M&A deal structure determines how much of the headline price a seller actually takes home, and the gap is almost always larger than founders expect.
A founder who sells a software company for $20 million may walk away with $12 million in year-one cash, $3 million stuck in escrow for eighteen months, and another $5 million tied to revenue targets that the new owner's sales team may or may not hit. The enterprise value is real. The net proceeds are a different conversation entirely.
This guide breaks down every major structural element you are likely to see in a term sheet, how each one shifts risk between buyer and seller, and what you should be asking before you sign anything. This is educational content only; it is not legal or tax advice, and you should engage qualified legal and tax counsel before making any decisions on a specific transaction.
Enterprise Value vs. Net Proceeds: Why the Headline Number Lies
Enterprise value, or EV, is the price a buyer places on your business. It is the number that ends up in the press release. It is almost never the number that hits your bank account.
Most deals are structured on a cash-free, debt-free basis. The buyer acquires the business assuming neither its cash nor its financial debt. At closing, outstanding debt is repaid from gross proceeds, and cash on the balance sheet is retained by the seller or added as a price adjustment. Your equity value is calculated roughly as: EV, minus debt, plus cash, plus or minus a working-capital adjustment, minus escrow holdbacks, minus transaction costs. Every one of those line items is negotiable.
The Net Working Capital Peg
Working capital is current assets minus current liabilities, and in most deals the buyer sets a target peg, typically the trailing twelve-month or trailing six-month average. At closing, your actual working capital is measured against that peg. Fall short and you owe the buyer a dollar-for-dollar adjustment.
A sloppy peg negotiation is one of the most consistent ways sellers lose money. Common traps include a peg calculated during an unusually high-revenue period, definitions of current liabilities that sweep in deferred revenue, and disputes about which receivables are collectible. Sellers who push back early and insist on clear definitions of each working-capital component routinely capture $200,000 to $500,000 in transactions at the $10M-$30M range that less-prepared sellers surrender without realizing it.
Escrows, Holdbacks, and Reps-and-Warranties Insurance
After the working-capital adjustment, the next biggest structural drag on year-one proceeds is the indemnification escrow. Buyers hold back a portion of the price to cover claims arising from breaches of your representations and warranties or post-closing surprises. Standard escrows run 5 to 15 percent of deal value, held for 12 to 24 months. On a $15 million transaction, that is $750,000 to $2.25 million you cannot touch.
The market has largely adopted a cleaner alternative: reps-and-warranties insurance (RWI). A third-party insurer covers buyer claims instead of your escrow. Premium costs typically run 2 to 4 percent of the coverage limit. For sellers, the practical effect is often a dramatic reduction in the escrow requirement, sometimes to zero beyond a small deductible basket, and a faster release of proceeds. RWI has become near-standard in PE-backed technology deals above $10 million.
Even with RWI in place, buyers frequently insist on a separate holdback for known risks: pending litigation, a customer concentration issue, or an unresolved tax audit. Each should be sized to actual probability-weighted exposure, not the buyer's worst-case scenario.
How Earn-Outs Work and Why They Cause Disputes
An earn-out is a contingent payment: you receive additional consideration after closing if the business hits specified targets. Buyers use them to bridge a valuation gap or retain seller engagement. Sellers often accept them to reach a headline number that a clean cash deal would not support.
In software businesses, earn-outs are typically structured on one of three metrics:
- Revenue. Cleaner to measure, harder for a buyer to manipulate. Common in SaaS where ARR is auditable. Watch for definitional fights about deferred revenue and how customer churn affects the calculation.
- EBITDA. More buyer-friendly; they control the cost base post-closing. New management layers, centralized functions, and intercompany allocations can all compress EBITDA without any bad faith. This is the most frequent source of earn-out disputes.
- Milestones. Product launches, customer counts, regulatory approvals. Binary by nature: if the milestone is not hit by the date, you receive nothing regardless of how close you came.
