What Must a Seller Consider Before Signing a Letter of Intent?

The 30-Second Definition

A Letter of Intent (LOI) — also known as Heads of Terms — is a non-binding document that records the buyer and seller's agreement in principle on the key commercial terms of a transaction. It is typically the point at which exclusivity is granted to the buyer. What many sellers do not realise is that the moment the LOI is signed, their negotiating leverage begins to erode. The buyer is now the only party in the room, the clock is running, and the seller is bearing the cost of management time, professional fees, and operational distraction. Everything that was not agreed before signature becomes harder to win afterwards.

The LOI is not the finish line. It is the starting gun for the phase in which sellers most commonly lose value.

Why the Pre-LOI Stage is Critical

In a well-run sale process, the Information Memorandum has attracted multiple buyers, indicative offers have been assessed, and a preferred bidder has been selected. At that point, the seller holds maximum leverage — there is competitive tension, the buyer has invested time, and they want the deal. The LOI converts that competitive tension into a bilateral negotiation in which the buyer's advisers are experienced, the seller is often running the process for the first time, and ambiguity in the LOI consistently resolves against the seller at the due diligence stage.

The six areas below represent the critical ground that must be addressed before signature.

Valuation and Price Mechanics

The headline price is the starting point, not the end point. Before signing, the following must be agreed and documented in the LOI itself.

The enterprise value and equity value must be clearly distinguished, along with how the bridge between them is calculated — typically by deducting debt, adding cash, and adjusting for working capital. Leaving the bridge undefined is one of the most common mechanisms by which price is reduced between LOI and completion.

The EBITDA basis must be agreed — which year or years the valuation multiple applies to, and whether add-backs have been accepted in principle. A buyer who has not explicitly acknowledged your adjusted EBITDA in the LOI retains the right to reject it entirely in due diligence.

The working capital peg methodology must be established before exclusivity. The peg defines the normalised level of working capital the business is expected to deliver at completion. Buyers routinely use working capital adjustments to recover several hundred thousand pounds of the agreed price at the completion accounts stage. A locked box mechanism — which fixes the price at a historic balance sheet date — is strongly preferable for sellers and should be pushed for at LOI stage.

If deferred consideration or an earnout forms part of the structure, the metric, measurement period, and any dispute resolution mechanism must be defined before signing. Vague earnout language rarely resolves in the seller's favour.

Deal Structure

The choice between a share sale and an asset sale is not a legal technicality — it is a fundamental tax and commercial decision. In a share sale, the buyer acquires the entire company including its history, liabilities, and contracts. In an asset sale, specific assets and liabilities are transferred. For UK sellers, a share sale typically attracts more favourable Capital Gains Tax treatment, including eligibility for Business Asset Disposal Relief (BADR) where conditions are met. The structure must be confirmed before the LOI is signed, not negotiated during legal drafting.

The completion mechanism — whether the deal will use a locked box or completion accounts — should also be agreed at this stage. Locked box is the seller-friendly option. Completion accounts give the buyer a mechanism to revisit the price after completion, creating ongoing exposure and dispute risk.

If the buyer expects the seller to reinvest a portion of the proceeds as rollover equity, the terms, valuation basis, and governance rights attached to that equity must be understood before exclusivity is granted.

Proof of buyer funding — whether equity finance, debt commitment letters, or a combination — should be obtained before signing. Sellers who enter exclusivity with an unfunded buyer discover, at significant cost in time and fees, that they have lost leverage for nothing.

Exclusivity Terms

Exclusivity is the mechanism by which a seller converts a competitive process into a bilateral negotiation. Its terms matter.

The exclusivity period should be time-limited to no more than 60 to 90 days for a standard SME transaction. Longer periods remove the seller's ability to reintroduce competitive tension and allow buyers to extend the process, exhaust the seller's advisers, and introduce price reductions without consequence.

The LOI should define the specific circumstances in which the seller can exit exclusivity — such as failure by the buyer to meet agreed milestones, failure to provide funding evidence, or introduction of material price changes without supporting due diligence findings. Without defined exit triggers, the seller has no clean mechanism to walk away.

The no-shop clause within the exclusivity period should be carefully scoped. A well-advised seller distinguishes between proactively soliciting new buyers — which the no-shop legitimately prevents — and responding to unsolicited approaches, which should be preserved.

Where feasible, a reverse break fee or cost-coverage clause should be sought. This requires the buyer to compensate the seller for professional fees and management time if the buyer withdraws without cause after exclusivity has been granted. Most buyers resist this, but it is a legitimate point of negotiation that signals seller sophistication.

Due Diligence Scope and Process Control

Due diligence is the period of maximum exposure for the seller. The buyer has access to sensitive commercial information, management time is diverted, and any finding — however minor — can be used to justify a price reduction request.

Before signing, agree the scope of due diligence in broad terms — which workstreams will be covered (financial, legal, commercial, tax, operational) — and the timeline. Open-ended due diligence with no agreed timetable is one of the most effective tools a buyer has for grinding down a seller's resolve.

