Two letters of intent arrive in the same week, and both say $20 million. An owner who reads only the headline sees a tie and starts choosing on chemistry. An advisor who reads the structure sees two offers nearly a million and a half dollars apart in expected value, and further apart than that in certainty and timing. Nothing about this example is exotic. It is what competing offers usually look like, because experienced acquirers know that most owners anchor on the headline and negotiate everything beneath it casually.
The headline is the price of the announcement. The deal is the structure: how much arrives as wired funds at close, how much sits in escrow, how much depends on the business’s performance after you no longer control it, how much you lend back to the acquirer, and how much you reinvest alongside them. Owners sell once. Acquirers structure deals for a living, and structure is where a thin bid dresses itself as a full one. This chapter is about reading a deal the way the other side writes it.
The Consideration Stack
Every offer, however it is worded, resolves into five components. Rank them by certainty, not by size.
Cash at close. Wired funds on the closing date. The only component with no conditions attached, and the only dollars worth exactly face value.
Escrow or holdback. A slice of the price parked with an escrow agent (or simply held back by the acquirer) for a defined period, commonly 12 to 24 months, to fund claims if statements made in the purchase agreement turn out to be wrong. In clean deals most or all of it comes back. It is still not your money until it does, and it is the first place post-close disputes land.
Earnout. Additional payments contingent on the business hitting defined targets after close, under the acquirer’s ownership and, usually, the acquirer’s accounting. Real value in the right design, and the most frequently disputed component in the stack.
Seller note. You finance part of your own sale: the acquirer signs a promissory note and pays you over time, almost always behind the senior lender in priority. You have become a junior creditor of your own former company.
Rollover equity. Not deferred payment but reinvestment: you take part of your proceeds in equity of the acquiring entity, illiquid until that entity itself transacts. The upside is real, and so is the possibility of zero.
Key point. A dollar of cash at close is worth a dollar. Every other dollar in the stack is worth less than face value and must be discounted for risk, for time, and for the incentives of the party who controls whether it gets paid.
Two Offers, One Headline
Back to the two $20 million letters. Offer A is $17 million cash at close, $1 million held in escrow for 18 months, and a $2 million earnout. Offer B is $12 million cash at close, $1 million in escrow, a $3 million seller note, and a $4 million earnout.
Expected-value thinking means multiplying each component by a realistic probability of receiving it, then asking hard questions about timing. The realization rates below are illustrative; reasonable people will argue every one of them, and the specific numbers matter less than the discipline. Assume the escrows in both deals return 90 cents on the dollar, the seller note pays 85 cents on the dollar after subordination risk, and each earnout, honestly handicapped, pays half its face value.
Two offers at the same $20 million headline, walked to expected value with illustrative realization rates:
| Component | Offer A | Offer B | Assumed realization |
|---|---|---|---|
| Cash at close | $17.0M | $12.0M | 100% |
| Escrow | $1.0M | $1.0M | 90% |
| Seller note | $0 | $3.0M | 85% |
| Earnout | $2.0M | $4.0M | 50% |
| Headline total | $20.0M | $20.0M | |
| Expected value | $18.9M | $17.45M |
Walk it through. Offer A: $17 million certain, plus $900,000 expected from escrow, plus $1 million expected from the earnout, comes to $18.9 million. Offer B: $12 million certain, plus $900,000 from escrow, plus $2.55 million expected on the note, plus $2 million expected on the earnout, comes to $17.45 million. Same headline, $1.45 million apart, and that is before time value: Offer B’s contingent dollars arrive over three to seven years, if they arrive at all.
Certainty tells the same story more bluntly. Offer A wires 85% of the headline at close; Offer B wires 60%. And Offer B’s contingent components share a single point of failure: the note, the earnout, and any escrow recovery all depend on the same acquirer’s post-close performance, solvency, and good faith. That is concentration, not diversification.