To protect yourself, negotiate for: a covenant requiring the buyer to operate the business in a manner consistent with the earn-out period; clear GAAP-based accounting definitions; the right to audit relevant financials; an acceleration clause if the business is sold again before the earn-out period ends; and dispute resolution via neutral arbitration. An earn-out with no operating covenants is an earn-out you should assume you will never collect.
Rollover Equity: The Second Bite of the Apple
When a private equity firm acquires a company, they rarely buy 100 percent. The standard structure is for the seller to reinvest a portion of proceeds back into the new entity alongside the PE firm, typically 10 to 30 percent of total equity value. You get a second liquidity event when the PE firm exits, usually in 3 to 5 years, hopefully at a much higher multiple.
The pitch is often accurate, but rollover equity is illiquid, minority-positioned, and entirely dependent on the PE firm's ability to execute its thesis. Before you commit:
- Understand the waterfall: where does your equity rank relative to the PE firm's preferred return and any management carve-outs?
- Examine the management incentive pool being carved out for incoming leadership, which will dilute your rollover stake if equity is issued below current value.
- Ask for the PE firm's track record on prior platform exits: average holding period and realized multiple on invested capital.
- Understand the tax treatment: rollover equity in a partnership or LLC structure may trigger a taxable gain on the amount rolled, while a corporate structure may allow tax-deferred treatment.
Seller Notes and What They Actually Mean
A seller note is debt you extend to the buyer as part of the purchase price. Instead of cash at closing, you receive a promissory note, typically paying 6 to 10 percent interest, with principal repaid over 3 to 7 years. Senior lenders often require seller notes to be subordinated to their debt, meaning you are last in line if the company hits trouble.
Seller notes represent real credit risk. You are betting that the business you just sold will continue to perform well enough to service the debt. Negotiate for personal guarantees from the buyer if the buyer is a holding company, security interests in business assets, a right to accelerate if financial covenants are breached, and clear default provisions. A seller note is only as good as the business that backs it.
Asset Sales vs. Stock Sales: The Tax Consequences Are Material
This structural question most dramatically affects your after-tax proceeds, and it is where buyers and sellers most reliably have conflicting interests.
In a stock sale, the buyer acquires your shares. You pay capital gains tax on the gain, currently 20 percent federal plus the 3.8 percent net investment income tax for most long-term holders. Qualified small business stock exclusions under IRC Section 1202 can eliminate federal capital gains entirely on up to $10 million in gains, or ten times your basis, for eligible C-corp shares held more than five years. Check 1202 eligibility early in every process.
In an asset sale, the buyer acquires the business's assets and receives a stepped-up tax basis, generating depreciation and amortization deductions. For the seller, asset sales create multiple tax layers: ordinary income rates on depreciation recapture, capital gains on other assets, and potential double taxation if the business is a C-corp. S-corps and LLCs generally avoid the double-tax problem.
Two election structures exist to bridge this gap. A Section 338(h)(10) election allows an S-corp seller and a corporate buyer to treat a stock sale as an asset sale for tax purposes, giving the buyer the step-up while preserving single-level taxation for the seller. An F-reorganization can convert a C-corp to an S-corp before sale, enabling similar economics. Both require careful planning well before a letter of intent is signed. Attempting them after signing dramatically reduces your options.
Reps, Warranties, Indemnities, and Caps
Representations and warranties are the statements you make in the purchase agreement about the condition of the business: accurate financial statements, no undisclosed litigation, no IP infringement, clear title to assets, and dozens of other matters. Your exposure depends on how these provisions are negotiated:
- Cap. The maximum you owe for rep-and-warranty breaches. Market for PE deals is often 10 to 20 percent of deal value. With RWI, the seller's cap is often reduced to the deductible, commonly 0.5 to 1 percent of deal value.
- Basket. A minimum threshold before claims can be brought. A tipping basket means once claims exceed the threshold, the buyer recovers all losses back to dollar one. A true deductible means only losses above the threshold are recoverable.
