An LOI, or Letter of Intent, is a document that describes a plan to work together in the future. LOIs are intended to be informal and non-binding, which is different from traditional contracts.
LOIs are used in lots of different industries and situations, including acquisitions, venture capital investments, job offers, and even buying a house. Startups most commonly use LOIs to secure non-binding commitments from prospective customers, often as proof of market validation to share with potential investors.They also are used in the early stages of acquisitions and VC financings, and often called term sheets in these settings.
To help B2B startups validate their market and gain early traction with customers and investors, we created an LOI template for commercial technology transactions.
Template LOI
We created a sample LOI that is available for free under the Creative Commons CC-BY 4.0 license.
Compared to a traditional sales contract, the LOI is shorter, more informal, and doesn’t cover as many details of the relationship between vendor and customer. Usually, the goal after signing an LOI is to move to a full-fledged contract like the Cloud Service Agreement or Professional Services Agreement.
The most important difference, however, is about legal enforceability. Put another way, while these other contracts are binding, the LOI is not.
Is an LOI legally binding?
The name of an agreement, whether it’s a Letter of Intent, Cloud Service Agreement, Service Level Agreement, etc, does not determine if it’s legally binding. That depends on the content of the document and the circ*mstances under which it is entered. The details can be very important, and there’s even been a case where a court ruled that a 👍 emoji was an enforceable contract.
In most commercial contexts, LOIs are intended to be non-binding. This means that signing the document has no legal impact on rights, obligations, or liabilities.
The Common Paper LOI is non-binding except for a binding confidentiality obligation. Vendors and customers often share sensitive information in the course of evaluating a potential relationship, and that information stays protected regardless of whether the deal ultimately moves forward.
When do startups use LOIs?
Startups almost always prefer to sign an actual sales contract rather than an LOI. Sales contracts represent revenue, and there’s nothing quite like paying customers to validate product-market fit. However, LOIs can be useful as evidence of traction for investors before it’s possible to get a signed sales contract.
If there is a mismatch between your funding requirements and your target customers’ procurement timeline, an LOI can help bridge the gap. Let’s say that you have a prospect that will take more than a year to evaluate your product and negotiate a contract, but you need to raise a round of funding within 3 months.
While you won’t be able to get to a signed sales contract, you may be able to get them to sign an LOI. The prospect has no legal obligation to move forward after the LOI, so investors don’t give it as much weight as a signed sales contract. However, it can be a valuable proofpoint that the purchase is being seriously considered.
LOI vs. Design Partner Agreement
A Design Partner Agreement is another option for formalizing a relationship before you’re ready for an actual sales contract. A design partnership typically takes place before the product is launched, while you’re working closely with a handful of prospects to iterate based on their feedback. The agreement outlines commitments from both sides about how they will work together.
The most notable difference from an LOI is that a Design Partner Agreement is binding. Note that binding does not necessarily mean that the parties are locked into doing business together long-term. Rather, binding in this context means that it’s an actual contract with legal force and obligations, even though either party can end the relationship at will.
The Design Partner Agreement is shorter and lighter weight than a full sales contract like the CSA, but it covers important things like clarifying that the vendor owns the IP for the product, which is not handled under an LOI.
There are increasing levels of formality going from LOI to Design Partner Agreement to CSA
| Letter of Intent | Design Partner Agreement | Cloud Service Agreement |
| Informal intention to work together | Lightweight contract for early stage product development | Full sales contract to cover the vendor/customer relationship |
| Quickest to review and sign | Shows some commitment, but not as much as CSA | Ultimate goal for revenue and evidence of traction |
| Non-binding except for confidentiality | Binding, covers IP ownership while being lighter weight than traditional sales contract | Binding and covers all traditional legal aspects of relationship |
Whether you sign an LOI or Design Partner Agreement, the goal is eventually to transition to a more traditional vendor-customer relationship along with a contract like the Cloud Service Agreement. To customize, propose, and sign your LOI for free, try Common Paper today.
Commercial vs. Acquisition LOI
LOIs also show up for startups during acquisitions. A prospective buyer might present your company with a term sheet, which is another name for an LOI. Just like in the commercial context, an acquisition LOI is a (mostly) non-binding agreement detailing the intent of both parties to enter into a formal agreement. It can include familiar terms like payment terms and a confidentiality clause.
However, there are a few key terms that are unique to acquisition LOIs. Deal structure describes the mechanics of the deal being proposed – for example, a merger, asset sale, or stock sale. Purchase price seems obvious but also covers how the payments will actually be made – for example, with cash, stock, or a combination. This isn’t an exhaustive list, and there are other specific terms to consider like closing date, exclusivity period, and length of the due diligence phase.
The LOI will typically have an associated expiration date, and both sides need to negotiate in good faith to get to a final deal before that date. The period from the signing of the LOI to the expiration date is often referred to as the exclusivity period, where the seller is required to stop any negotiations with other parties. If both sides agree, the expiration date can be pushed back.
During the exclusivity period, each party may be performing due diligence on the other, and the lawyers will be working on the definitive agreements. Those are the final, legally binding agreements that cover the acquisition. While the LOI outlines the broad strokes of how the deal might work, it’s the actual binding contracts like the purchase agreement that govern the terms of the transaction.
If you find yourself receiving serious acquisition interest from a prospective buyer, a qualified lawyer can help sort through any LOIs that might come your way. Thankfully, commercial LOIs with customers tend to be much simpler.
Generate your free LOI
Venture Capital Term Sheets
Term sheets that startups receive from VCs are also LOIs. They have parallels with acquisition LOIs, including expiration dates, exclusivity periods, and a plan to conduct due diligence and draft the definitive documents.
Some of the specific terms from a VC will differ from an acquisition or commercial LOI. Things like ownership percentages, board seats, veto rights, and anti-dilution protection are important terms in a venture capital financing.
When fundraising, there are widely used standards that have parallels to the Common Paper standard commercial agreements. Y Combinator created the SAFE, which is widely used for seed and pre-seed fundraising. The National Venture Capital Association, or NVCA, created model legal documents that are more popular inseries A and later rounds. It’s worth talking with your attorney and investor to see if these standards are a fit for your deal.
The letter of intent is a valuable tool, and regardless of how you use it, Common Paper can help you create, propose, and sign one quickly.
