From Letter of Intent to Purchase Agreement: The Terms That Decide Your Proceeds

Most owners remember the number in the letter of intent. Few remember the definitions that sit underneath it, and yet those definitions decide how much of that number arrives in their bank account. A $40 million offer can become $36 million of cash at closing, $1.5 million parked in escrow for two years, and a further exposure to indemnity claims that does not expire until well after the owner has moved on. None of that is unusual, and none of it means the buyer acted in bad faith. It is simply how private-company acquisitions are documented.

This guide follows a transaction from the letter of intent (LOI) through the definitive purchase agreement to closing. It explains which LOI terms are binding, how purchase price adjustments and the net working capital peg work, how representations, warranties and indemnification allocate risk, how escrows, holdbacks and representations and warranties insurance (RWI) change that allocation, and what can still go wrong between signing and closing. The figures are indicative ranges drawn from the lower middle market, where most founder-owned and sponsor-backed B2B companies trade.

Headline price versus proceeds

Buyers almost always quote an enterprise value: the price for the operating business on a cash-free, debt-free basis with a normal level of working capital. The equity value the seller receives is derived from it through a series of additions and subtractions, and then a portion of that equity value is withheld at closing. Every step in that bridge is defined somewhere in the purchase agreement, and each definition is negotiable.

• Enterprise value, as stated in the LOI.
• Less funded debt and “debt-like items” such as unpaid prior-period bonuses, deferred compensation, pre-closing income taxes, and sometimes deferred revenue or customer deposits.
• Plus cash left in the business, if the deal is cash-free.
• Plus or minus the difference between closing net working capital and the agreed peg.
• Less unpaid transaction expenses, including advisor and legal fees and any change-of-control payments.
• Less amounts withheld at closing: the adjustment escrow, the indemnity escrow or holdback, and any special escrows.
• Less, later, any indemnity claims paid, plus or minus the final working capital true-up, plus any earnout or deferred consideration actually earned.

The price is set in the LOI; the proceeds are set in the definitions.

The letter of intent: what binds and what does not

An LOI is usually a short document, three to eight pages, that records the economic deal and the process for getting to a signed purchase agreement. Most of its terms are expressly non-binding: either party can walk away until the definitive agreement is signed. A handful of terms are binding from the moment the LOI is countersigned, and those are the ones that shape the next two to four months.

Because the economic terms are non-binding, owners sometimes treat the LOI as a formality and leave details for the lawyers. That is a mistake. Once the LOI is signed and exclusivity begins, the seller has stopped talking to other buyers, and every open point is negotiated against a single counterparty that knows it. Anything the LOI is silent on tends to be resolved in the buyer’s favor, or traded for something else the seller wanted. A detailed LOI costs a week more negotiation; a vague one can cost a percentage point or more of the price.

Exclusivity and the confirmatory diligence period

Exclusivity, also called a no-shop, prevents the seller and its advisors from soliciting, encouraging or negotiating with other buyers for a fixed period. In the lower middle market it typically runs 45 to 90 days, and buyers often ask for an automatic extension if they are “working in good faith.” Sellers should resist automatic extensions; any extension should be a fresh decision, made with the benefit of knowing how diligence is going.

Two provisions make exclusivity safer for a seller. The first is a fall-away: if the buyer proposes a reduction in price or a material change in terms, exclusivity ends at the seller’s option. The second is a schedule: an agreed sequence for delivering the first draft of the purchase agreement, completing the quality of earnings review and finalizing financing. Buyers with a credible schedule rarely object, and those who do are signaling something useful.

The purchase agreement: structure and anatomy

The definitive agreement takes one of three main forms. In a stock purchase agreement (SPA), the buyer acquires the shares or membership interests of the company, which keeps its contracts, permits and liabilities. In an asset purchase agreement (APA), the buyer acquires selected assets and assumes only listed liabilities. In a merger agreement, the target merges with a buyer subsidiary, which is useful when there are many shareholders who cannot all be made to sign. The choice is driven by tax, the number of owners and how hard it is to transfer contracts and licenses.

Whatever the form, the agreement follows a predictable architecture. Knowing where each issue lives makes the drafts much easier to read.

Purchase price adjustments and cash-free, debt-free

On a cash-free, debt-free basis, the seller keeps the cash (or is paid for cash left in the business) and repays all funded debt at closing. The principle is simple; the fight is over what counts as debt. Bank loans and capital leases are uncontroversial. Buyers will also seek to include accrued but unpaid bonuses for prior periods, deferred compensation, unpaid pre-closing income taxes, deferred rent, earnouts owed from the seller’s own past acquisitions, and sometimes deferred revenue or customer deposits. Each of these reduces the price dollar for dollar, so the seller should ensure that nothing is counted twice: an item treated as debt must be excluded from working capital, and vice versa.

