An M&A term sheet, often called a letter of intent (LOI), is a short document that sets out the main business terms of an acquisition before the parties invest in full due diligence and definitive agreements. The most important terms to negotiate are the deal structure, purchase price and how it is paid, escrow or holdback, indemnification, exclusivity, and what happens to founders and employees. Most of the LOI is non-binding, but a few provisions, such as confidentiality and exclusivity, usually are binding, and the terms you accept at this stage tend to anchor the final deal.
Whether you are buying a startup or selling the company you founded, here are the key terms to understand before you sign.
Binding vs. Non-Binding Provisions
An LOI typically states that the economic terms are non-binding and that no deal exists until definitive agreements are signed. Certain provisions are normally binding from signing, including:
- Confidentiality (or a reference to a separate NDA)
- Exclusivity or “no-shop” obligations
- Expenses, usually each side paying its own
- Governing law and dispute resolution
Make sure the document clearly says which sections are binding. Ambiguous drafting can create arguments that a binding deal, or a duty to negotiate in good faith, was formed.
Deal Structure
Startup acquisitions generally take one of three forms:
- Asset purchase. The buyer acquires selected assets (such as intellectual property, contracts, customer relationships and equipment) and assumes only the liabilities it agrees to take. Buyers often prefer this structure because it limits inherited liabilities and can provide a tax basis step-up. For a C corporation seller, however, an asset sale can produce two levels of tax: once at the corporate level and again when proceeds are distributed to stockholders. Asset deals also require assigning contracts, which may need third-party consents.
- Stock purchase. The buyer buys the outstanding shares directly from the stockholders. Sellers often prefer this because it is usually taxed once, at the stockholder level, and the buyer takes the company with its liabilities. It becomes impractical when there are many stockholders who all need to sign.
- Merger. Most venture-backed startup acquisitions are structured as a merger, often a reverse triangular merger in which a buyer subsidiary merges into the target. A merger requires board and stockholder approval at the required thresholds rather than every holder’s signature, and the target generally survives as a subsidiary so many contracts stay in place.
The right structure depends on the entity type (C corporation, S corporation or LLC), tax attributes, liabilities and the cap table. Tax advisors should be involved early.
Purchase Price and Form of Consideration
The LOI should specify the headline price and how it is paid:
- Cash, buyer stock or a mix. Buyer stock raises questions about valuation, liquidity, securities law compliance and whether the deal can qualify as a tax-deferred reorganization.
- Deferred payments. Not all of the price may be paid at closing. Escrows, holdbacks, earnouts and seller notes all shift part of the payment into the future.
- Adjustments. Many deals adjust the price for cash, debt, transaction expenses and working capital at closing. Sellers should understand the mechanics, because these adjustments can significantly change what stockholders actually receive.
Proceeds are then allocated through the cap table and the company’s charter, including any liquidation preferences. Founders should model the waterfall before agreeing to a price. Our article on capitalization tables explains why an accurate cap table matters.
Earnouts and Founder Retention
An earnout makes part of the price contingent on post-closing performance, such as revenue or product milestones. Earnouts can bridge valuation gaps but frequently lead to disputes, so the LOI should define the metrics, measurement period and any obligations on the buyer to operate the business in a way that gives the earnout a fair chance.
Buyers also commonly require key founders and employees to stay for a period after closing, using new employment agreements, retention bonuses or re-vesting of some equity. If payments are tied to continued employment, the founder should seek protection if terminated without cause or if they resign for good reason. Payments contingent on employment can also have different tax treatment than purchase price, and large change-in-control payments may raise Section 280G golden parachute issues.
Escrow and Holdback
Buyers typically hold back or deposit into escrow a portion of the price for a period after closing to secure indemnification claims and purchase price adjustments. The amount and duration are negotiated and depend on the deal size, the risk profile and whether representations and warranties insurance is used. Sellers should push for a clear release schedule and limits on what claims can be made against the escrow.
Representations, Warranties and Indemnification
In the definitive agreement, the seller makes representations about the company, such as its capitalization, financial statements, IP ownership, contracts, employees and compliance. If a representation proves false, the buyer may be entitled to indemnification. Key negotiated points include:
- How long representations survive after closing
- A deductible or “basket” before claims can be made
- A cap on total liability, often tied to the escrow, with exceptions for fundamental representations and fraud
- Whether representations and warranties insurance will be used to shift risk to an insurer
Due Diligence and Confidentiality
After the LOI is signed, the buyer conducts legal, financial and technical diligence. The seller should have an NDA in place before sharing sensitive information and may stage disclosure of the most sensitive material, especially when the buyer is a competitor. Common problem areas for startups include missing IP assignments from founders and contractors (see our article on CIIAAs), incomplete stock records, open-source license issues, and privacy compliance gaps.
Exclusivity and Break-Up Fees
Buyers usually ask for an exclusivity or no-shop period during which the seller cannot solicit or negotiate with other bidders. Sellers should keep this period reasonably short and consider a right to terminate exclusivity if the buyer materially changes the price or terms. Break-up fees are less common in private startup acquisitions than in public deals, but they can appear when a seller is giving up other opportunities or the buyer needs certainty of a commitment.
Other Terms to Consider
- Treatment of employee equity: whether unvested options are assumed, converted, accelerated or cancelled
- Closing conditions: stockholder approval, third-party consents, key employee agreements, and any required antitrust filings under the Hart-Scott-Rodino Act if the deal exceeds the current thresholds
- Transaction expenses: each side typically pays its own advisors, and seller expenses often reduce the purchase price
- Restrictive covenants: California generally allows non-competes for selling owners in connection with the sale of a business’s goodwill or ownership interest under Business and Professions Code §16601, subject to reasonableness
The Takeaway
A term sheet may be short and mostly non-binding, but it sets the framework for the entire deal. Founders and buyers who think carefully about structure, payment terms, escrow, indemnification and exclusivity before signing are in a stronger position when the definitive agreements are drafted.
Frequently Asked Questions
Is an M&A letter of intent binding?
Usually only in part. The economic terms are typically non-binding, while confidentiality, exclusivity, expense and governing law provisions are usually binding. The LOI should clearly state which provisions bind the parties.
What is the difference between an asset purchase and a stock purchase?
In an asset purchase, the buyer acquires selected assets and only the liabilities it agrees to assume. In a stock purchase, the buyer acquires the company’s shares and takes the business with its existing liabilities. The tax consequences for each side can differ significantly.
What is an escrow or holdback in an acquisition?
It is a portion of the purchase price set aside after closing to cover indemnification claims and price adjustments. The amount and duration are negotiated based on deal size and risk.
What is an earnout?
An earnout is a part of the purchase price paid only if the business meets agreed performance targets after closing. Clear metrics and buyer operating covenants help reduce disputes.
How Sutter Law Can Help
Sutter Law advises startup founders and buyers on letters of intent, deal structure and definitive agreements as part of our mergers and acquisitions practice, working alongside tax advisors. Contact us for a free consultation.
This article is general information, not legal advice. Reading it does not create an attorney-client relationship.
