What Is A Letter Of Intent?

When used between individuals, businesses, or LLCs, a letter of intent allows each individual party to define the relationship and its parameters and establish goals or future plans without a formal legal arrangement. Although a letter of intent is not a binding agreement, it can serve as a show of good faith, and often, the terms set out in the letter of intent are incorporated into the final contractual agreement. For these reasons, in the business world it is very common to have a letter of intent drafted by a contract attorney, who can provide advice on the most advantageous terms and clauses to include. The attorneys at Roulet Law Firm. P.A. can assist with a letter of intent for a Minnesota or Florida business dealing. Call our Minnesota office at 763-420-5087 or our Florida office at 941-909-4644 to learn more about how a letter of intent can further your goals.

The Purpose of a Letter of Intent

In real estate and commercial purchases, the purpose of a letter of intent (LOI), also referred to as a term sheet, is to cover three key areas of the anticipated contract. These three areas, broadly speaking, are as follows:

• Terms and conditions of the agreement
• Pricing and other financial considerations
• Timeline for completion of the proposal or duration of the business agreement

While typically not a legally binding document, a letter of intent nonetheless sets out essential parameters of a business agreement, subject to negotiation. A good letter of intent contains enough specific details regarding the prospective deal that regulatory agencies such as the United States Federal Trade Commission rely on letters of intent as a form of documentation that allow them to review contracts for potential problems, such as violations of anti-trust laws.

Terms and Conditions

The terms and conditions of an agreement in a letter of intent are similar to the same structures found elsewhere, such as in phone contracts or various service subscriptions. One frequent inclusion is a “no-shop clause,” which according to the Institutional Limited Partners Association helps to ensure the exclusivity of the offer. A no-shop clause gives the buyer the opportunity to consider and complete the transaction without other bids to consider. The terms and conditions portion will also typically include specifics for both buyer and seller to complete their respective due diligence. Due diligence must be completed prior to signing the finished contract, so the terms and conditions laid out in the LOI will in this respect differ from those that eventually become part of the legally binding agreement.

Pricing

Pricing will include not only the sale price of the business or real property but also the provisions for financing and payment. Pricing will also address provisions for any third-party funding or other seller financing, as external financial backing is a common element in sales of businesses and of real property.

Timelines

A good LOI will need to establish the deadlines for due diligence completion, executing any official purchase agreement, and the transaction closing date. Depending on the complexity of the deal under negotiation and the factors to consider, the LOI may also include proposed provisions for updated schedules should the transaction not be completed by the specified date.

Identification of Document

Finally, in addition to the other three elements, a letter of intent should clearly state that it is a letter of intent and, therefore, not a legally binding contract. This can help avoid misunderstandings and underscore the document’s purpose as a “good faith” offer.

Reasons To Write a Letter of Intent

The letter of intent serves as an introductory offer or proposal. This type of document is generally structured as an outline that includes the terms of the proposed agreement and is most often used in a real estate or business transaction, although letters of intent do also have some non-business applications, such as indicating to a local school district that a child will be homeschooled.            

Common functions for which an LOI is used include:

• Identify the terms of a proposed agreement early, and negotiate terms that may be problematic
• Concentrate negotiations on the most important terms
• Create consistency during negotiations
• Provide the ability to obtain third-party approval, if necessary
• Promote mutual understanding of key terms of the agreement

When Is a Letter of Intent Not the Best Choice?

There are some situations in which a letter of intent may not be the best option to reach your goals. Some of these include:

• If the transaction is very simple, then a letter of intent may add unnecessary steps to the process
• If spending time negotiating the terms of the LOI may negatively impact the timeframe for closing the deal
• If the letter of intent is not drafted correctly, then it may create binding obligations for one or both parties when neither party intended these
• If the letter of intent is not drafted carefully, its wording may diminish the negotiating position of either party to propose new terms during the course of negotiations

The experienced attorneys at Roulet Law Firm regularly assist our clients in drafting carefully nuanced letters of intent, tailored to the needs of their specific business and types of transactions. If you have received a letter of intent, one of our business attorneys may also be able to review the letter to ensure that it contains terms favorable to your interests, or advise you in terms to propose during negotiations. We can also examine the document’s wording to ensure that it is non-binding before you sign.

Florida Rules for a Letter of Intent

Each state has its own regulations for letters of intent. In Florida, even if both parties intend the letter of intent to be binding, a Florida court will often only enforce the terms of the agreement if all the elements of the deal are contained in the letter.