Cash has its own wrinkles. Buyers commonly exclude “trapped cash” that cannot be freely distributed, customer deposits held in operating accounts, and outstanding checks. Some buyers cap the cash they will pay for, or require a minimum cash balance to be left in the business with no credit. These are legitimate positions when the business genuinely needs cash to operate, but they should be priced into the enterprise value, not introduced quietly in the first draft.

Mechanically, the seller delivers an estimated closing statement a few days before closing and is paid on the basis of those estimates. Within roughly 60 to 120 days after closing, the buyer prepares a final closing statement. The seller has a review period, typically 30 to 60 days, with access to the books, and unresolved disagreements go to an independent accounting firm whose decision is binding and usually limited to the disputed items. A separate adjustment escrow, often around 0.5% to 1.5% of enterprise value, secures any amount the seller owes after the true-up.

The net working capital peg

The working capital adjustment exists because a buyer is paying for a business that comes with a normal level of receivables, inventory and payables. If the seller collected receivables aggressively and delayed payables before closing, it would be extracting value the buyer paid for. The peg is the agreed “normal” level; closing working capital above the peg increases the price, and below the peg reduces it, dollar for dollar.

Net working capital for this purpose is usually current operating assets (receivables, inventory, prepaid expenses) less current operating liabilities (payables, accrued expenses), excluding cash, debt, debt-like items, income tax balances and transaction-related accruals. The definition should reference a sample calculation attached as an exhibit and specify that the closing statement uses the same accounting principles, policies and judgments as the financial statements on which the peg was set. Without that consistency clause, a buyer can increase reserves after closing and recover the difference as a working capital shortfall.

How the peg is set

The most common starting point is the average of month-end adjusted net working capital over the trailing twelve months. Twelve months captures a full seasonal cycle, and averaging smooths out timing noise. The quality of earnings report usually supplies the monthly figures, adjusted for the same normalizations applied to EBITDA. Buyers sometimes argue for a shorter period when the business is growing quickly, since a growing business needs more working capital; sellers sometimes argue for a longer one when the latest months were unusually high. Both arguments can be legitimate, and both are worth modeling before agreeing.

Seasonality

A flat average works well for a business whose working capital is steady through the year. For a seasonal business it can produce a meaningful price adjustment purely because of the closing date. If the closing falls in a month when working capital is naturally low, the seller pays a shortfall even though nothing abnormal happened; in a seasonal peak, the seller collects a windfall. The fixes are a month-specific peg (a schedule of targets by closing month), a seasonal adjustment to the average, or a deliberate choice of closing date.

Two further protections are worth negotiating. A collar or de minimis band, under which no adjustment is made unless the difference exceeds an agreed amount, avoids disputes over small variances, though it cuts both ways. And the definition of the peg and the closing calculation should be locked to the same exhibit so neither side can reclassify accounts between signing and the true-up.

Representations and warranties

Representations and warranties are statements of fact about the company: its financial statements are accurate, it complies with laws, it owns its intellectual property, it has no undisclosed litigation, its material contracts are in force, and so on. A typical lower middle market agreement contains twenty to thirty sections of company reps. They serve two purposes. Before signing, they force disclosure: the seller must list every exception in the disclosure schedules. After closing, they allocate risk: if a rep turns out to be untrue, the buyer may recover its losses through indemnification or insurance.

The disclosure schedules are the seller’s best protection. A fact properly disclosed against the relevant rep is generally not a breach. Schedules should be prepared early, with care, and with cross-references so that a disclosure in one section is deemed to apply wherever its relevance is reasonably apparent.

Fundamental, general and tax reps

Reps fall into tiers with different survival periods and caps. Fundamental reps cover matters that go to the heart of the transaction: the seller’s authority to sign, the company’s organization, capitalization and title to the shares, and brokers’ fees. Tax reps are often treated separately, alongside a standalone indemnity for pre-closing taxes. Everything else is a general, or operational, rep.

Knowledge qualifiers

Some reps are given “to the Company’s Knowledge,” which means the seller is liable only if the named people knew the statement was untrue. The definition of Knowledge matters. Sellers prefer actual knowledge of a short list of officers; buyers prefer constructive knowledge, meaning what those officers would have known after reasonable inquiry of their direct reports. Knowledge qualifiers are commonly accepted for reps about third-party behavior, threatened litigation and infringement by others, and rarely for reps about the company’s own financial statements.

