---
title: "From LOI to Close: Pegs, Earnouts and Escrows | Capstone CFO"
description: How the working capital peg, debt-like items, earnouts, escrows and rollover equity turn a headline price into cash at close, and what to settle in the LOI.
image: https://capstonecfo.com/hubfs/capstone-2026/insights-covers/loi-to-close-working-capital-peg-earnout-escrow.png
---

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Insights

# From LOI to Close: Working Capital Pegs, Earnouts and Escrows Explained

Capstone CFO

**TL;DR:** The headline price in a letter of intent is not what you take home. Between the LOI and closing, a handful of terms decide your actual proceeds: the working capital peg, the treatment of debt and debt-like items, earnouts, escrows and holdbacks, rollover equity and the definition of EBITDA itself. Each one can move real money. Founders who understand these terms before signing the LOI negotiate them when they still have leverage, instead of discovering them in the purchase agreement.

## From headline price to cash at close

Most deals are priced on a "cash-free, debt-free" basis with a "normal" level of working capital. The purchase agreement then converts the headline enterprise value into what the seller receives. A simplified, illustrative bridge:

| Line | What it means |
| --- | --- |
| Headline enterprise value | The price in the LOI, often a multiple of adjusted EBITDA |
| Plus cash, minus debt | You keep excess cash and pay off loans and lines of credit |
| Minus debt-like items | Items the buyer treats as debt, such as deferred revenue, unpaid bonuses or customer deposits |
| Plus or minus working capital adjustment | The difference between actual working capital at close and the agreed peg |
| Minus escrow or holdback | Held back for a period to cover indemnification claims |
| Minus rollover equity | The part of your proceeds reinvested in the buyer's new company, if any |
| Minus transaction costs | Advisory, legal and accounting fees |
| Equals cash at close | Before taxes, and before any earnout or escrow release |

## The working capital peg

Buyers expect the business to come with enough working capital (mainly receivables and inventory, net of payables and accrued liabilities) to operate normally on day one. The **peg** is that agreed normal level. If working capital at close comes in below the peg, the price goes down dollar for dollar; above it, the price goes up.

The peg is usually based on an average over a recent period, often the trailing twelve months, to smooth out seasonality. That sounds technical, but the choices behind it move money:

- **The averaging period.** A period that captures a seasonal peak sets a higher peg than one that doesn't.
- **What's included.** Whether items like deferred revenue, accrued bonuses or income taxes sit in working capital or in debt changes the math.
- **Growth.** A growing company needs more working capital each month, so a trailing average can understate what's needed at close, or overstate it, depending on the definitions.
- **Accounting consistency.** The peg and the closing balance must be calculated the same way, using the same policies.

The working capital analysis in a sell-side quality of earnings report is the best starting point for negotiating the peg.

## Debt and debt-like items

Bank debt is obvious. Debt-like items are less so, and they're where surprises happen. Buyers commonly argue to deduct items such as:

- Deferred revenue for work you've been paid for but haven't delivered
- Customer deposits
- Earned but unpaid bonuses and commissions
- Unpaid prior-period income taxes
- Deferred rent, unpaid capital expenditures or deferred maintenance
- Transaction-related bonuses owed to employees

Agree on the definition of debt in the LOI, or at least the principle, so it isn't negotiated item by item late in the process.

## Earnouts

An earnout makes part of the price contingent on future performance, usually revenue or EBITDA over one to three years after closing. Earnouts bridge a gap when a buyer and seller disagree about the future, but they shift risk to the seller, and the business is no longer under your control.

| Term | Questions to settle |
| --- | --- |
| Metric | Revenue is harder for a buyer to influence than EBITDA. Which metric, and how is it calculated? |
| Targets | Are they achievable based on your forecast, not the buyer's stretch case? |
| Payout structure | All-or-nothing, or paid proportionally as targets are approached? |
| Operating covenants | What must the buyer do, or avoid, so the target stays reachable? |
| Accounting | Which policies apply, and how are integration costs and allocations treated? |
| Disputes | Who resolves disagreements over the calculation, and how? |

## Escrows, holdbacks and indemnification

Buyers typically hold back part of the price for a set period to cover claims if representations in the purchase agreement turn out to be untrue. The size and length depend on the deal, the risks identified in diligence and whether representations and warranties insurance is used, which can reduce the amount the seller has to leave behind. Negotiate the amount, the duration, what claims can be made against it and whether there's a deductible before claims apply.

## Rollover equity

Private equity buyers often ask founders to reinvest part of their proceeds in the new company. Rollover aligns incentives and gives you a "second bite" if the business grows under new ownership, but it's illiquid and subordinate to the buyer's plans. Understand the valuation of the rollover, your rights as a minority holder and the expected path to the next sale.

## The LOI is where your leverage is

Before you sign an LOI, you usually have competing interest and time. After, you typically agree to exclusivity, and the buyer has both. The terms worth defining at the LOI stage:

1. How the working capital peg will be set
2. What counts as debt and debt-like items
3. Earnout metric, targets and payout structure, if there is one
4. Escrow size and duration, and whether R&W insurance will be used
5. Rollover amount and terms
6. The EBITDA basis for the price, including agreed add-backs

This article is general information, not legal or tax advice. Deal terms should be negotiated with your M&A attorney, tax advisor and investment banker.

## How Capstone CFO helps

We sit on the seller's side of the table on the numbers that move your proceeds. We:

- Model the bridge from headline price to cash at close for every offer you receive
- Prepare the normalized working capital analysis and support the peg negotiation
- Identify debt-like items early and build your position on each
- Stress-test earnout targets against a realistic forecast
- Calculate the closing working capital and review the buyer's post-closing statement
- Work alongside your attorney, banker and tax advisor from LOI through close

## Frequently asked questions

### What is a working capital true-up?

After closing, the actual working capital delivered is calculated, usually within a few months, and compared with the estimate used at closing. The price is then adjusted up or down for the difference.

### Are earnouts a good idea for sellers?

They can be, when targets are realistic and the terms protect your ability to hit them. They work best as a modest part of the total price that rewards upside, not as a way to close a large valuation gap.

### When should my CFO get involved in a sale?

Before the LOI. The numbers behind the peg, debt-like items and earnout targets are far easier to shape before you agree to exclusivity than after.

## Related reading

- [Sell-Side Quality of Earnings: What Buyers Will Find and How to Get There First](https://capstonecfo.com/blog/sell-side-quality-of-earnings)
- [Beyond a Full Sale: Recapitalizations, ESOPs and Management Buyouts for Founder-Led Companies](https://capstonecfo.com/blog/recapitalization-esop-management-buyout-founder-liquidity)
- [Why Now May Be the Time to Exit Your Business: AI, SaaS Multiples and the 2026 Deal Market](https://capstonecfo.com/blog/why-now-may-be-the-time-to-exit-your-business-ai-macro)
- [The New QSBS Rules: What Founders Need to Know Before an Exit](https://capstonecfo.com/blog/new-qsbs-rules-founders-exit)

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