If the essential terms of the agreement are left open for negotiation in the letter of intent, then a Florida court may not enforce the agreement. The logic typically used in Florida for such cases is that an agreement with open-ended terms is essentially unenforceable.

Minnesota Rules for a Letter of Intent

The general rule in Minnesota regarding the enforceability of letters of intent is that they are unenforceable in court. Essentially, the LOI is an agreement for both parties to agree on the terms of the deal; non-binding options for an agreement are still open for negotiation.

Similar to their counterparts in Florida, therefore, Minnesota courts do not usually consider letters of intent to be legally binding because they do not constitute the final and complete agreement of both parties. However, the letter of intent can be enforceable if, in the letter, both parties agree to be bound by its terms.

When Is a Letter of Intent a Good Thing?

LOIs are most useful to identify the intentions of both parties to negotiate a deal. They create an agreement to discuss terms, and establish parameters under which each party may propose alternatives to the terms the other offers for consideration.

In a complex deal, one in which one party may be concerned about multiple bids or offers, a letter of intent may serve to place their offer before others, setting forth their good-faith agreement to enter into negotiations.

Get Help With a Letter of Intent

Do you need to draft a letter of intent for yourself or your business? The experienced estate planning and business attorneys at Roulet Law Firm may be able to help. Our services include drafting letters of intent on your behalf and reviewing any letters of intent sent to you. Call our Minnesota office at 763-420-5087 or our Florida office at 941-909-4644 to learn more about how a letter of intent can further your goals.

Business owners often hear about certain benefits of incorporating in "incorporation-friendly" states like Delaware, Alaska, or Nevada and wonder if incorporating in one of these states would be right for them. Most of the clients I see would not benefit under this arrangement, because they are headquartered in Minnesota and most of  their business is conducted in the Minnesota.  Typically, they would still have to follow Minnesota law, unless they leaned heavily on accountants and lawyers to try to set up a really complicated arrangement. If they were to incorporate in Delaware, the registration, upkeep, accounting and legal fees would generally offset any potential advantages. We find that incorporating in another state is just not a cost-effective option for many small businesses who do most of their business in Minnesota.

For business who will be operating in multiple states, the option to incorporate in a "business-friendly" state like Delaware, Alaska, or Nevada becomes a more viable option.

If you have questions about whether incorporating in a "business-friendly" state is right for you, please contact our office. 

The Corporation as an Entity.

A corporation is an entity. A corporation exists separate from its owner(s). A corporation can sue and be sued. A corporation has its own “social security number” in the form of its Employer Identification Number or EIN.

Corporate Structure

A corporation is owned by its shareholders. If you own stock in any corporation, you are an owner of that corporation. The shareholders elect the Board of Directors. The Board of Directors is in turn responsible for running the corporation on behalf of the shareholder-owners. The Board of Directors then elects and oversees the officers of the corporation that are responsible for the day-to-day operation of the corporation subject to the oversight of the Board of Directors.

Federal Insurance Contributions Act (FICA) Taxes

FICA is used to provide for the federal system of old age, survivors, disability and hospital insurance. The first three of these is funded by the Social Security system. Hospital insurance is funded by a Medicare tax. Both the corporation as employer and the employee(s), are required to pay FICA taxes on income earned as an employee of the corporation. The FICA tax rate is 7.65%. The breakdown of the 7.65% is 6.2% for the Social Security portion (old age, survivors and disability or OASDI) and 1.45% for the Medicare portion.

It is important to note that FICA taxes are paid by BOTH the corporation and the employee at the rate of 7.65%. Thus, the actual FICA tax rate is 15.3%. So, if you are the owner/shareholder of your own corporation, as well as the employee of your corporation, your income you’re your corporation will be subject to a 15.3% FICA tax. It should be noted that there are limits on the amount of OASDI taxes. However, that is beyond the scope of the discussion here. For now, you simply need to understand what FICA taxes are, the FICA tax rate and that they are paid by both the corporation and the employee(s) of the corporation.

Unemployment Insurance

Another tax that must be understood by all owners of corporations is the unemployment tax. IRS regulations require that all corporations have at least one employee. For most small business owner, they will end up being shareholder/owner, director, officer and employee of the corporation they own. Many states will require the owner of the corporation to carry unemployment insurance for the employee(s) of the corporation even if the only employee of the corporation is its owner. Even if the state of incorporation does not require unemployment insurance, the federal government will. What the small business owner needs to understand is that they will need to pay for unemployment insurance for themselves as the employee of their corporation. However, because they are the sole owner of the corporation, they cannot collect unemployment should the corporation they own ever fail and they find themselves without an income from their corporation.