- Survival period. How long the buyer has to bring a claim. General business reps typically survive 12 to 24 months; fundamental reps often survive indefinitely or until the statute of limitations; tax reps track the tax statute of limitations.
- Knowledge qualifiers. Reps can be limited to matters actually known to specified individuals. Broader constructive-knowledge definitions increase your exposure.
Questions to Ask About Any Term Sheet
Before accepting or countering a term sheet, work through these with your advisor and legal counsel:
- What is my actual cash at closing after debt repayment, working-capital adjustment, and escrow holdback?
- How is the working-capital target calculated, and what are the precise definitions of current assets and liabilities in the draft agreement?
- Is reps-and-warranties insurance available, who pays the premium, and what would it allow me to reduce in escrow?
- If there is an earn-out, what operating covenant protects me from the buyer managing the business in a way that depresses the metric?
- What percentage of my total consideration is contingent, either earn-out or seller note, and what is my realistic probability-weighted expectation?
- Is this structured as an asset or stock sale, and what is my after-tax net in each scenario? Has my tax advisor modeled Section 1202, 338(h)(10), or F-reorg applicability?
- What is the non-compete scope, geography, and duration, and does it prevent anything I plan to do after this transaction?
Frequently Asked Questions
What is a typical earn-out period in software deals?
Earn-outs in software and SaaS transactions most commonly run 12 to 36 months, appearing in roughly 30 to 40 percent of middle-market deals. They are more common when a founder has projected aggressive forward growth the buyer cannot verify, and less common in highly recurring-revenue businesses where buyers feel confident enough in the numbers to pay clean cash.
How much is typically held in escrow, and when do I get it back?
Without reps-and-warranties insurance, escrows of 10 to 15 percent of deal value held for 18 to 24 months are standard in middle-market tech transactions. With RWI, sellers have routinely negotiated escrows down to 0.5 to 1 percent held for 12 months, covering only the deductible layer. A dispute filed late in the survival period can tie up funds considerably longer than the headline escrow duration.
How much does the asset-vs-stock question actually matter financially?
The difference in after-tax proceeds between a stock sale and an asset sale can range from 5 to 15 percent of total deal value depending on entity structure, holding period, asset mix, and state tax position. On a $20 million transaction, that is $1 million to $3 million in real money. S-corp and LLC sellers often accept slight headline-price discounts in exchange for stock-sale structure because the tax math still favors them.
What does rollover equity actually look like at exit?
When the PE firm exits, all equity holders participate in the proceeds according to the waterfall. If you rolled 20 percent at a $20 million enterprise value and the business sells three years later at $50 million, your 20 percent is worth $10 million on the new transaction before any dilution from new equity issuances. Reviewing the LLC agreement or shareholder agreement in detail at signing is critical because management equity pools and dilutive events can reduce your effective ownership percentage materially.
When should I start planning deal structure with advisors?
Twelve to 24 months before you intend to go to market is the right window. Tax structuring decisions, particularly entity conversion for QSBS purposes or S-corp elections, require seasoning periods that make last-minute changes impossible or ineffective. Sellers who enter a process with clean structure and ready answers to these questions close faster, with less friction, and with better final terms. FIH has run processes for 79 companies across 27 countries since 2020, typically reaching LOI in around 97 days, and the transactions that close smoothest are almost always the ones where the founder did the structural homework early.
The Bottom Line
Headline enterprise value is a starting point. The deal structure surrounding it determines whether you actually realize that number. Every component, from the working-capital peg and escrow size to the earn-out metric and tax election, is negotiable, and each one involves a risk transfer between you and the buyer. Understanding the mechanics before you are sitting across the table from a buyer's deal team is the single most useful thing you can do to improve your outcome.
If you are weighing an exit in the next one to five years and would like a confidential valuation or an honest conversation about what your deal structure might look like, the FIH team is available to talk, with no retainers and no obligation.