated hard before signature, not deferred to "we'll work that out in the purchase agreement." The LOI is a buyer's easiest point of leverage over a seller; the seller's easiest point of leverage over the buyer is the moment before signing.
The definitive purchase agreement: the real contract
The purchase agreement (sometimes called an asset purchase agreement or a stock/equity purchase agreement, depending on deal structure) is the document that actually transfers the business and is fully binding once signed. It typically covers:
Operative terms
Exactly what is being sold — which assets, contracts, customer relationships, and intellectual property transfer, and which stay with the seller. It sets the final price and how it may adjust, commonly through a working-capital target (the deal assumes the business will have a certain level of cash, receivables, and inventory net of payables at closing, with a post-closing true-up if the actual number is higher or lower). It also spells out which liabilities the buyer is assuming (like ongoing vendor contracts) and which stay with the seller (like a pending lawsuit or old debt) — a distinction that matters enormously and is easy to gloss over.
One limit is worth understanding before you rely on that split. The purchase agreement allocates liabilities between you and the seller; it does not automatically bind people who never signed it. In an asset deal a buyer generally takes the assets without inheriting everything the old business owed — that's a big reason buyers prefer asset structures — but successor-liability doctrines can still reach a buyer in some situations and some states: unpaid state sales or employment taxes, environmental conditions, certain product-liability claims, or a transaction that looks like the same business continuing under a new name. Some states add their own steps, such as a bulk-sales notice or a tax-clearance certificate from the state tax agency confirming the seller's taxes are paid before the business changes hands. These rules differ meaningfully by state, so ask a business attorney licensed in your state what applies to your deal and check with your state's tax agency. And remember that a seller's contractual promise to cover a liability is only as good as the seller's ability to pay it later — which is exactly what escrows and indemnification caps are really about.
Purchase price allocation (asset deals)
In an asset purchase, the agreement usually includes a schedule allocating the purchase price across categories of assets — equipment, inventory, intangibles, goodwill, and the seller's non-compete. This is not housekeeping paperwork. The allocation drives the tax outcome for both sides: it affects how much of the seller's gain is treated as ordinary income rather than capital gain (including depreciation recapture, where depreciation the seller already deducted on equipment gets pulled back into ordinary income), and it sets what the buyer can depreciate or amortize going forward. Buyer and seller frequently want the allocation pushed in opposite directions, which is why it gets negotiated rather than filled in at the closing table. For these asset sales, federal law requires both parties to report the allocation and to report it consistently, on IRS Form 8594. Have your CPA model the allocation before you agree to it, not after, and confirm the current rules on irs.gov.
Representations and warranties
These are the seller's factual promises about the state of the business — that the financial statements are accurate, that there's no undisclosed litigation, that the business owns what it claims to own, that taxes have been filed and paid, that key contracts are in good standing. Reps are often qualified by knowledge ("to Seller's knowledge, there is no pending claim") and by materiality (immaterial, trivial issues don't trigger a breach). The buyer is essentially asking the seller to stand behind the picture of the business the buyer relied on to set the price.
If your deal is structured as a sale of stock or membership interests rather than assets, there's an extra layer worth knowing about: you may be selling a security. The sale of corporate stock is a securities transaction even when it's a small private company sold entirely to one buyer, and whether LLC membership interests count depends on the facts of the arrangement. A private sale like that isn't registered with anyone, but federal antifraud rules still apply to what a seller says — and to what a seller leaves out. That's not cause for alarm; it's a reason the representations in an equity deal are drafted carefully, and a reason to be straightforward in diligence rather than clever. The SEC's plain-language investor site (investor.gov) is a reasonable starting point, and this is a good question for your attorney.
Indemnification
This is the remedy if a representation turns out to be false — say, a seller warranted there was no pending litigation and a lawsuit surfaces two months after closing. Indemnification provisions typically include:
A cap — the maximum the seller can owe for breaches of most reps, often a portion of the purchase price (fundamental reps like ownership and authority to sell are usually carved out and may have a higher or no cap).
A basket (or deductible) — a threshold of losses the buyer has to absorb before the seller owes anything, meant to filter out small, immaterial claims.
