Letter of Intent / Term Sheet — US Drafting Reference

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Drafting reference for US letters of intent, term sheets, and MOUs — binding vs non-binding doctrine, Type I vs Type II agreements, M&A LOI, VC term sheets.

The letter of intent (LOI) — also termed term sheet, memorandum of understanding (MOU), or agreement in principle — is a preliminary document setting out the key terms of a contemplated transaction before the parties sign a definitive agreement. LOIs are ubiquitous in M&A, joint ventures, real-estate transactions, financing rounds, and major commercial deals. They are also the single most-litigated category of “non-binding” document in US commercial law, because of the recurring failure to draft with precision around what is binding and what is not. This page is the US drafting reference for the contract type. Cross-reference contract law basics for offer-acceptance and capacity, and standard clauses for boilerplate.

Binding vs. Non-Binding — The Central Drafting Problem

The doctrinal premise of an LOI is simple: the parties intend to negotiate further and enter into a final definitive agreement, and the LOI is not itself the final binding contract. The drafting problem is that intent to be bound under Restatement (Second) of Contracts § 27 is determined by what the parties objectively manifest, not by their subjective belief. A letter that says “this LOI is non-binding” but reads like a definitive agreement — with completely specified terms, signed by authorised representatives, and acted on by both parties — may be held binding notwithstanding the disclaimer. Conversely, a letter explicitly contemplating a “definitive agreement to follow” may bind on certain provisions if those provisions are sufficiently specific and the parties clearly intended to be bound by them.

The cautionary tale is Texaco, Inc. v. Pennzoil Co., 729 S.W.2d 768 (Tex. App. 1987). Pennzoil and Getty Oil signed a “Memorandum of Agreement” and a press release announcing an “agreement in principle” for Pennzoil to acquire Getty stock. Texaco then made a superior offer and Getty’s board sold to Texaco instead. Pennzoil sued Texaco for tortious interference with contract, won a jury verdict of $10.53 billion (including $3 billion punitive damages — at the time the largest civil verdict in US history), and forced Texaco into Chapter 11 bankruptcy. The key legal premise: the jury found that the “agreement in principle” was in fact a binding contract under New York law, notwithstanding the parties’ contemplation of a more formal definitive agreement to follow. The case is a permanent reminder that the form of the document, not the label, controls.

Type I vs. Type II Preliminary Agreements

Federal courts — particularly the Second Circuit — have developed a two-tier framework for analysing the binding effect of preliminary agreements.

Adjustrite Systems, Inc. v. GAB Business Services, 145 F.3d 543 (2d Cir. 1998) and the lead earlier decision in Teachers Insurance & Annuity Ass’n v. Tribune Co., 670 F. Supp. 491 (S.D.N.Y. 1987), articulated the distinction:

Type I preliminary agreement. Fully binding even though the parties contemplate a further, more formal document. The Type I agreement reflects all the essential terms and the parties have agreed to be bound; the contemplated future document is a mere formalisation. Liability for breach of Type I includes ordinary expectation damages.

Type II preliminary agreement. The parties have agreed to certain open terms and have a binding obligation to negotiate the remaining terms in good faith. The Type II agreement does not commit the parties to ultimate consummation; if good-faith negotiation fails, neither party is liable for the failure to consummate. Liability for breach of Type II is for failure to negotiate in good faith — typically out-of-pocket reliance damages, not expectation damages.

The four-factor test (from Teachers Insurance) for Type I vs. Type II classification:

  1. The language of the agreement — does it expressly disclaim or reserve binding effect?
  2. The context of the negotiations — sophistication of parties, prior course of dealing, complexity of the deal.
  3. The existence of open terms — are there material terms still to be negotiated?
  4. Whether partial performance has occurred — and on what understanding.

Brown v. Cara, 420 F.3d 148 (2d Cir. 2005) reaffirmed the framework and emphasised that Type II “binding preliminary commitment” requires the parties to negotiate further details in good faith but does not impose substantive obligations. The drafter who wants neither type of binding effect must say so unambiguously.

