Most sellers think the purchase agreement is where the deal gets decided.

In reality, the LOI often decides the deal. The LOI sets the framework for price, terms, diligence, and leverage. If you sign a weak LOI, you usually spend the next 30 to 90 days trying to fix it with less power.

Earnouts are similar. Buyers often present earnouts as a way to “get you your price.” Sellers often accept them without realizing how easy they are to miss, dispute, or delay.

If you are planning an exit in the next 12 months, you need to understand LOIs and earnouts from the buyer’s perspective and your own.

We will break it down in plain English, with practical guardrails you can use in real negotiations.

What an LOI is, and what it is not

An LOI is a letter of intent. It is a written agreement in principle that outlines the major deal terms before the definitive purchase agreement.

LOIs matter because they create momentum and set expectations. They also set the buyer’s path to re-trade price if key terms are vague.

LOI vs purchase agreement

The LOI is the roadmap.
The purchase agreement is the final contract.

If the roadmap is unclear, the final contract becomes a negotiation marathon.

A solid LOI answers:
What is the purchase price.
How will it be paid.
What is included and excluded.
What is the working capital target.
What diligence will be required.
What conditions must be met to close.
What happens if something changes.

Binding vs non-binding sections

Most LOIs say the main business terms are non-binding. Some sections are usually binding.

Common binding sections:
Exclusivity, also called no-shop.
Confidentiality.
Governing law and venue.
Sometimes fees, expense reimbursements, or break-up terms.

Even if the economics are “non-binding,” do not treat them as casual. They set the tone and the baseline for the purchase agreement.

The LOI terms that drive your net proceeds

The headline purchase price is only one part of what you actually walk away with.

In most transactions, your net proceeds depend on:
How much cash you get at close.
Working capital adjustments.
Debt payoff requirements.
Escrows, holdbacks, and indemnity caps.
Any seller note or earnout probability.

Purchase price and how it is paid

Every LOI should spell out the payment mix.

Common components:
Cash at close.
Seller note.
Earnout.
Equity rollover, in some deals.

Two LOIs can have the same headline number and completely different risk.

Example:
LOI A: $5,000,000 with $4,500,000 cash at close.
LOI B: $5,000,000 with $3,000,000 cash at close, $1,000,000 seller note, $1,000,000 earnout.

They are not the same offer.
One is more certain. One is more conditional.

Working capital peg and balance sheet targets

Working capital is one of the most common sources of surprises.

Many deals set a working capital target, often based on an average of historical working capital. If you deliver less working capital at closing, the purchase price adjusts down.

Common working capital pitfalls:
The target is not defined clearly.
The method for calculating working capital is vague.
The buyer controls the closing balance sheet.
The seller does not understand seasonal swings.

A strong LOI should define:
What accounts are included in working capital.
How inventory and WIP are valued.
How aged receivables are treated.
How deferred revenue is treated.
Whether cash and debt are excluded, often they are.

Debt, cash, and what stays in the business

Many LOIs are structured as debt-free, cash-free.
That means:
You pay off certain debts at closing.
Cash may be retained or adjusted separately.

You should clarify:
Which debts are paid off.
Whether any equipment loans are assumed.
Whether any lines of credit are treated as “debt-like.”
Whether cash is excluded or included.

This is where sellers can get blindsided.
Ask for clarity early.

The LOI terms that control risk and timeline

Even if the economics look good, bad process terms can hurt you.

Exclusivity and why it matters

Exclusivity prevents you from shopping the deal while the buyer diligences.

Exclusivity can be reasonable.
It can also be abused.

If you grant exclusivity, protect yourself:
Keep it short, often 30 to 60 days.
Require a diligence schedule and milestones.
Require active progress, not “we are still reviewing.”
Limit buyer access early until they show commitment.

The longer you are exclusive, the more leverage shifts to the buyer.

Diligence scope and buyer access

Diligence should be scoped.
You want to avoid “unlimited requests forever.”

A good LOI outlines:
Diligence categories, financial, legal, operational, customer, HR.
Timing and stages.
Who pays third-party diligence costs.
Whether a quality of earnings review is expected.

Also define buyer access.
You want diligence without disrupting operations or risking confidentiality.

Closing conditions and financing

Many deals die because financing was assumed, not confirmed.

If the buyer needs financing, the LOI should say so.
It should also define:
Whether closing is contingent on financing approval.
Whether the buyer has lender pre-qualification.
Whether the buyer can extend timelines easily.

Financing conditions can be reasonable.
They can also be a “free option” for the buyer if not drafted carefully.

Earnouts explained in plain English

An earnout is a contingent payment. You receive additional consideration only if the business hits agreed performance targets after closing.

Earnouts shift risk from the buyer to you.

When buyers ask for earnouts

Buyers usually ask for earnouts when:
They doubt the durability of earnings.
They worry about customer concentration.
They worry about owner transition.
They believe growth depends on you.
They want to bridge a valuation gap.

Earnouts are most common when the buyer and seller disagree on “what will happen next.”

When sellers should push back

You should push back when:
You will not control the levers that drive performance post-close.
The target depends on buyer decisions, pricing, staffing, marketing.
The definitions are vague.
The measurement is complex or easy to manipulate.
The earnout is replacing cash at close without a real reason.

Earnouts can work, but only when they are fair, measurable, and tied to levers you can influence.

Common earnout structures and how they are measured

Earnouts can be built on different metrics. Each has pros and cons.

Revenue-based earnouts

Revenue earnouts are simple to measure, but they can still be gamed through pricing and booking rules.