A survival period — how long after closing a rep can still be the basis of a claim; general reps typically survive for a defined window, while fundamental reps (title, authority, taxes) often survive much longer.
Sometimes an escrow — part of the purchase price held back by a third party for a period to fund any indemnification claims — or representation-and-warranty (R&W) insurance, a policy the buyer (or seller) buys that pays claims instead of, or alongside, the seller's own pocket. R&W insurance is far more common in larger transactions; on a small-business deal it may not be available or worth the premium, so treat it as a question to ask your advisors rather than something to build the deal around.
Covenants
Promises about future conduct, not past facts. The most common for a small-business sale is the seller's non-compete — an agreement not to open or work for a competing business within a certain area and time — plus a commitment to help with the transition: introducing the buyer to key customers and vendors, training on operations, and being available to answer questions for a defined period, sometimes as a paid consulting arrangement. Non-compete enforceability is governed by state law and varies a great deal — several states restrict or limit non-competes tied to employment far more than ones tied to the sale of a business's goodwill, but the details differ by state, so confirm the current rule with a business attorney licensed there before relying on a non-compete to protect the deal's value.
Closing conditions
The list of things that have to happen before the deal actually closes — financing coming through, a landlord consenting to assign or issue a new lease, a liquor or professional license being transferred or reissued, key employees agreeing to stay, no material adverse change in the business between signing and closing. If a condition isn't met, either side may be able to walk away or delay.
The ancillary documents you'll also sign
Closing a small-business sale usually involves several documents beyond the purchase agreement itself:
A bill of sale, transferring ownership of tangible business assets.
An assignment and assumption agreement, transferring contracts, leases, and licenses (and the associated obligations) from seller to buyer.
A lease assignment or new lease, since most landlords require their own consent and paperwork before a tenant's business changes hands.
Third-party consents — some contracts, franchise agreements, or loans require the other party's or lender's sign-off before they can be transferred.
An employment or consulting agreement if the seller, or key employees, are staying on for a transition period or beyond.
What to do
Before you sign anything, decide on your real bottom-line price, structure, and non-compete terms — don't count on fixing them later.
Have a business attorney read the LOI before you sign, specifically to identify which clauses are binding.
Push back on an unreasonably long exclusivity period; every extra week is leverage you're giving up.
In an asset deal, have your CPA model the price allocation before you sign off on it — it changes what each side actually keeps after tax.
Ask a business attorney licensed in your state whether successor-liability or tax-clearance rules apply to your deal; don't assume the contract's liability split is the end of the story.
Track every closing condition (lease consent, license transfer, financing) as its own checklist item with an owner and a deadline; a missed consent can delay or kill a closing.
Read the assumed-liabilities section of the purchase agreement as carefully as the price — what you're not responsible for matters as much as what you're paying.
Confirm anything jurisdiction-specific before you rely on it. Non-compete enforceability, successor-liability and bulk-sales rules, tax-clearance certificates, licensing-transfer requirements, landlord-consent requirements, and lien or filing deadlines tied to a sale vary by state and sometimes by city — confirm current rules with your state's Secretary of State, your state's tax agency, the relevant licensing agency, and a business attorney licensed in that state. The U.S. Small Business Administration's free counseling network (SBA-affiliated Small Business Development Centers and SCORE mentors, findable through SBA local assistance) can also help you think through deal structure at no cost.
Key takeaways
An LOI's price and deal terms are usually non-binding — but its exclusivity, confidentiality, and expense provisions usually ARE binding the moment you sign.
Once you sign an exclusivity clause, your leverage shifts to the buyer; negotiate the terms that matter before signing, not after.
The purchase agreement is where the seller's representations and warranties, and the indemnification cap, basket, and survival period that back them up, actually live.
The contract splits liabilities between buyer and seller — it doesn't bind outsiders. Successor-liability and state tax-clearance rules can still reach a buyer, and they vary by state.
In an asset deal, the price allocation drives both sides' taxes and must be reported consistently by both on IRS Form 8594 — model it with a CPA before you agree to it.
Never sign a letter of intent without a business attorney reading it first.
Frequently asked questions
Is a letter of intent legally binding?