C Corporations and S Corporations

A corporation can either be a “C” corporation or an “S” corporation. “C” and “S” refer to the subchapters of the Internal Revenue Code that govern the tax treatment of the two. All corporations are subchapter C corporations by default; when a corporation is formed it is a C corporation unless the shareholders of the corporation choose to be an S corporation instead by electing to become an S corporation in their minutes and filing the required form with the Internal Revenue Service. There are very significant differences between them.

 S Corporations

An S corporation avoids the “double taxation” of a C corporation, but there are a number of rules that must be followed before a corporation can become an S corporation. For instance, an S corporation can have no more than 100 shareholders, and each shareholder must be an individual who is either a United States citizen or a Permanent Resident Alien.

The Corporation as an Entity.

A corporation is an entity. A corporation exists separate from its owner(s). A corporation can sue and be sued. A corporation has its own “social security number” in the form of its Employer Identification Number or EIN.

Corporate Structure

A corporation is owned by its shareholders. If you own stock in any corporation, you are an owner of that corporation. The shareholders elect the Board of Directors. The Board of Directors is in turn responsible for running the corporation on behalf of the shareholder-owners. The Board of Directors then elects and oversees the officers of the corporation that are responsible for the day-to-day operation of the corporation subject to the oversight of the Board of Directors.

Federal Insurance Contributions Act (FICA) Taxes

FICA is used to provide for the federal system of old age, survivors, disability and hospital insurance. The first three of these is funded by the Social Security system. Hospital insurance is funded by a Medicare tax. Both the corporation as employer and the employee(s), are required to pay FICA taxes on income earned as an employee of the corporation. The FICA tax rate is 7.65%. The breakdown of the 7.65% is 6.2% for the Social Security portion (old age, survivors and disability or OASDI) and 1.45% for the Medicare portion.

It is important to note that FICA taxes are paid by BOTH the corporation and the employee at the rate of 7.65%. Thus, the actual FICA tax rate is 15.3%. So, if you are the owner/shareholder of your own corporation, as well as the employee of your corporation, your income you’re your corporation will be subject to a 15.3% FICA tax. It should be noted that there are limits on the amount of OASDI taxes. However, that is beyond the scope of the discussion here. For now, you simply need to understand what FICA taxes are, the FICA tax rate and that they are paid by both the corporation and the employee(s) of the corporation.

Unemployment Insurance

Another tax that must be understood by all owners of corporations is the unemployment tax. IRS regulations require that all corporations have at least one employee. For most small business owner, they will end up being shareholder/owner, director, officer and employee of the corporation they own. Many states will require the owner of the corporation to carry unemployment insurance for the employee(s) of the corporation even if the only employee of the corporation is its owner. Even if the state of incorporation does not require unemployment insurance, the federal government will. What the small business owner needs to understand is that they will need to pay for unemployment insurance for themselves as the employee of their corporation. However, because they are the sole owner of the corporation, they cannot collect unemployment should the corporation they own ever fail and they find themselves without an income from their corporation.

C Corporations and S Corporations

A corporation can either be a “C” corporation or an “S” corporation. “C” and “S” refer to the subchapters of the Internal Revenue Code that govern the tax treatment of the two. All corporations are subchapter C corporations by default; when a corporation is formed it is a C corporation unless the shareholders of the corporation choose to be an S corporation instead by electing to become an S corporation in their minutes and filing the required form with the Internal Revenue Service. There are very significant differences between them.

C Corporations

Let’s examine a C corporation against our three criteria for a business: 1) Limited liability; 2) Tax efficiency; and 3) Operating efficiency.

Limited Liability. A corporation has a limited liability shield. If the corporation is properly incorporated and properly maintained, creditors of the corporation can only attach assets owned by the corporation; the assets of the officers, shareholders and directors are safe. However, if the corporation is not properly incorporated or fails to meet certain operating requirements, a potential creditor may “pierce the corporate veil” and attach the assets of the officers, shareholders or directors. Some reasons courts may allow creditors to pierce include lack of corporate formalities (e.g. failure to hold meetings of directors and/or shareholders), mixing business and personal funds, entering into agreements in one’s own name versus the name of the corporation, failing to identify the corporation as a corporation to the public and lack of capitalization.

As an example, let's say that Sally and Janet have started making and selling quilts together. If Janet drove out to a quilting show and got in an accident, Sally could be held jointly liable with her depending on the form of entity they chose. If they had chosen a partnership, Sally could be held liable with Janet.

