The letter of intent: the terms that matter more than price

Most sellers read a letter of intent from the top: the headline number, then perhaps the structure, then a quick skim of the rest. Buyers write them the other way around. The price is the term everyone will remember, so it is the one a buyer is least able to move later. The terms further down the page are where value is quietly given back between signing the LOI and closing. By then the seller has granted exclusivity and lost most of its leverage.

An LOI is usually non-binding on the economics, but it sets the frame for the purchase agreement. Anything left vague becomes a negotiation conducted after competitive tension has disappeared. The practical rule is simple: negotiate the terms below while you still have other bidders in the room.

Exclusivity: length, scope and exits

Exclusivity is the one provision in an LOI that is almost always binding, and it is the moment leverage shifts from seller to buyer. Buyers typically ask for 60 to 90 days. For a well-prepared company with a clean data room and a buyer that has already done meaningful work, 45 to 60 days is often achievable.

• Tie the period to milestones: confirmatory diligence complete by a set date, first draft of the purchase agreement within a few weeks of signing.
• Allow the period to end early if the buyer signals a price reduction or a material change in structure.
• Make extensions require the seller’s written consent rather than happening automatically.
• Keep the scope narrow: a ban on soliciting other buyers, not a gag on routine conversations with lenders, advisors or existing shareholders.

The working capital peg

Most lower-middle-market deals are priced on a cash-free, debt-free basis with a normalized level of net working capital delivered at closing. If actual working capital at closing falls short of the target, or peg, the price drops dollar for dollar. The peg is therefore a price term, even though it rarely appears in the headline.

Buyers often propose an LOI that says the peg will be “a normalized level to be agreed.” That language invites a debate during exclusivity, when a buyer can argue for a higher number based on diligence findings. A seller is better served by agreeing the methodology in the LOI: typically a trailing twelve-month average, with defined treatment of seasonality, deferred revenue, accrued bonuses and any one-time items. For businesses with large seasonal swings, the choice between a twelve-month average and a month-specific target can move value by more than a turn of EBITDA would suggest at first glance.

Escrow, holdbacks and indemnity caps

The purchase agreement will contain representations about the business, and the seller will indemnify the buyer if those prove inaccurate. What matters is how much of the price is at risk and for how long. Without representations and warranties insurance, general indemnity caps often sit around 10 to 15 percent of enterprise value, with a similar or smaller amount held in escrow for 12 to 24 months. Fundamental representations, such as title to shares, authority and capitalization, are usually capped at the purchase price and survive longer. Tax representations often run to the statute of limitations.

The LOI should state the escrow amount and duration, the general cap, the deductible or basket, and whether the basket is a true deductible or a tipping basket that reverts to first-dollar recovery once exceeded. Each of these is easy to negotiate as a line in an LOI and difficult to move once a buyer’s counsel has drafted a full agreement around a different assumption.

The terms further down the page are where value is quietly given back between signing the LOI and closing.

Representations and warranties insurance

R&W insurance has become common in sponsor-led deals well into the lower middle market. The buyer purchases a policy that covers losses from breaches of representations, and the seller’s indemnity exposure shrinks to a small retention escrow, often in the range of half a percent to one percent of enterprise value, or in some cases to nothing beyond fraud and fundamental matters.

If the buyer intends to use a policy, the LOI should say so, along with who pays the premium and how the retention is shared. Premiums and underwriting costs are meaningful, and a buyer that expects the seller to fund half of them is effectively lowering the price. Note also what a policy will not cover: known issues identified in diligence, certain wage-and-hour or environmental matters, and forward-looking statements. Those exclusions sometimes come back as special indemnities, which should be anticipated rather than discovered late.

Employment and rollover terms

For an owner-operator, the post-closing role is often the term with the most personal consequence. The LOI should outline title, reporting line, base compensation, the length of any transition period, and the scope of non-compete and non-solicit covenants. Five-year non-competes with a broad geographic scope are common opening positions; a seller with leverage can usually narrow both.

Where the seller rolls equity into the buyer’s structure, the LOI should state the rollover percentage, whether it is tax-deferred, which security the seller receives, and the basic governance and liquidity rights attached to it. A rollover into a different class of security than the sponsor holds is not the same economic deal, even if the percentage looks identical.

Conditions and financing

Finally, read the conditions. A financing contingency, a broad diligence out, or a condition that requires satisfactory employment agreements with key staff each gives the buyer an option to walk or retrade. Sponsors with committed funds can often drop a financing condition altogether. Strategic buyers can usually confirm board approval status. Where a condition must remain, make it specific and time-bound.

A practical checklist

• Is the price stated as enterprise value, with the cash-free, debt-free definition of debt spelled out?
• Is the working capital peg methodology agreed, not deferred?
• Are escrow size, duration, indemnity cap and basket type stated?
• If R&W insurance is used, who pays, and what is the seller’s residual exposure?
• Is exclusivity limited in length, linked to milestones and terminable on a price change?
• Are the seller’s employment, non-compete and rollover terms described in enough detail to evaluate?
• Are the closing conditions narrow and time-bound?

Comparing LOIs side by side on these dimensions frequently changes which bid is the best one. A slightly lower headline price with a fixed peg methodology, an insured deal and a short exclusivity window often delivers more certain proceeds than the highest number on the page.