Data room access should be governed by a Non-Disclosure Agreement already in place before the LOI is signed. Access to the most commercially sensitive information — customer lists, pricing schedules, supplier terms — should be restricted to what is strictly necessary for due diligence and released in stages as the deal progresses.

Management access to the buyer and their advisers should be coordinated through the seller's M&A adviser, not left open. Unsupervised conversations between a buyer's team and a seller's key staff create retention risk, destabilise the business, and can result in the buyer forming views — about culture, capability, or risk — that have not been subject to the seller's management. This is particularly important in businesses where operational dependency on the founder is already a valuation risk.

Any post-due diligence price reduction request should be required in writing, supported by specific findings, and addressed through the seller's advisers rather than informally. Resist headline chip-down requests — those framed as a general risk adjustment rather than specific identified issues — as a matter of principle.

Legal, Tax, and Financial Structuring

Tax structuring must be addressed before the LOI is signed, not after. The two key areas for UK sellers are Capital Gains Tax exposure and Business Asset Disposal Relief (BADR) eligibility.

BADR reduces the rate of CGT on qualifying disposals to 14 per cent (2025/26 rates) on gains up to a lifetime allowance of £1 million. To qualify, the seller must hold a minimum of 5 per cent of ordinary shares and voting rights, must have been a director or employee of the company, and must have held the shares for at least two years prior to disposal. These conditions should be confirmed with a tax adviser before any transaction structure is agreed — and certainly before the LOI is signed.

Where BADR does not apply, CGT on business asset disposals is charged at 18 per cent for basic rate taxpayers and 24 per cent for higher rate taxpayers (post-Autumn 2024 Budget). The difference between BADR and non-BADR rates on a £5 million gain is £500,000. This is not a detail to leave to the SPA drafting stage.

The quantum and terms of any post-completion retention or escrow should be addressed at LOI stage. Retentions represent money that remains at risk after completion and should be minimised. Where a retention is unavoidable, agree the maximum amount, the release triggers, and a hard long-stop date for any warranty claims.

Warranty and Indemnity (W&I) insurance transfers the risk of warranty claims from the seller to an insurer and can materially clean up the seller's net proceeds. The feasibility of W&I cover should be assessed before heads of terms are agreed, not during legal drafting — the cost of the premium is typically reflected in deal economics from early in the negotiation.

Non-compete clauses — which restrict the seller from competing with the business post-completion — should be reviewed before signing. Buyers will push for the widest possible scope and the longest duration. UK courts will not enforce unreasonably wide restraints, but contesting an over-broad non-compete is expensive and distracting. Agree the geographic scope, sector definition, and duration (typically two to three years) at heads of terms stage.

People, Operations, and Contractual Risk

Two categories of risk in this area consistently cause late-stage deal failure or price reduction: change-of-control clauses and key person dependency.

Material customer contracts, supplier agreements, and financing facilities frequently include change-of-control provisions that require the counterparty's consent before the transaction can complete. A buyer who discovers mid-due diligence that a contract representing 30 per cent of revenue requires a third-party consent — and that consent is not guaranteed — has been handed a significant piece of leverage. The seller's obligation is to identify these provisions before the LOI is signed, assess the consent requirements, and where necessary begin the consent process proactively rather than reactively.

Key person dependency — where the operational performance of the business is materially reliant on the founder or one or two senior individuals — is a standard buyer concern and a valuation risk factor. Founders who are planning to remain involved post-completion should agree the terms of their transition role before the LOI is signed: duration, remuneration, notice period, and the scope of their authority. A founder without a contract post-completion has no protection if the relationship with the buyer deteriorates.

If the transaction involves an asset sale, the Transfer of Undertakings (Protection of Employment) Regulations — commonly known as TUPE — will apply to transferring employees. The seller should understand their obligations and any indemnities they may carry for pre-transfer employment liabilities before entering exclusivity.

Key employees who are critical to the value of the business should be identified before the deal is announced internally. Retention payments, contractual lock-ins, or participation in a transaction incentive plan should be structured before the due diligence phase, not after — the period when staff are most likely to be approached by the buyer or to form their own views about the transaction.

The GRAX Connection

This entry sits within the Exit stage of the GRAX framework. The X in GRAX — Exit — is not a single event. It is a sequence of decisions, each of which either protects or erodes the value the seller has built. The pre-LOI stage is the most consequential of those decisions, because it is the last point at which the seller holds the full weight of competitive leverage. Everything agreed here sets the terms on which the rest of the transaction unfolds.

Deal Readiness — the operational, financial, and structural preparation that Rostone builds through the Grow, Raise, and Acquire stages — exists partly to ensure that when this moment arrives, the seller is not negotiating from a position of urgency or under-preparation. 

A business that has clean management accounts, a robust EBITDA bridge, no undisclosed change-of-control issues, and a management team that does not depend entirely on the founder is a business that can afford to negotiate slowly and hold firm.

This content is for information purposes only and does not constitute legal or financial advice. You should take independent professional advice before making any decisions in connection with a business sale or transaction.