None of this makes structure illegitimate. A credible acquirer with real capital may use structure to bridge an honest disagreement about the future, and a well-designed earnout from a well-capitalized counterparty can be worth close to face value. The failure is comparing headlines. The negotiating move this suggests is simple: ask the acquirer behind Offer B what the price becomes if the structure converts to cash. If the headline falls, you have learned what the bid really was.
Asset Sale or Equity Sale
Before any of those components get papered, the deal takes one of two legal forms. In an asset sale, the acquirer buys assets and specified liabilities out of your entity: the contracts, equipment, inventory, intellectual property, and goodwill it wants, and generally not the exposures it does not. Your entity survives, holding the proceeds and whatever was left behind, and eventually winds down. Every contract, lease, permit, and title must be assigned or reissued, and any contract requiring counterparty consent to assignment hands that counterparty a moment of leverage most owners never saw coming.
In an equity sale, the acquirer buys the entity itself. Contracts, licenses, and history ride along automatically unless a change-of-control clause says otherwise. So do the liabilities, known and unknown, which is precisely why acquirers resist the form.
The preference gap is structural. Acquirers favor asset deals for two reasons: a stepped-up tax basis in what they bought, which generates deductions for years, and a liability screen against what they could not diligence. Owners usually prefer equity sales because the tax outcome is generally better (Chapter 14 owns that arithmetic), the consent problem largely disappears, and the separation is cleaner. The two preferences are the same dollars viewed from opposite sides, and the gap gets bridged the way every gap does: through price, or through hybrid structures. Two names will come up in that conversation. An F-reorganization is a pre-closing restructuring, common for S corporations, that can deliver asset-sale tax treatment to the acquirer inside what otherwise works like an equity deal; your tax advisor will walk you through it. A 338(h)(10) election treats a qualifying stock sale as an asset sale for tax purposes only; your tax advisor will model whether it helps. What matters here is sequencing: the asset-versus-equity question changes your net proceeds materially, and it needs to be settled with tax counsel before the letter of intent is signed, because it is nearly impossible to renegotiate afterward.
Earnouts: Bridge or Camouflage
An earnout is legitimate when it bridges a genuine gap between an owner’s confidence and an acquirer’s evidence. You believe next year justifies a higher price because of contracts just signed; the acquirer cannot underwrite growth that has not happened yet; the earnout lets you get paid for being right. Used this way it is a risk-sharing instrument, and it works best when the owner stays involved enough to influence the result.
The same instrument is camouflage when an acquirer who cannot or will not fund the full price parks the difference in an earnout designed to be missed: targets set above anything the business has ever done, measured on metrics the acquirer controls, inside a unit the acquirer plans to reorganize beyond recognition. The difference is not the concept but the design. And the market’s revealed behavior tells you how much weight contingent structure actually carries: in the IBBA and M&A Source Market Pulse survey’s $5 million to $50 million segment, owners in late 2025 received roughly 87% of consideration in cash at close, with seller financing and earnouts making up most of the remainder. Earnouts dominate negotiation airtime; they are a minority of the money.
If you accept one, the design principles matter more than the size:
- Metric. Revenue is the hardest number for an acquirer to suppress. EBITDA is the easiest, because post-close the acquirer controls costs, allocations, and integration charges. Gross profit is often the workable middle: it captures pricing and mix without importing the acquirer’s overhead decisions.
- Measurement. Accounting defined in the agreement and consistent with the company’s historical practice, with the business measured as a standalone unit and integration costs excluded from the calculation.
- Conduct covenants. Acquirers rarely promise to maximize an earnout, but they can commit to operate the business in the ordinary course, keep it adequately resourced, and not divert customers or revenue to affiliates.
- Shape. Prefer graduated payouts over all-or-nothing cliffs; a cliff target missed by 2% pays zero and breeds litigation. Terms commonly run one to three years; longer terms entangle the earnout in integration noise.
- Protection. Acceleration if the acquirer resells the business during the earnout period, information and audit rights over the calculation, and a defined dispute path to an independent accountant rather than a courtroom.
Even papered well, an earnout is a forecast defended by lawyers. Handicap it below face value, and apply one test before signing: if the earnout paid zero, would you still do this deal? If the answer is no, the guaranteed components are too thin, and the earnout is not a bonus. It is the price.
