A Continued Conversation: On LOIs and Early Leverage

Daniel Novela responds to Viktor’s questions on the role of the LOI.

Continuing the Conversation

This entry builds on my earlier conversation with Viktor, where we explored the practical realities behind structuring and closing transactions. That discussion opened the door to a more focused exchange this time with Viktor turning the lens toward my perspective as counsel.

His questions center on a specific stage of the deal process that is often underestimated: the Letter of Intent (LOI). In many transactions, the LOI is approached as a preliminary step. In practice, it is where key economic and structural decisions are first defined, often with lasting consequences.

What follows is a continuation of that dialogue. Viktor’s questions are designed to surface the areas where business owners tend to misread risk, overlook detail, or defer legal input too late in the process. My responses focus on how those early decisions shape negotiation dynamics, pricing, and leverage long after the LOI is signed.

Interview with Daniel Novela, Corporate M&A & Art Law Attorney at Novela Law.

Q1: From a lawyer’s perspective, what is the most misunderstood provision in an LOI among business owners?

The phrase “non-binding.” Business owners hear that the LOI is non-binding and conclude that nothing in the document matters. That is both legally incorrect and strategically dangerous.

Every LOI contains provisions that are explicitly binding: exclusivity, confidentiality, expense allocation, and governing law. Those carry real legal consequences. But even the non-binding provisions set the baseline for every negotiation that follows. Once a seller signs an LOI with a specific purchase price, deal structure, and working capital framework, that usually becomes the baseline for the definitive agreement negotiations. Any attempt to improve those terms during the purchase agreement drafting will be treated as overreach by the buyer’s counsel.

The LOI is the most important document in the transaction that nobody reads carefully enough. By the time clients bring the LOI to me, the business people have often already agreed to it in principle, and I’m left trying to negotiate around commitments that are already baked in. The best outcomes happen when counsel is involved before the LOI is signed, not after.

Q2: From a legal perspective, what provisions in an LOI tend to create the most problems later in the purchase agreement if they aren’t clearly defined upfront?

The working capital peg.

In most lower middle market acquisitions, the purchase agreement requires the seller to deliver the business at closing with a normalized level of working capital. The parties agree on a target for that level, the peg, and after closing the buyer measures actual working capital as of the closing date. If actual closing working capital is below the peg, the purchase price is adjusted downward. If it is above the peg, the purchase price is adjusted upward. The adjustment is intended to ensure the buyer receives the business with a normalized level of short-term operating assets and liabilities, so the seller does not improve its pre-closing economics by accelerating collections, delaying payables, or otherwise changing ordinary course balance sheet management.

The concept is fair. The problem is that “net working capital” is not a standardized term. It is a constructed number built from specific balance sheet accounts, and when the LOI leaves it undefined, those components become contested in the purchase agreement and again in the post-closing true-up.

Take accounts receivable and inventory: the seller may have an incentive to maximize these current assets on the books through closing, while the buyer’s accountants will usually apply more conservative reserves. On the liability side, accrued items like payroll, vacation, and bonuses all require estimates, and whether management transaction bonuses are included in working capital or treated as a separate purchase price deduction can alone move the adjustment by hundreds of thousands of dollars.

When the LOI is silent on these issues, the purchase agreement negotiation becomes the first time the parties actually discuss the economics of the deal they thought they already agreed to. And if the purchase agreement definitions are themselves imprecise, the same fights resurface after closing, when the buyer controls the business and the books and the seller is contesting numbers from a position of diminished leverage.

The LOI should address the peg with enough specificity to prevent this: the working capital target, the measurement methodology, the major accounts included or excluded, and the governing accounting principles. You do not need to finalize every detail at the LOI stage, but without that framework, you are negotiating price twice.

Q3: Are there certain deal terms that you believe should always appear in an LOI for lower middle market transactions but often don’t?

Three provisions are more often worth raising than sellers realize.

First, an expense reimbursement or deposit provision. In larger transactions, it is standard for the seller to negotiate some form of cost protection if the buyer fails to close without cause. In the lower middle market, this almost never appears, even though sellers in this segment are more vulnerable because the process is more disruptive to their operations. Even a modest expense reimbursement changes buyer behavior. When walking away has a real cost, diligence tends to be more disciplined and good faith.

Second, a clear enumeration of diligence conditions beyond “satisfactory completion of due diligence.” That phrase gives the buyer unlimited discretion to kill the deal for any reason. I prefer LOIs that specify the diligence categories: financial, legal, environmental, customer, and key employee. If a buyer cannot articulate what they need to confirm, they probably have not thought carefully about whether they actually want to buy the business.

Third, the seller’s post-closing role and non-compete obligations. In the lower middle market, the founder is the business. Buyers will eventually insist on an employment or consulting arrangement plus a non-compete. But if none of this appears in the LOI, the founder often signs thinking they are selling and walking away, only to discover during purchase agreement negotiations that the buyer expects them to stay for two or three years on terms they find unacceptable. Addressing this at the LOI stage prevents one of the most common sources of late-stage deal friction.

Q4: When you look at an LOI, what language immediately tells you the buyer’s counsel has thought carefully about the transaction versus using a generic template?

I can tell within the first page. If the LOI references the seller’s actual business, its industry, its operational characteristics, and tailors the deal structure to what makes sense for that company, someone has done real work. If the LOI could apply to any business of any size in any sector with the name and number swapped in, it is a template.

One specific tell is how the LOI addresses the seller’s continued involvement. A generic LOI will not mention it. A thoughtful one will outline expectations for a transition period, non-compete scope and duration, and any consulting or employment arrangement. In a lower middle market deal, the founder’s cooperation post-closing is critical to realizing the value the buyer just paid for. Counsel who understands this addresses it early.

Another signal is timing. A generic template proposes a 60-day exclusivity period and leaves it there. A well-advised buyer buyer maps out the post-exclusivity process: quality of earnings report by a specific date, draft purchase agreement by another, target closing date by another. When I see a buyer who has built that schedule into the LOI itself, I know their counsel has closed these deals before and understands that structure and momentum are what get lower middle market transactions to the finish line.

Closing Reflection

Taken together, these points reinforce a simple but often overlooked reality: the LOI is not a draft of what might happen; it is the framework for what usually does.

By the time a transaction reaches the purchase agreement stage, most of the meaningful economics and expectations have already been set. When those elements are clearly defined early, the process tends to move with alignment and momentum. When they are not, the same issues resurface later, typically with higher stakes and less flexibility.

This exchange with Viktor highlights why that early stage deserves more attention. Not as a formality, but as a point of inflection where thoughtful structure can prevent avoidable friction and preserve leverage through closing.

Categorised in: News

This post was written by Daniel Novela