The Non-Binding Disclaimer — Required Language

Every LOI intended to be non-binding must include explicit disclaimer language. The standard pattern:

Non-Binding Nature. This Letter of Intent reflects the present mutual understanding of the Parties concerning a possible transaction. Except for the provisions of Sections [X] (Confidentiality), [Y] (Exclusivity), [Z] (Expenses), [W] (Governing Law), and [V] (Termination) (collectively, the “Binding Provisions”), this Letter of Intent is NON-BINDING and does not constitute an offer, acceptance, agreement, or commitment of either Party. No legal obligation, right, or liability of any nature shall arise from this Letter of Intent or from any negotiations conducted in connection with the contemplated transaction. The Parties’ rights and obligations with respect to the contemplated transaction shall be set forth solely in a fully-executed Definitive Agreement (if any), and either Party may withdraw from negotiations at any time, for any reason or no reason, without liability.

The disclaimer must operate at every level — no offer, no acceptance, no agreement, no commitment — and must enumerate the binding carve-outs by section number. The “no liability for withdrawal” recital is critical to defeat any later good-faith-negotiation claim that strays toward Type II liability.

Standard Binding Carve-Outs

Even a non-binding LOI typically includes a small number of expressly binding provisions:

  • Confidentiality. Each Party shall keep confidential the existence and terms of the LOI and any non-public information disclosed in negotiations. Often a stand-alone NDA is signed in parallel; the LOI’s confidentiality provision references it.
  • Exclusivity / no-shop. During the LOI period (typically 30-90 days), the seller (or in a financing context, the company) commits not to solicit, entertain, or negotiate competing transactions. Critical for buyer to invest in due diligence.
  • Expense allocation. Each Party bears its own expenses; or, in some transactions, the buyer reimburses certain seller expenses up to a cap on consummation.
  • Break-up fee. In M&A contexts, a fee payable on certain termination events (typically 1-3% of transaction value).
  • Governing law and forum. Even for a non-binding LOI, dispute over the binding carve-outs requires a governing law selection.
  • Public-announcement restrictions. No party shall make any public announcement except as required by law (SEC filings) or with the other party’s consent.
  • Termination of LOI itself. Mechanics for terminating: mutual agreement, expiration of LOI period, signing of Definitive Agreement, material breach of binding provisions.

Exclusivity / No-Shop Period

The exclusivity provision is the single most-negotiated term in any M&A LOI. It commits the seller to deal exclusively with the prospective buyer during the negotiation period. Standard structure:

  • Duration. 30 to 90 days, often with provision for mutual extension.
  • Scope. Asset transaction (assets being acquired) or stock/membership-interest transaction (entire company). Sometimes carved by line of business.
  • Restricted activities. Solicit, encourage, initiate, entertain, discuss, negotiate. The verbs matter — “solicit” alone permits inbound inquiry; comprehensive enumeration prevents back-channel activity.
  • Fiduciary out. Public-company boards have Revlon duties (Revlon, Inc. v. MacAndrews & Forbes Holdings, 506 A.2d 173 (Del. 1986)) that constrain absolute no-shops; a “fiduciary out” permits the board to entertain unsolicited superior offers without breaching the LOI.
  • Notice obligations. Seller must notify buyer of any unsolicited inquiry within a defined period and disclose material terms.

M&A Letter of Intent Structure

A complete M&A LOI typically covers:

  1. Parties and contemplated transaction. Buyer, Seller, target, transaction structure (asset purchase, stock purchase, merger, reverse triangular merger).
  2. Purchase price and payment mechanics. Cash, stock, contingent consideration (earnouts, holdbacks, escrow), working-capital adjustment, indebtedness/cash treatment.
  3. Conditions to closing. Due diligence satisfaction, regulatory approvals (HSR, CFIUS), key employee retention, third-party consents (lessors, customers, licensors), no material adverse change, representations and warranties at closing.
  4. Due-diligence access. Scope of diligence, virtual data room mechanics, management presentation, site visits, customer/supplier diligence (with consent procedures).
  5. Transaction structure and tax treatment. Asset deal step-up vs. stock deal carryover basis; § 338(h)(10) election; § 1060 allocation.
  6. Representations and warranties. Outline only — full reps to be negotiated in Definitive Agreement.
  7. Covenants pending closing. Ordinary-course operation, no extraordinary transactions, employee retention, access to records.
  8. Exclusivity. As discussed above.
  9. Expense allocation and break-up fee. As applicable.
  10. Confidentiality. Cross-reference or stand-alone provision.
  11. Definitive Agreement timing. Outside date for signing definitive agreement; outside date for closing.
  12. Termination. Mutual agreement, expiration, signing of definitive, material breach.
  13. Governing law. Typically Delaware or New York for M&A.
  14. Non-binding nature. Disclaimer as above.

