The Earnest Money and Letter of Intent Basics

Why this matters

Buyers new to acquiring a business often treat the letter of intent as a formality to rush through so the "real" negotiation can start. That instinct is backwards. The letter of intent is where most of your actual leverage exists, because both sides still have the option to walk away cheaply. Once you are deep into due diligence with earnest money on the table, walking away gets expensive and emotionally harder. Understanding what these two tools actually do, and do not do, protects you before you have spent real money and time on a deal that may not close.

What a letter of intent actually is

A letter of intent, often shortened to LOI, is a document that states the buyer's proposed terms for acquiring the business: purchase structure, a price range or formula, timeline, and the major conditions of the deal. It is a starting position, not a contract.

• Most of an LOI is non-binding. Either side can walk away without financial penalty if due diligence reveals a problem or the parties cannot agree on final terms.
• A small handful of clauses are typically binding even in a non-binding LOI: confidentiality, exclusivity (see below), and sometimes a no-shop provision. Read these sections closely, because they are the only parts that actually obligate you before a purchase agreement is signed.
• The LOI sets the frame for everything that follows. A vague LOI leads to a painful renegotiation later when both sides discover they meant different things by "purchase price."

What belongs in a solid letter of intent

• Structure of the deal: an asset purchase versus an entity purchase, since the two carry very different tax and liability implications and should be decided with your accountant and attorney before you write the LOI.
• Price mechanism: whether it is a flat figure, a multiple of a defined earnings metric, or a formula with adjustments for inventory, receivables, or working capital at closing.
• Financing contingency: a clear statement that the deal is contingent on the buyer securing financing on acceptable terms, protecting you if lending falls through.
• Due diligence period: a defined window, commonly measured in weeks, during which the buyer reviews financials, contracts, licenses, equipment condition, and staff, with the right to walk away or renegotiate based on findings.
• Exclusivity period: the seller agrees not to negotiate with other buyers for a set window while you complete diligence. This is usually the one binding clause that matters most to a buyer, because without it you can spend weeks on diligence while the seller quietly keeps shopping the deal.
• Key employee and non-compete expectations: whether the seller stays on for a transition period, and whether they are restricted from starting a competing shop nearby afterward.
• Target closing timeline: not binding, but it sets expectations and flags a seller who is not actually motivated to move.

What earnest money is and is not

Earnest money is a deposit the buyer puts down, usually held in an escrow or attorney trust account, to signal genuine intent to close. It is common in real estate deals and increasingly used in small business acquisitions that involve a property or a highly motivated seller.

• It is refundable under the conditions you negotiate. A well-drafted agreement returns the earnest money to the buyer if the deal falls through during the diligence contingency period, if financing falls through, or if the seller misrepresents material facts.
• It becomes at-risk once contingencies are satisfied and waived. After the diligence period closes and you have formally accepted the findings, walking away without cause can mean forfeiting the deposit to the seller.
• It is not a substitute for diligence. Earnest money proves you are serious. It does not verify the business's numbers, its customer relationships, or the condition of its equipment. Those are separate work.
• Confirm where it is held and under what terms, ideally in a neutral escrow account controlled by a third party, not directly by the seller. Your attorney should review the exact release conditions before you wire anything.

The sequence that protects a buyer

1. Sign a mutual non-disclosure agreement before either side shares real financials.
2. Negotiate and sign the letter of intent, with an exclusivity clause protecting your diligence window.
3. Conduct full due diligence: financials, contracts, licenses, equipment, staff, customer concentration. See related: What a Shop Buyer Should Ask Current Employees.
4. Only after diligence is satisfactory, place earnest money and move to a binding purchase agreement.
5. Close, with your attorney confirming every condition from the LOI made it into the final contract.

The mistake to avoid

Do not let excitement about a deal push you to skip or shorten the LOI stage, or to place earnest money before diligence has meaningfully started. A seller who resists a reasonable exclusivity period or a fair diligence window, or who pushes hard for earnest money before you have seen real financials, is telling you something about how the rest of the deal will go. Involve an attorney and, ideally, a business broker or accountant experienced in small business acquisitions before you sign anything with financial consequences.

References

• U.S. Small Business Administration (SBA), guidance on buying an existing business
• International Business Brokers Association (IBBA), standard practice on letters of intent and due diligence
• See related: What a Shop Buyer Should Ask Current Employees, Financing Options for Buying a Small Shop