The materiality scrape

Many reps say “in all material respects” or “except as would not have a Material Adverse Effect.” A materiality scrape tells the parties to read those qualifiers out of the reps for indemnification purposes. A single scrape removes materiality only when calculating losses; a double scrape removes it both when deciding whether a breach occurred and when calculating losses. Combined with a basket, a double scrape means many small inaccuracies can be aggregated into a claim. With RWI, policies commonly honor a full scrape, which makes the point less costly for the seller to concede.

Sandbagging

If the buyer knew of a breach before closing, can it still close and then claim? A pro-sandbagging clause says yes; an anti-sandbagging clause says no; silence leaves the answer to the governing law, which differs by state. Because the default is uncertain, the agreement should address the point expressly. RWI policies, for their part, exclude matters actually known to the buyer’s deal team, whatever the contract says.

Indemnification: baskets, caps and survival

Indemnification is the contractual remedy for breaches of reps and covenants after closing. It is usually the buyer’s exclusive remedy, apart from fraud and equitable relief, which is why sellers should insist on an exclusive-remedy clause and a non-reliance clause in which the buyer confirms it relied only on the written reps. Three limits define the seller’s exposure: the basket, the cap and the survival period.

Basket: deductible versus tipping

The basket is a threshold of aggregate losses below which the seller pays nothing. In a deductible basket, the seller pays only losses above the threshold. In a tipping, or first-dollar, basket, once losses exceed the threshold the seller pays from the first dollar. Baskets in the lower middle market often sit around 0.5% to 1% of enterprise value. Many agreements add a mini-basket, a per-claim threshold below which a claim neither counts toward the basket nor is recoverable.

Caps and survival periods

The cap is the maximum the seller can owe. For general reps without RWI, caps commonly fall between 10% and 20% of the purchase price, and the indemnity escrow often equals or approaches the cap. For fundamental and tax reps, the cap is usually the purchase price actually received. Fraud is carved out of caps; under Delaware law, which governs many agreements, a party generally cannot contract out of liability for its own intentional misrepresentations in the written reps.

Survival periods set how long a claim can be brought. General reps commonly survive 12 to 24 months, long enough for a buyer to complete one audit cycle; fundamental reps survive six years or until the statute of limitations expires; tax reps survive until the relevant statute of limitations plus a short tail. A claim notified within the survival period remains alive until resolved, so escrow release mechanics should hold back only the amount of pending claims, not the whole escrow.

Escrows, holdbacks and representations and warranties insurance

An escrow is money deposited at closing with a third-party escrow agent, usually a bank, and released under the agreement’s terms. A holdback is a portion of the price the buyer simply does not pay at closing and keeps on its own balance sheet until the release date. A holdback is cheaper and simpler for the buyer, but it leaves the seller as an unsecured creditor of the buyer and gives the buyer de facto control of disputes. Sellers should prefer an escrow, or, if a holdback is accepted, require interest, a guarantee or security, and a clear release mechanism.

How RWI works

Representations and warranties insurance is a policy, usually bought by the buyer, that pays for losses from breaches of the seller’s reps. Losses fall first on a retention, a self-insured amount comparable to a deductible, then on the insurer up to the policy limit. Limits are commonly about 10% of enterprise value. Retentions have fallen in recent years and in our experience often sit around 0.5% to 1% of enterprise value, frequently dropping after twelve months. Premiums are usually quoted as a percentage of the limit, often in the range of about 2.5% to 3.5%, plus an underwriting fee and surplus lines taxes. On a $40 million deal with a $4 million limit, the all-in cost might be roughly $150,000 to $200,000. Who pays is negotiated; sellers with leverage push the cost to the buyer, and splits are common.

RWI changes the seller’s position more than any other single term. Instead of a 10% escrow held for 18 months, the seller may contribute a fraction of the retention, or nothing at all, and walk away with its general rep liability effectively ended at closing. The trade-off is that underwriting adds diligence scrutiny, and insurers write coverage that is narrower than the contract.

RWI is most common on deals of roughly $20 million of enterprise value and above, though it is available on smaller deals at a higher relative cost and with minimum premiums. Sponsor buyers use it routinely; strategic buyers are increasingly comfortable with it, particularly when it is the difference between winning and losing an auction.

Non-competes, non-solicits and post-closing roles

Buyers pay for goodwill, and they expect sellers not to rebuild the same business across the street. Sale-of-business non-competes of three to five years are common, together with non-solicitation covenants covering employees and customers. Scope should be tied to what the business actually does and where it does it; an overbroad covenant is more likely to be narrowed or struck by a court.