VC Term Sheet Structure

For venture-capital financings, the term sheet covers economic and control terms. Standard 2025 conventions:

Economic terms:

  • Pre-money valuation. The agreed value of the company before the new investment.
  • Investment amount. Cash invested in this round.
  • Post-money valuation. Pre-money + investment.
  • Option pool. Reservation of unissued common stock for future employee grants — typically structured as an increase in the option pool before the investment, which dilutes existing shareholders rather than new investors.
  • Liquidation preference. Most 2025 institutional rounds: 1× non-participating preferred. Participating preferred (double-dip) and multiple liquidation preferences (2×, 3×) are anomalous and signal distress or strong investor leverage.
  • Anti-dilution. Broad-based weighted average is the 2025 institutional standard; full ratchet is rare and aggressive; narrow-based weighted average is unusual.
  • Dividends. Typically non-cumulative, payable only on declaration. Cumulative dividends are uncommon in standard VC deals.
  • Conversion. Each preferred share converts to common at a 1:1 ratio (subject to anti-dilution adjustments) at the investor’s option or automatically on a qualified IPO.

Control terms:

  • Board composition. Investor right to designate one or more directors; independent-director seat as company grows.
  • Protective provisions. Investor consent required for enumerated actions: amend charter or bylaws, issue senior/pari passu securities, sell company, take on debt above a cap, redeem stock, change option pool, change board size, etc.
  • Drag-along. Majority preferred holders may compel minority to participate in a sale on the same terms.
  • Tag-along. Founders cannot sell shares without offering investors pro-rata participation.
  • Right of first refusal (ROFR). On transfers of common stock by founders/employees, the company and investors have first right to purchase.
  • Pre-emptive rights. Investors may participate pro-rata in future rounds.
  • Information rights. Quarterly financials, annual budget, audit access.
  • Voting agreement. Coordinated voting on board composition and other key matters.

Investor protections:

  • Founder vesting. Existing founder shares re-vested over four years with one-year cliff. Material to ensure founder retention.
  • Founder non-compete and non-solicit. Subject to enforceability (California Cal. B&P § 16600 limitations).
  • Conditions to closing. Diligence satisfaction, KYC/AML on founders, employment agreements with key employees, no MAC.

Letter Agreement vs. Term Sheet vs. MOU — Format Conventions

The format conventions vary by industry:

  • Letter agreement / LOI. Standard for M&A. Prose document, signed by both parties. Typically 4-10 pages.
  • Term sheet. Standard for VC financings, joint ventures, complex commercial deals. Outline format with headings and bullet points. Typically 3-6 pages. Often signed by both parties (creating Type I or II issues) but sometimes initialled or stamped “accepted” only.
  • Memorandum of Understanding (MOU). Common in government, international, and non-profit contexts. Often non-binding by industry custom but the same drafting rules apply — intent to be bound is determined by content, not label.

Governing Law Preferences

Delaware governing law is the default for M&A and VC transactions involving Delaware-incorporated entities, which is the majority of US transactions. New York law is the default for finance-heavy transactions, complex commercial deals, and where neither party is Delaware-incorporated. Delaware courts have developed specialised LOI jurisprudence — Black Horse Capital v. Xstelos Holdings, C.A. No. 8642 (Del. Ch. 2014) and SIGA Technologies, Inc. v. PharmAthene, Inc., 132 A.3d 1108 (Del. 2015) (Type II expectation damages available for breach of obligation to negotiate in good faith).

Securities Law Context

For LOIs covering equity financings, securities-law overlay is critical:

  • Rule 506 of Regulation D. Most VC financings are issued under Rule 506(b) (limited general solicitation, unlimited accredited investors, up to 35 sophisticated non-accredited) or 506(c) (general solicitation permitted, all purchasers accredited and verified). Form D filing required within 15 days of first sale. The LOI/term sheet stage typically precedes the “sale” trigger but issuers and counsel should verify that pre-Form-D communications comply with general-solicitation rules.
  • Rule 144 holding periods. Affects later resale of securities issued under the financing.
  • Blue-sky laws. State-level securities filing in addition to federal Form D.

Bibliography

Cross-references

  • Contract Law Basics — offer-acceptance, intent to be bound, R2K § 27
  • Standard Clauses — boilerplate for binding carve-outs
  • NDA — confidentiality companion document for LOI negotiations
  • MSA — definitive-agreement form for services transactions that follow an LOI

Disclaimer: This content is informational, not legal advice. Last verified: 2026-05-10. Always consult licensed counsel for binding decisions.