Purposes of an LOI

Common purposes of an LOI are:

To allow parties to sketch out fundamental terms quickly before expending substantial resources on
negotiating definitive agreements, finalizing due diligence, pursuing third-party approvals and other
matters

To declare officially that the parties are currently negotiating, as in a merger or joint venture proposal

To provide safeguards in case a deal collapses during negotiation

To verify certain issues regarding payments made for someone else (e.g., credit card payments)

Potential downsides to using an LOI may include:

The parties may engage in protracted negotiations on only a subset of a deal’s terms

Management time and focus may be diverted

Alternative opportunities may be missed and markets may move against the parties during negotiations

Parties may reduce their lack of a workable deal framework into an LOI, with a hope of making progress
later

Public disclosure obligations may be inadvertently triggered

The risk of leaks, exacerbated by the desire of some to tout the LOI to the world, or shop it to other
parties

The Importance of a Letter of Intent

A letter of intent serves several other important purposes. First, it identifies “deal breakers” early in the
process. Forcing the parties to confirm agreement on important terms early on, even in a nonbinding
document, sometimes reveals that no agreement is in fact possible – that a certain right or obligation
that one party demands is unacceptable to the other. In that case, the parties can terminate
negotiations after incurring only minimal cost. Drafting lengthy and complicated definitive documents
can be an expensive step, so if there are disputed points that cannot be reconciled, it is far better to
reveal them early on.

Second, an LOI creates a clear path to closing. A well-drafted LOI will identify each definitive agreement
that will be signed at closing and assign drafting responsibility for it. This avoids confusion and
potentially duplicative efforts. Finally, an LOI gives both parties an early “test run” at the relationship. If,
in the course of negotiating an LOI, a party shows itself to be unreasonable or dishonest, the
counterparty has an early opportunity to weigh that behavior and decide whether to proceed with the
proposed business venture.