On the other hand, choosing a C corporation would provide limited liability protection for both Sally and Janet. That is to say, assuming the corporation is properly formed and properly maintained, a potential creditor could only attach assets owned by the corporation. A creditor could not attach Sally and Janet’s personal assets. However, there are also tax and operating efficiency considerations.

Tax Efficiency. A C corporation, unlike a S corporations, LLCS, and partnership, pays its own separate taxes. At the end of its tax year, a C corporation reports its profits to the Internal Revenue Service on Form 1120. The corporation then pays taxes on those profits at the rate as determined by the bracket the profits put it into; just like you. Then, if the corporation pays a dividend to its shareholders, the shareholder is responsible for reporting the dividend on the shareholder’s individual tax return and paying taxes on the dividend earnings. As a result, profits of a C corporation are subject to double taxation. That is, the profits are taxed the first time when the corporation reports its income and pays its taxes on that income and then the profits are taxed a second time when they are paid to the shareholders of the corporation and reported on the shareholder’s tax return. The double-taxation of profits of a C corporation is one of the biggest drawbacks to its use. That being said, there are ways of “zeroing out” the profits of the C corporation so as not to pay the double tax. There are also some significant tax planning opportunities available to the C corporation.

Dividends paid to shareholders must be in directly proportional to the percentage ownership of the corporation. So, if two shareholders own the corporation 50/50, the dividends paid must be 50/50. If the two shareholders own the corporation 80/20, the dividends paid must be 80/20.

Internal Revenue Service rules also require all corporations to have at least one employee. For most small businesses, that means that the owner MUST be an employee of their corporation. If there is more than one owner/shareholder, at LEAST ONE, but NOT all, of the owners/shareholders MUST be an employee of the corporation. The employee(s) of the corporation must be paid a salary in the form of “W-2” income. That means income from the corporation paid to the employee as an employee of the corporation gets reported on form W-2. The income is also subject to Federal Insurance Contributions Act (FICA) taxes.

Operating Efficiency. Unlike partnerships, a C corporation is a perpetual entity; it exists until it is dissolved. Dissolution of the corporation occurs when the shareholders of the corporation choose to dissolve or by operation of law (e.g. the corporation does something requiring it to be dissolved such a result of a court action, or fails to do something which dissolves it such as failing to make an annual filing).

Corporations are creatures of statute. State laws mandate the structure and operating structure of corporations. Thus, in order to start a corporation, a filing must be made with the appropriate government agency in the state in which the corporation will exist and all state requirements as to the structure and operations of the corporation must be met. In addition, most states also require annual filings and still others will require yearly filing fees to maintain the corporation. Exhibit A has an alphabetical listing of the websites for each state’s office that handles business incorporations.

Summary. A C corporation is attractive because of the limited liability protection it affords. However, administrative and compliance can be large. Lastly, profits of a C corporation are subject to double-taxation unless the owners choose to “zero-out” the profits of the corporation by paying all profits out as W-2 income to its employee(s).

To learn more, download a FREE copy of my book "Be Your Own Boss: A Fast & Friendly Legal Guide to Starting Your Own Business" by clicking on the link.

Choosing your business entity can be a confusing process, especially when you're seeing options like "LLC" and "LLP." Laws can vary from state to state, but what is the difference between the two?

LLC  (Limited Liability Company)

• Owners of an LLC are called "members" and they may include individuals, corporations, other LLCs, and foreign entities. With an LLC, members have limited personal liability for the debts and actions of the business, but not for another member of the LLC. If someone makes a mistake that requires legal action, every member could be held accountable.
• Some businesses like banks and insurance companies usually can't be organized as an LLC.
• LLC is not a recognized classification for federal taxes; a corporation, partnership or sole proprietorship tax return must be filed.
• Owners of an LLP are called partners. Much like a general partnership, but each partner isn't liable for the misconduct, negligence, or mistakes of other partners. They are only responsible for their own actions.
• LLPs are common for professional occupations that require a license, such as a legal practice or accountants’ partnership.
• The LLP's income is not taxed as a business, but it is taxed on an individual level when the profit is passed down to partners.

LLP  (Limited Liability Partnership)

If you would like to learn about the exact laws for Minnesota business owners, contact Maple Grove business services attorney Chuck Roulet for a free consultation. He will be able to recommend whether your company should be an LLC or LLP, or possibly another business entity entirely. Call Chuck at 941-909-4644 or 763-420-5087 and download a free copy of his book, Be Your Own Boss: A Fast and Friendly Legal Guide to Starting Your Own Business.