In a strict definition, a letter of intent (LOI) is simply a legally non-binding offer to buy a practice from a seller. You’re simply telling a seller, “I want to buy your practice for this much money on this date with these broad terms spelled out.”
The main purpose of the LOI is two-fold. First, and most importantly, the LOI gets two parties together and provides a mechanism for them to shake hands and agree on what’s going to happen in the future and when it will happen.
Second, the LOI saves both parties time and legal costs by providing both the attorneys a starting point on most of the major legal aspects of the deal. Whichever attorney drafts the first version of the official legal documents knows the price, timing, and major deal points that have been agreed to already.
Typically a buyer will submit an LOI after they’ve seen three prior years’ financial details of the practice and some basic details of the physical layout of the practice and basic production details. Additionally, almost every buyer will physically visit the practice and meet either the seller and/or broker (sometimes very briefly) before submitting a letter of intent.
The seller can then take your offer and accept it, negotiate with you on the price or terms, or reject it outright.
2 Mistakes to Avoid
My first word of warning around LOIs comes fast in this chapter. If you work with certain brokers around the country on an LOI you’ll hear two things that can be dangerous to you as the buyer.
Here’s the first:
“The LOI is legally non-binding, so go ahead and sign it and if you need to change it later you can.”
While this statement is technically true, it ignores basic reality. Sure, an LOI is legally non-binding. But it’s absolutely psychologically binding.
Imagine yourself as the seller with a buyer who says, in writing with their signature on the page, “I plan to pay you $950,000 for your business.” You’re a happy seller. You’re mentally counting the stacks of cash in your head.
Then, the buyer requests some additional information and comes back to you two weeks later and says, “I analyzed your business more and I want to change my offer to $900,000.”
As a seller, you justifiably feel like $50,000 just got ripped out of your pocket. Even if you move forward with the transaction, you’re going to be thinking some negative thoughts about the buyer and wondering what’s wrong with your practice.
That crucial transfer of goodwill from the old to new owner has been irreparably damaged.
There are a couple of dual-rep brokerage firms (where they say they represent both buyer and seller) around the country that will not release ANY financial information on the practice until you’ve signed an LOI. This is a blatant attempt to get the buyer to psychologically commit to a price before seeing actual financials to analyze a practice. I consider this to be unethical.
This has been a common practice among a subset of brokers for many years and the only way it’s going to change is if enough buyers tell these brokers to go jump in a lake and stop looking at their listings.
The second dangerous statement you might hear from some brokers out there is:
“Just use this LOI from our firm. It’s super-standard and fine for both parties.”
This statement is less dangerous than the first, but can potentially conceal dangerous terms and conditions that are favorable in the direction of the seller.
At work is the psychological principle of “anchoring” or our brain’s tendency to latch onto the first number we hear in the context of a question as close to the “correct” number.
This is one reason getting a good buyer’s accountant and rep is vital. They will review the LOI with you and either use their LOI format or go over the broker’s LOI with a fine-toothed comb to fix the things that need fixing.
Regardless of whose LOI format is used, signing and submitting a letter of intent is a huge deal and a big step in your journey to ownership.