California is stricter than most states. Business and Professions Code Section 16600 generally voids non-competes, but Section 16601 permits a reasonable non-compete from a person selling all of their ownership interest in a business or the goodwill of a business, limited to the geographic area where the business is carried on. Owners who sell only part of their interest, or who roll equity, should confirm with counsel how the exception applies to them. At the federal level, the FTC’s 2024 non-compete rule, which in any case exempted bona fide sales of a business, never took effect after a federal court set it aside.

Most buyers want continuity, so owners and key managers typically sign employment or consulting agreements running six to twenty-four months, sometimes longer when equity is rolled. Watch the tax line between price and compensation. Payments contingent on continued employment, including some earnouts, may be treated as compensation taxed at ordinary rates rather than as purchase price. Similarly, any amount of the price specifically allocated to a non-compete is generally ordinary income to the seller, while the buyer amortizes it over fifteen years. Corporate sellers should also consider whether golden parachute rules apply to change-of-control payments; private companies can often address them with a shareholder vote.

Closing conditions and MAC clauses

When signing and closing are separated, the agreement lists conditions that must be satisfied before each side is obliged to close. The usual list includes the accuracy of the reps at closing (the bring-down), performance of covenants, receipt of regulatory approvals, absence of an injunction, key third-party consents, and the absence of a material adverse effect. Sellers should aim for a short, objective list, with no financing condition and no diligence condition after signing.

• Bring-down standard: sellers should seek a bring-down qualified by Material Adverse Effect for general reps, so that minor inaccuracies do not give the buyer a walk right; fundamental reps are usually brought down in all respects.
• Regulatory approvals: transactions above the Hart-Scott-Rodino size-of-transaction threshold, which is adjusted annually and has exceeded $120 million in recent years, require a filing and a waiting period, typically 30 days, and the filing itself can take several weeks to prepare.
• Third-party consents: limit the condition to a short schedule of genuinely critical contracts, and agree who bears the cost of obtaining them.
• Financing: sponsor buyers typically sign without a financing condition; where financing risk exists, a reverse termination fee payable by the buyer is the usual protection.

A Material Adverse Effect (MAE or MAC) clause allows the buyer to refuse to close if the business suffers a serious, lasting deterioration between signing and closing. Courts set a high bar: the Delaware Court of Chancery found an MAE for the first time only in 2018, in a case involving a sharp, sustained collapse in the target’s performance alongside serious regulatory compliance failures. Even so, the definition matters because it shapes negotiating leverage when results soften. Sellers should insist on carve-outs for general economic and industry conditions, changes in law or accounting rules, the announcement of the deal, natural disasters, pandemics and hostilities, and failure to meet projections (though not the underlying cause). Buyers will usually accept those carve-outs subject to an exception for effects that fall disproportionately on the company.

Signing versus closing

In much of the lower middle market, the purchase agreement is signed and the deal closed on the same day. That removes conditionality, bring-down risk and the MAC question entirely, and it is usually achievable when no HSR filing is required and consents can be gathered in advance. A deferred closing becomes necessary when regulatory clearance, licenses, landlord or customer consents, or financing need time.

In a deferred closing, interim operating covenants require the seller to run the business in the ordinary course and to obtain buyer consent before taking listed actions, such as signing large contracts, changing compensation or incurring debt. The list should be specific, the consent should not be unreasonably withheld, and the buyer should respond within a fixed number of days. Buyers must also avoid exercising control before HSR clearance, which limits how far they can direct operations in the interim.

A practical sequence for sellers

1. Before inviting LOIs, prepare monthly working capital for at least twenty-four months and a sell-side quality of earnings report, so the peg and debt definitions can be argued from data.
2. Ask bidders to state their peg methodology, debt definition, indemnity package and position on RWI in the LOI, and compare LOIs on those terms as well as price.
3. Sign an LOI with a 45- to 60-day exclusivity period, a fall-away on any price reduction and an agreed timeline.
4. Have counsel prepare disclosure schedules in parallel with the buyer’s diligence, not after the first draft arrives.
5. Model the closing bridge at several possible closing dates before agreeing the peg.
6. Review the RWI exclusions as soon as the binder is issued, and negotiate any special indemnities they create.
7. Where possible, sign and close simultaneously; otherwise, narrow conditions, define the MAC carefully and tie interim covenants to an ordinary-course standard.

The distance between a headline price and the cash that stays with the seller is rarely decided by one dramatic concession. It is the sum of a dozen definitions, each defensible on its own. Laurent Capital advises owners of lower middle market B2B companies through this stage of a sale: running competitive processes that put peg methodology, debt definitions and indemnity terms into the LOI while buyers are still competing, and working alongside the seller’s counsel and accountants through the purchase agreement and closing statement. Our fees are results-based, so our interest is aligned with the proceeds you actually receive.