LOIs, APAs, and the Financial Terms That Actually Matter

The LOI Is a Financial Document Before It's a Legal One

A Letter of Intent sets the economic framework for the entire transaction. While it's typically marked "non-binding" (except for exclusivity and confidentiality provisions), the financial terms established in the LOI become the baseline that shapes every subsequent negotiation. Changing economic terms after the LOI is signed is possible but expensive — in time, in legal fees, and in relationship capital with the buyer.

This is why financial analysis must precede legal drafting. An attorney can structure an LOI that's legally sound but financially suboptimal — not because the attorney is wrong, but because the financial implications of specific terms require modeling, not legal judgment.

Purchase Price Allocation

In an asset sale, the total purchase price is allocated across asset categories — equipment, inventory, customer relationships, goodwill, covenant-not-to-compete, and others. Each category carries a different tax rate for the seller and different amortization benefits for the buyer. The allocation is negotiable, and the negotiation has direct, quantifiable tax consequences for both parties.

For the seller, goodwill is the most favorable category — taxed at long-term capital gains rates. Equipment may trigger ordinary income through depreciation recapture. A covenant-not-to-compete is taxed as ordinary income. Shifting $500,000 from goodwill to a non-compete covenant can increase the seller's tax bill by $50,000 to $100,000, depending on marginal rates.

The buyer has the opposite preference: non-compete covenants and equipment can be amortized more quickly, producing larger near-term tax deductions. The allocation negotiation is inherently adversarial, and the seller who hasn't modeled the tax impact of different allocations is negotiating blind.

Working Capital Provisions

The working capital provision is one of the most technically complex — and financially consequential — terms in any acquisition agreement. It establishes a "target" level of net working capital that the business should have at closing. If actual working capital at closing exceeds the target, the seller receives an upward adjustment. If it falls short, the buyer receives a downward adjustment.

The disputes arise in how the target is set and how working capital is measured. A target based on a trailing twelve-month average may not reflect seasonal patterns. A target that includes or excludes specific balance sheet items can shift the calculation by hundreds of thousands of dollars. The working capital definition in the LOI is worth as much attention as the headline purchase price — because the final payment to the seller is the purchase price plus or minus the working capital adjustment.

Holdbacks and Escrow

Buyers typically require that a portion of the purchase price — commonly 10% to 15% — be held in escrow for 12 to 24 months after closing to cover potential indemnification claims. The holdback is the buyer's insurance against post-closing surprises: undisclosed liabilities, breaches of representations and warranties, or customer losses that were not anticipated.

For the seller, the holdback represents capital that's inaccessible during the escrow period. The terms that matter are the amount (percentage of purchase price), the duration, the release mechanics (single release at expiration vs. staged releases), and the claim threshold (minimum claim size before the escrow can be accessed).

Earn-Out Structures

Earn-outs bridge valuation gaps by tying a portion of the purchase price to post-closing performance. The seller receives additional payments if the business achieves specified financial targets — typically revenue or EBITDA thresholds — during a defined earn-out period.

The financial modeling of earn-outs requires careful attention to the metric definition (how is EBITDA calculated post-closing?), the target levels (are they achievable given the seller's reduced involvement?), the measurement period, and the buyer's operational decisions that might affect results. An earn-out that looks like a $2 million opportunity on paper may be worth $500,000 in present value after accounting for probability, timing, and the buyer's discretion over post-closing operations.