When a Signed Letter of Intent Was Only the Opening Bid

The situation

Samir had spent a decade as a sales director before joining a private equity fund's operating platform as a deal lead, buying and consolidating commercial refrigeration and HVAC service companies across southwestern Ontario. Wei, a former police sergeant, had moved into the same platform a year earlier to run operations and diligence on the acquisitions it made. Together they had closed two smaller deals already. The third was bigger: a commercial refrigeration service company based in Chatham, built over two decades by its founder, Liang, with long-term maintenance contracts across the region's food processing and cold storage sector.

The three sides had reached a letter of intent, a document that sets out the price and key terms a buyer and seller intend to put into a binding agreement, but is mostly non-binding while the deal is still being confirmed. The letter valued the business at roughly $38 million, subject to a customary adjustment for the target's normal level of working capital — cash, receivables and inventory net of short-term liabilities — at closing. It gave the platform a period of exclusivity to complete due diligence and negotiate a definitive share purchase agreement, the binding contract that would actually transfer ownership. Everyone treated the number in the letter as close to final. Our team, retained to represent the buying platform, treated it as a starting point.

What due diligence uncovered

Three problems surfaced once the platform's accountants and our team began reviewing the target's contracts, financials and corporate records in earnest.

The first was working capital. The letter of intent had used a single historical balance sheet to describe the target's "normal" working capital level, but the business was seasonal, with receivables and inventory swinging by several hundred thousand dollars across the year depending on when major maintenance contracts were billed. The month chosen in the letter happened to be near the annual high point. Built into the definitive agreement as written, that baseline would have overstated normal working capital by roughly $900,000, meaning the buyer would effectively overpay by that amount at closing even though the headline price stayed the same.

The second was contract assignability. A meaningful share of the target's revenue, roughly a quarter, came from maintenance contracts with large processing facilities that contained clauses requiring the customer's consent before the contract could be assigned to a new owner. Some of those consents were not guaranteed. If even two or three of the larger customers declined to consent after closing, the business the platform was buying would be worth measurably less than the one it had agreed to buy.

The third was Liang's own exposure. Two years earlier the company had settled a workplace injury claim from a former technician, and while the settlement had closed, the definitive agreement as first drafted would have required Liang to personally indemnify the buyer, without any real limit, for any related claim that surfaced later. Liang's counsel flagged, reasonably, that an unlimited personal indemnity years after a sale for a matter already settled was not what the letter of intent had described.

None of these were deal-breakers individually. Together, four weeks before the exclusivity period was set to expire, they meant the letter of intent's numbers and structure no longer matched what either side had actually agreed to buy or sell.

What we did

1. Rebuilt the working capital mechanism before arguing about the number. Rather than negotiate a single fixed target, we proposed a twelve-month trailing average approach to smooth out the seasonal swing, with the actual adjustment calculated against a closing-date balance sheet under a defined accounting methodology. This moved the argument from a one-time dollar fight to a formula both sides' accountants could apply consistently.
2. Split the at-risk contract revenue into an earnout instead of a price cut. Rather than asking for an upfront reduction to the $38 million price to reflect the assignability risk, we structured roughly $3 million of the purchase price as an earnout, paid over 18 months only if the flagged customer contracts were successfully assigned or renewed on comparable terms. This gave Liang the ability to earn the full price if the contracts held, and gave the platform protection if they did not.
3. Negotiated a capped, time-limited indemnity backed by an escrow holdback. In place of Liang's open-ended personal indemnity for the settled injury claim, we agreed to a specific indemnity limited to a defined dollar cap and a two-year survival period, secured by roughly $1.2 million held in escrow rather than a personal guarantee that would have followed Liang indefinitely.
4. Reordered the closing conditions around consent risk. We made the receipt of consent from the two largest at-risk customers a condition of closing rather than a post-closing risk absorbed entirely by the earnout, giving the platform the ability to walk away or renegotiate again if the most important contracts were not going to transfer.
5. Kept the exclusivity period from lapsing mid-negotiation. With four weeks left and real issues still open, we negotiated a short extension of the exclusivity period in exchange for a modest, non-refundable extension fee payable to Liang, so neither side lost negotiating leverage to an artificial deadline while the mechanics above were being finalized.

The outcome

The deal closed roughly ten weeks after the original letter of intent had targeted, at a headline price of $38 million with the working capital mechanism, $3 million earnout and $1.2 million escrow built in. It was not the clean, fully-priced transaction either side had described when the letter was signed. Samir and Wei's platform did not get the unconditional purchase it had modeled, and Liang did not get the full $38 million at closing that the letter had implied — a meaningful piece of the price now depended on customer contracts renewing over the following year and a half.

Both sides got a deal they could actually stand behind. The platform avoided overpaying for working capital it was never going to receive and kept real protection against the contract and indemnity risks diligence had found. Liang kept the ability to earn the full agreed price if the business performed as represented, and exchanged an open-ended personal indemnity for a capped, time-limited one secured by an amount already set aside rather than a promise to pay indefinitely. One of the two flagged customer contracts was successfully assigned before closing; the second required a renegotiated, shorter-term arrangement that reduced the achievable earnout by roughly $700,000, a cost the earnout structure was specifically designed to absorb rather than reopen the whole deal over.

The letter of intent had not been wrong to sign. It had been incomplete in the way letters of intent usually are — a statement of intent to reach a deal, not a fully-tested description of what the business was actually worth once its contracts, seasonality and legacy liabilities were examined closely. The definitive agreement is where that gap gets closed, and closing it took real compromise from both sides rather than either party simply holding the other to the letter's original numbers.

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