— Pillar · Deal structure
LOI, asset vs stock, working capital adjustments, earnouts, escrow, reps and warranties — the technical layer that determines what actually hits the wire.
A business sale is structured through a sequence of documents: NDA → LOI → APA or SPA → ancillary agreements → closing. The most consequential terms outside the headline price are: asset vs stock, working capital target, earnout structure, seller financing or note, escrow holdback, reps and warranties survival period, and indemnification caps. Each can move millions of dollars in net proceeds.
The LOI is mostly non-binding, but the terms locked into it become almost impossible to renegotiate later.
The LOI sets out the proposed price, structure, and timeline. The binding elements are usually exclusivity (no-shop), confidentiality, and expense responsibility. Everything else is conditional on diligence. Sellers treat the LOI like a handshake; sophisticated buyers treat it like a structural roadmap. Read the complete LOI guide.
Asset deals favor buyers (better tax treatment, no inherited liabilities). Stock deals favor sellers (cleaner exit, capital gains treatment). Most $1M-$5M deals are asset deals.
In an asset purchase, the buyer purchases specific assets (equipment, inventory, customer lists, IP, contracts) and assumes specific liabilities. The legal entity stays with the seller. The buyer gets stepped-up basis in the assets for tax depreciation.
In a stock purchase, the buyer purchases the equity of the legal entity. All assets and all liabilities transfer with the entity. The buyer inherits the seller's tax basis.
The structural choice has major tax and liability implications for both sides. In smaller deals it's typically a buyer-favorable asset deal, often with a 338(h)(10) election if the target is an S-corp to give the seller stock-deal tax treatment while preserving the buyer's asset-deal basis.
Working capital is where the most undisclosed value transfer happens at closing. Get the target wrong and you can lose six or seven figures.
Deals are typically structured on a "cash-free, debt-free" basis with a normalized working capital target. The seller delivers the business with working capital at or near the target. If actual working capital at closing is below target, the purchase price is reduced. If above, the price is increased.
The target is usually set as a trailing 12-month average. The math is technical and assumption-heavy. Disputes during the post-closing true-up process are common.
Earnouts bridge valuation gaps. They also bridge buyer-seller trust gaps, badly. The litigation rate on earnouts is high.
An earnout is a portion of the purchase price contingent on future performance. Useful when buyer and seller can't agree on a value because the future is genuinely uncertain. Problematic because the buyer controls the business post-closing and gets to influence whether the earnout is hit.
Best practice: keep earnouts simple, short (12-24 months), tied to a single hard metric (revenue or EBITDA), with seller protections around how the business will be operated during the earnout period.
A seller note is normal in deals of this size. Treat it as a real loan, not a deferred payment.
In most $1M-$5M deals, the seller takes back a note for 10-30% of the purchase price. The note typically subordinates to senior debt (SBA or bank financing), has a 3-7 year amortization, and carries an interest rate above prime.
If you take back a seller note, treat it like the loan it is. Personal guarantee from the buyer, collateral where possible, default provisions, acceleration clauses.
A portion of the purchase price is held in escrow at closing as security for the seller's reps and warranties. Typical: 10% for 12-18 months.
The escrow holdback is the buyer's recourse if reps and warranties turn out to be inaccurate, or if undisclosed liabilities emerge post-closing. The size of the holdback and the survival period are negotiated alongside the indemnification cap.
Reps and warranties are the seller's contractual statements about the business. They survive closing and create the basis for post-closing claims.
Standard reps cover: financial statements accuracy, undisclosed liabilities, tax compliance, contract status, intellectual property ownership, employee matters, litigation, environmental, customer relationships. Surviving for 12 to 24 months is typical. Specific reps (tax, environmental) may survive longer.
Indemnification is the cap on what the seller can be liable for after closing. The cap is typically 10-15% of purchase price, though specific carve-outs can exceed it.
Standard indemnification structure: a basket (deductible) of 0.5-1% of purchase price, a cap of 10-15% for general reps, with carve-outs (no cap) for fundamental reps like title and authority. Survival period typically matches reps and warranties.
This guide is general educational information and not legal or financial advice. Specific deal terms require negotiation with experienced M&A counsel.
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