A well-crafted letter of intent is the foundation of a successful acquisition, setting the tone for negotiations and protecting the company's bottom line.
While the M&A market did not accelerate as much as expected during the first half of 2025 due to continued economic uncertainty, M&A professionals remain optimistic about the remainder of the year, with deal values increasing in March over the same period in 2024, particularly in the technology and consumer products sectors.
With this expected increase in M&A activity and increasing pressure for successful exits, more CFOs are under pressure to deliver deals that drive growth while minimizing financial risks to the buyer or the seller, as applicable. A well-crafted letter of intent is the foundation of any successful acquisition, setting the tone for negotiations and protecting the company's bottom line. However, a poorly structured LOI or ineffective representations and warranties can lead to cash flow surprises, undervalued deals or prolonged exclusivity that can tie up resources.
As CFOs navigate economic uncertainty and tighter budgets, mastering the LOI process and leveraging representations and warranties are critical to maximizing return on investment and ensuring long-term value. Outlined below are five actionable strategies to optimize the LOI process and purchase agreement. These steps will empower CFOs to add value to acquisitions with confidence, safeguard liquidity and position their organizations for success in a competitive market.
1. Clarify cash-free/debt-free terms to protect cash flow
One of the most common pitfalls in an LOI is ambiguity around whether the deal is cash-free/debt-free. Buyers may include a provision requiring that the target company be delivered "debt-free" but remain silent on cash, expecting to inherit a certain amount of the company's cash reserves. This can erode the purchase price and leave sellers shortchanged.
CFOs on the sell-side should raise the issue and request specific language that the deal is both cash-free and debt-free, ensuring the buyer absorbs liabilities without claiming the company's cash.
While attorneys can help identify this issue, they are not always involved at the LOI stage. As a consequence, the buyer could have an upper hand after the LOI is signed and the target company is subject to exclusivity obligations, which could result in the buyer walking away with the company's cash. To avoid this, include a clear definition in the LOI, such as: "The transaction will be cash-free and debt-free, with all cash retained by the seller at closing." This clarity protects liquidity and ensures a fair valuation.
2. Define working capital adjustments for a smooth transition
Working capital adjustments can make or break a deal's financial outcome. Typically, when the parties sign an LOI, they leave open the dollar amount of the working capital target — which is essentially the amount of working capital (current assets minus current liabilities) that the buyer expects to receive with the business — simply stating that the target would be delivered with a "normalized" level of working capital. This commonly happens at this point in the process because the buyer has not completed its financial due diligence and needs more data about the target company's performance and working capital needs.
However, if the working capital is eventually set too high (over and above the target company's typical working capital needs), then the buyer could effectively reduce the purchase price that the sellers receive. The buyer can also delay proposing a specific working capital target number until later in the deal process, which could result in the buyer having more leverage to obtain a higher target number, resulting in lower proceeds to the seller.
CFOs should consider requesting that the parties stipulate that working capital will be proposed within a specific timeframe, such as four weeks after the LOI is signed, so that the buyer will have all major financial deal terms in place as soon as possible. Additionally, sellers can consider defining what constitutes "normalized" working capital to conceptually align on approach and to minimize any potential "land grab" by the buyer later in the sale process. In some cases, parties can specify that the working capital target would be expressed as a 12-month average for a business whose revenue predictably fluctuates based on recurring factors such as consumer behavior, weather or holidays.
3. Manage RWI costs and responsibilities
If your transaction is large enough (i.e., purchase price is over $20 million), consider negotiating at the LOI stage that Representations and Warranties Insurance (RWI) will be used by the parties. RWI shifts the risk of unknown issues from sellers to insurers, significantly reducing or eliminating seller indemnity, escrow and holdback requirements compared to deals without RWI, where sellers typically bear liability capped at 7%-20% of deal value (for breaches of non-fundamental representations) with 10%-15% escrow at closing (as compared to 0.5%-1% escrow at closing in deals with RWI).
RWI also benefits buyers as it allows for broader representations and potentially longer survival periods, but it introduces premium costs (2%-6% of coverage amount) and underwriting requirements, typically resulting in slightly higher transaction costs for buyers. If the parties agree to use RWI, then the LOI should specify who covers the cost. RWI, which protects against breaches in representations, can cost over $100,000 in premiums and other costs, depending on deal size.
Without clarity, sellers may end up footing the bill or a part of it, cutting into their proceeds. CFOs should negotiate that the buyer covers RWI costs, especially in competitive markets where buyers are eager to close. For example, in a recent transaction, the seller saved several hundred thousand dollars by ensuring the LOI stated, "The buyer shall bear all costs associated with RWI," which was eventually reflected in final transaction documents.
4. Understand exclusivity terms to minimize risk
Exclusivity clauses in an LOI can tie up the seller for months, limiting the ability to explore other offers. Buyers often push for long exclusivity periods to lock in the deal, but this can strain the seller's operations, especially if the buyer walks away after months of intense diligence. CFOs should carefully review exclusivity provisions to make sure that the initial exclusivity term and any automatic extensions are limited (e.g., 30-45 days from signing the LOI for the initial term and one seven- or 15-day extension).
For example, one of our clients recently avoided a six-month exclusivity trap by capping the exclusivity period at 45 days (with no automatic extensions), allowing them to pivot to another buyer when negotiations stalled. Additionally, consider including a clause that exclusivity ends if the buyer fails to meet diligence milestones or attempts to renegotiate material deal terms. This protects the seller's negotiating power and keeps the process moving forward efficiently, preserving resources for other strategic priorities.
5. Engage financial and tax diligence experts early
CFOs on the buy-side can add significant value by leading or supporting financial and tax diligence. A CFO's early involvement can help buyers identify financial issues, protecting the value of the deal, including preparing financial statements in accordance with GAAP (or cash basis, if applicable) and clarifying key metrics like EBITDA, if applicable. This is also important in highly competitive deals in which RWI is used because RWI underwriters do not provide insurance coverage for areas that a buyer or its advisers did not investigate thoroughly.
One of our clients engaged a tax diligence team too late in the process and that team could not deliver its findings until after the transaction closed. As a result, the buyer missed the opportunity to shift the risks identified by the tax diligence team to the seller and instead had to live with those issues going forward because RWI did not cover known issues/risks. Whether buying or selling, CFOs should get involved in diligence as early as possible and collaborate with advisers to fully understand financial and tax risks with respect to the acquisition target.
CFOs can add significant value to an acquisition process in many ways, including by clarifying cash-free/debt-free terms, defining working capital adjustments, managing RWI costs, confirming exclusivity terms and engaging in early diligence.
Start by reviewing your next LOI draft with these strategies in mind and involve your team to ensure alignment. In a market where every dollar counts, a well-structured LOI can mean the difference between a deal that drives growth and one that drains resources.
Originally published by CFO.com.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
