What is a letter of intent and how can it help my startup?

If you are an entrepreneur, letter of intent (or LOI) is one of the things that you should know that can be useful for your company’s business dealings.

How does it work?

An LOI is a type of letter drafted by a party that relates to commercial dealing. The transaction can be broadly defined as any commercial matter between the parties such as a potential collaboration, new investment, purchase of product or services, or even a company’s acquisition.

For example, if a company intends to buy out a startup, the buyer will then issue a letter of intent to the startup’s existing shareholders. The letter will set out the indicative commercial terms like the purchase consideration for the company’s 100% equity interest and other usual covenants like conditions precedent that needs to be satisfied by the existing shareholders before the shares sale for the startup can get completed.

What other things to include?

Generally, a letter of intent is not meant to be legally binding except certain usual clauses like exclusivity and confidentiality provisions. If you are a purchaser, exclusivity clause allows you to ‘buy’ some time so that you consider other steps to conclude the deal including conducting the necessary financial and legal due diligence before deciding whether to acquire a startup.

How can letter of intent be good for me as a startup?

If you are a startup, it may be a good idea to use a letter of intent when negotiating new deals. It also helps you manage expectations with third parties.

When you are only exploring a new collaboration with a new party like hiring a vendor or even a new customer, it may be a good idea to start a formal discussion with a letter of intent. This is relevant, especially if you are dealing with a more established or formal parties like an institutional or a large corporate.

A good letter of intent also shows that you are serious about a deal and makes you look more professional and tells the counterparty that you know what you’re doing.