Seller Notes and the Standby Reality
A seller note obligates the acquirer to pay part of the price over time, commonly three to seven years, at interest rates typically a few points above what senior lenders charge, reflecting where you sit: behind them. The subordination agreement you will be asked to sign is not a formality. If the company trips a covenant with its bank, the bank can block payments on your note entirely while the problem gets worked out, and you will have no meaningful say in how long that takes.
The rules tighten further in SBA-financed deals, where many notes at the smaller end of the market live. SBA 7(a) loans top out at $5 million, and under the SBA’s SOP 50 10 8, effective June 2025, acquisition loans require at least a 10% equity injection; a seller note counts toward that injection only if it sits on full standby, meaning no payments at all, for the life of the loan, and it can supply no more than half of the injection. An owner holding a standby note behind a typical 10-year 7(a) loan has agreed to wait a decade for the first dollar. Price that dollar like what it is: patient, junior, at-risk capital.
Used deliberately, a modest note earns its keep. It signals confidence in the business you are handing over, it can close a financing gap that would otherwise kill the deal, and it is sometimes a rational trade for a better price. The line to hold is proportion. A note that is a sliver of the price is a signal; a note that is a third of the price makes you the acquirer’s largest junior lender, so underwrite them the way a lender would: personal guarantees where available, the acquirer’s other obligations, cross-default protection, and what security, if any, stands behind your paper.
Rollover Equity and the Second Bite
Rollover equity turns a sale into a partial sale. In the standard private equity recapitalization, the owner sells a majority, reinvests a minority stake alongside the sponsor, and collects what the industry calls the second bite of the apple when the platform itself sells years later. Sponsors want rollover because it keeps the person who built the business invested in its next chapter; owners accept it because it takes most of their chips off the table while preserving real upside. The arithmetic deserves respect in both directions.
Illustrative example. An owner sells her company to a private equity platform at a $20 million enterprise value, funded with $10 million of debt and $10 million of equity. She rolls $2 million into the new entity (a 20% stake) and takes roughly $18 million gross at close. Five years later the platform has grown EBITDA by 75% and sells at a $40 million enterprise value with $10 million of net debt: the equity is worth $30 million, and her undiluted 20% returns $6 million, a 3.0x second bite that lifts her total to about $24 million on a $20 million headline. Now the part the folklore leaves out. For her second bite to exceed her first, her 20% would need to be worth more than $18 million, which requires roughly $90 million of exit equity value, call it a $100 million exit: the platform must quintuple. And if the platform stalls instead (flat EBITDA, a turn of multiple compression, $8 million of debt still outstanding), a $16 million exit leaves $8 million of equity, her stake returns $1.6 million against the $2 million she rolled, and if rescue capital came in ahead of her on preferred terms along the way, less than that, potentially nothing.
Three realities temper the math. First, dilution: platforms grow through add-on acquisitions that often require new equity, and unless your documents protect you, a 20% stake quietly becomes 15%. Second, the waterfall: if the sponsor’s capital sits in preferred units that must be repaid with a return before common equity participates, a mediocre exit can leave your class with little, so roll into the same security the sponsor holds or understand exactly what stands in front of you. Third, control: you will hold a minority position with no ability to force an exit, set its timing, or block a refinancing that adds leverage. The shareholder agreement, not the pitch meeting, governs all of it: distributions, tag-along and drag-along rights, information rights, and what happens to your equity if your employment ends. Diligence the sponsor the way they diligence you, including references from owners who rolled into their earlier platforms and have been through the exit.
The Working Capital Peg
No clause in the letter of intent looks more like an accounting formality than the working capital peg, and no clause moves real money more quietly. Lower-middle-market deals are done cash-free, debt-free: the owner keeps the cash, pays off the debt, and delivers the business. But a business cannot be delivered empty. It needs receivables converting, inventory on shelves, and payables at normal levels to operate the day after close. Without a peg, a departing owner could collect receivables hard, stretch vendors, sell down inventory, and hand over a machine with an empty tank. The peg is the acquirer’s guarantee of a full one.