Watch for:
What counts as revenue, gross vs net.
Refunds and chargebacks.
Timing of recognition.
Whether new business vs existing business is treated differently.

Revenue earnouts can be fair in high-margin businesses where revenue is a good proxy for profit.
They can be dangerous in low-margin businesses where revenue can be bought with discounts.

EBITDA or gross profit earnouts

Profit-based earnouts align better with economics, but they are harder to define.

Watch for:
Accounting method, cash vs accrual.
Add-backs and one-time items.
Owner comp and management fees.
Corporate allocations if you are rolled into a larger group.
Discretion over expenses.

If the buyer can allocate costs to your business post-close, they can reduce EBITDA and reduce your earnout.

Milestone earnouts and customer retention earnouts

These are tied to specific outcomes.

Examples:
A key customer renews for 12 months.
A product launch hits a delivery milestone.
A retention threshold is met.

These can be clean if the milestone is objective and verifiable.
They still require clear definitions.

The biggest earnout traps, and how to avoid them

Most earnout disputes come from the same set of issues.

Control, reporting, and operational decisions post-close

The biggest earnout question is simple.
Who controls the business after closing.

If you do not control staffing, pricing, marketing, and delivery, you should be careful about earnouts tied to profit.

Protect yourself with LOI language that addresses:
Operational control and “ordinary course” requirements.
Limits on cost allocations.
Limits on management fees.
A requirement to run the business in good faith toward the earnout.

Definitions, GAAP, add-backs, and management discretion

Earnout math depends on definitions.

If the earnout is EBITDA-based, define EBITDA clearly.
Define what add-backs are allowed.
Define whether accounting must be consistent with past periods.
Define whether GAAP applies, and if so, how.

If you leave this vague, the buyer’s accountant defines it later.
That is not what you want.

Caps, floors, and time windows

Earnouts should have clear boundaries.

Protective terms to consider:
A cap, maximum earnout payout.
A floor or minimum guarantee, sometimes achievable with milestones.
A time limit, 12 to 36 months is common.
A catch-up mechanism, if you miss early but exceed later.

Also clarify payment timing.
Monthly, quarterly, annually.
And clarify whether disputes delay payment.

LOI red flags that lead to retrades

Retrades happen when LOIs are vague or overly buyer-friendly.

Here are common red flags.

Vague language and missing definitions

Watch for:
“Working capital to be determined.”
“Earnout based on performance,” with no metric.
“Buyer to conduct diligence in its sole discretion.”
“Purchase price subject to adjustment.”

If something impacts money, define it now.

“To be determined” items that should be fixed now

In most LOIs, you should not leave these open:
Working capital target and methodology.
Debt and cash treatment.
Diligence timeline and scope.
Financing conditions.
Earnout metric, definitions, and control protections.
Escrow amount and term.
Non-compete and employment expectations for the seller.

If these are open, the buyer will fill them in later, usually in their favor.

A seller’s negotiation playbook for LOIs and earnouts

You do not need to be aggressive. You need to be clear.

What to negotiate first

Negotiate the items that impact your net proceeds and risk first:
Cash at close.
Exclusivity length and milestones.
Working capital definition.
Debt and cash treatment.
Earnout structure and definitions.
Escrow and indemnity framework.

If these are right, the rest of the deal is easier.

What to concede and what to protect

Concede where it does not change your risk profile.
Protect where it does.

Common reasonable concessions:
A short exclusivity period with a defined timeline.
A working capital target based on history, with clear methodology.
A seller note that is properly secured, if it increases cash at close.

Common areas to protect:
Control over earnout levers.
Definitions and accounting methods.
Limitations on cost allocations.
Clear dispute resolution.
Avoiding open-ended diligence.

How to compare two LOIs apples-to-apples

Build a simple LOI comparison table for yourself.

List:
Headline purchase price.
Cash at close.
Seller note amount, interest, term, security.
Earnout amount, metric, probability, control protections.
Working capital target and method.
Debt payoff requirements.
Escrow amount and term.
Exclusivity length.
Diligence timeline.
Financing contingency.

Then estimate expected value.
An earnout that is “possible” is not worth 100 cents on the dollar.
Many earnouts are worth far less in expected terms.

A practical example, two LOIs with the same headline price

Here is a simplified example.

LOI A
Price: $6,000,000
Cash at close: $5,400,000
Seller note: $0
Earnout: $600,000 tied to revenue, simple definition
Exclusivity: 45 days with milestones
Working capital: defined, based on 12-month average, clear accounts list

LOI B
Price: $6,000,000
Cash at close: $4,000,000
Seller note: $1,000,000 unsecured
Earnout: $1,000,000 tied to EBITDA with vague definitions
Exclusivity: 90 days, no milestones
Working capital: to be determined

These are not equal.
LOI A is more certain and has less downside risk.
LOI B can still be good, but only if you tighten the note security, the earnout definitions, and the working capital method.

How an earnout can be worth less than it looks

If an earnout is $1,000,000 but you believe there is only a 50 percent chance you collect it, the expected value is $500,000.
Then discount again for time and dispute risk.

This is why we tell sellers to focus on cash at close and clear terms first.
Earnouts can be upside. They should not be your foundation.

Next step

LOIs and earnouts are not “paperwork.”
They are leverage.

A strong LOI protects your time, your confidentiality, and your proceeds.
A clean earnout structure protects your ability to actually get paid.

If you are reviewing an LOI, we recommend you slow down and pressure-test the terms before you go exclusive.

Curious what your business might bring in today’s market? Reach out for a confidential, no-obligation business value discussion.
Contact us here: https://waddellmergers.com/contact/