Mostly not, but not entirely. The price, structure, and other deal terms are usually written as non-binding. However, well-drafted LOIs make exclusivity, confidentiality, and expense-allocation clauses binding regardless of whether the deal ever closes — read the document's own language on which sections apply.
Can I back out of a deal after signing a letter of intent?
Generally yes, as to the deal itself, since the price and terms are typically non-binding — but you may still be bound by the exclusivity period (meaning you can't shop the deal to someone else during that window) and you'll typically still owe your own legal and advisory expenses. Read the specific document; some LOIs include break-up fees or other binding commitments.
What is the difference between a cap and a basket in indemnification?
The cap is the maximum amount the seller can owe in total for breaches of representations. The basket (or deductible) is the minimum threshold of losses the buyer has to reach before the seller owes anything at all — it screens out small claims.
Does the purchase agreement protect me from the seller's old debts?
Between you and the seller, largely yes — it states who is responsible for what, and a seller who breaches that promise owes you. But it doesn't bind people who never signed it, and it's only worth what the seller can actually pay. In some states and some situations, successor-liability rules, unpaid state sales or employment taxes, or environmental claims can reach a buyer even in an asset deal. Those rules vary by state, so ask a business attorney licensed there and check with your state's tax agency about any clearance certificate.
What does representation and warranty insurance do?
It's an insurance policy, purchased by the buyer or sometimes the seller, that pays valid indemnification claims arising from a breach of the seller's representations, instead of (or on top of) the seller paying out of pocket or an escrow being used. It's most common in larger transactions and may not be available or economical on a small-business deal — worth asking your advisors about rather than assuming.
Do I need a lawyer to review a letter of intent, or just the final purchase agreement?
Both, but especially the letter of intent — because by the time you get to the purchase agreement, you've usually already signed away your ability to shop the deal elsewhere. A lawyer reviewing the LOI before signature is the best-timed money you'll spend in the whole process.
This article provides general business information, not legal, tax, or financial advice, and does not create an attorney-client or accountant-client relationship. Deal terms and state law vary — consult a qualified business attorney and CPA before signing a letter of intent or purchase agreement.
Frequently asked questions
Is a letter of intent legally binding?
Mostly not, but not entirely. The price, structure, and other deal terms are usually written as non-binding. However, well-drafted LOIs make exclusivity, confidentiality, and expense-allocation clauses binding regardless of whether the deal ever closes — read the document's own language on which sections apply.
Can I back out of a deal after signing a letter of intent?
Generally yes, as to the deal itself, since the price and terms are typically non-binding — but you may still be bound by the exclusivity period and you'll typically still owe your own legal and advisory expenses. Read the specific document; some LOIs include break-up fees or other binding commitments.
What is the difference between a cap and a basket in indemnification?
The cap is the maximum amount the seller can owe in total for breaches of representations. The basket (or deductible) is the minimum threshold of losses the buyer has to reach before the seller owes anything at all — it screens out small claims.
Does the purchase agreement protect me from the seller's old debts?
Between you and the seller, largely yes — it states who is responsible for what, and a seller who breaches that promise owes you. But it doesn't bind people who never signed it, and it's only worth what the seller can actually pay. In some states and some situations, successor-liability rules, unpaid state sales or employment taxes, or environmental claims can reach a buyer even in an asset deal. Those rules vary by state, so ask a business attorney licensed there and check with your state's tax agency about any clearance certificate.
What does representation and warranty insurance do?
It's an insurance policy, purchased by the buyer or sometimes the seller, that pays valid indemnification claims arising from a breach of the seller's representations, instead of (or on top of) the seller paying out of pocket or an escrow being used. It's most common in larger transactions and may not be available or economical on a small-business deal — worth asking your advisors about rather than assuming.
Do I need a lawyer to review a letter of intent, or just the final purchase agreement?
Both, but especially the letter of intent — because by the time you get to the purchase agreement, you've usually already signed away your ability to shop the deal elsewhere. A lawyer reviewing the LOI before signature is the best-timed money you'll spend in the whole process.
This article is general legal information, not legal advice, and may not reflect the most current law or the law in your jurisdiction. Laws vary by state and change over time. For advice about your specific situation, consult a licensed attorney.
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