The mechanics are simple to state. The parties agree on a target level of net working capital, commonly set from a trailing 12-month average of the company’s normalized balance sheet. The price adjusts at close against an estimate; a final true-up, commonly 60 to 90 days later, settles the difference dollar for dollar, in either direction. Deliver more working capital than the peg and you are paid the excess; deliver less and you write a check. Some agreements collar the adjustment or make it one-way; read which.
“Dollar for dollar” is the phrase to sit with. Consider a distributor whose net working capital swings from $1.3 million after the holiday season to $2.4 million at the September inventory peak, averaging $1.8 million across a full year. Every $100,000 the peg moves is $100,000 of purchase price, moved without anyone saying the word price. An acquirer who proposes a $2.2 million peg based on “the recent run rate,” when the honest full-cycle average is $1.8 million, has just repriced the deal by $400,000. Owners who would fight for weeks over the last $250,000 of headline routinely concede more than that inside a definitions exhibit they skimmed.
The definitions are where the second fight lives. What counts as working capital, what counts as cash, and what counts as debt are negotiated line by line: deferred revenue (acquirers argue it is debt-like, since you collected the cash and they owe the work), receivables aged past 90 days (often excluded), accrued bonuses and unused vacation, customer deposits, inventory reserves, unpaid invoices for capital equipment. Each classification moves the peg or the debt-like list, and every move is purchase price. The defense is preparation and timing: build a monthly net working capital schedule early, ideally alongside sell-side quality of earnings work, propose the peg methodology yourself, and negotiate the definitions at the letter-of-intent stage while competition still exists. After exclusivity, you argue from politeness.
Common pitfall. Letting the peg be set from a distorted reference period. A trailing average that captures a pandemic-era demand spike, a one-time inventory build ahead of a supplier price increase, or only the six months around a seasonal peak will overstate the business’s true operating level. An owner who accepts a peg $400,000 above the true full-cycle average has surrendered $400,000 of purchase price with the headline untouched, and most discover it in the true-up statement two months after the wire clears.
Employment Agreements and Non-Competes Are Deal Terms
The last components are the ones owners most often hand to their lawyer as an afterthought: the employment or consulting agreement and the non-compete. Both are purchase price wearing different clothes. An owner who agrees to stay two years at half of market compensation has handed the acquirer back the difference. One who negotiates above-market consulting fees has arranged deferred purchase price, generally taxed as ordinary income rather than capital gain, a distinction worth a conversation with your tax advisor before signing rather than after. Purchase price allocated to the non-compete itself carries the same character problem.
The non-compete is legitimate: an acquirer paying for goodwill is entitled to protection from the one person most capable of destroying it. It commonly runs three to five years and covers the business actually sold; the negotiation is over scope. Define the restricted business precisely, keep the geography honest, and read the non-solicit clauses covering employees and customers as carefully as the headline restriction, because they outlast most owners’ plans. And if your deal includes an earnout or rollover, tie the documents together: termination of your employment without cause during the earnout period should protect or accelerate the earnout, and the shareholder agreement’s repurchase rights on departure should not let the sponsor buy back your rolled equity at a discount you would never have accepted at close.
The Bottom Line
- Compare offers on expected value and certainty, never on headlines: cash at close is the only component of the stack worth face value.
- The asset-versus-equity decision allocates taxes and liabilities between the parties; settle it with tax counsel before the letter of intent, not after.
- Accept an earnout only if the deal still works when it pays zero, and paper the metric, conduct covenants, and dispute path as if you expect to use them.
- A seller note makes you a junior lender to your own former company, and under SBA standby rules it can mean no payments for the life of the loan.
- Rollover equity can deliver a genuine second bite, but it is illiquid, minority, and governed entirely by the shareholder agreement, so diligence the sponsor.
- The working capital peg and its definitions move six-figure sums silently; negotiate them at the letter-of-intent stage with the same attention as the price.