When reviewing a Sales and Purchase Agreement (SPA), the most dangerous clauses are the ones that shift risks you cannot control onto your shoulders. You need to identify whether the contract protects your net proceeds or if it creates liabilities that could surprise you after the closing date.
The short answer
- The working capital peg should be anchored to your historical averages to prevent unfair price deductions.
- Limit your total post-sale liability to 10% to 15% of the purchase price, and keep the survival period short.
- Avoid earnout metrics based on net profit, as buyers can easily manipulate expenses to lower the payout.
- Only subordinate your seller note to the senior bank lender, never to vendors or other creditors.
01Why does the working capital peg matter?
The working capital peg is where many deals quietly lose value for the seller. It acts as a baseline, ensuring the business has enough liquidity to operate after you leave. If your business typically carries $200,000 in inventory and receivables, but the buyer sets the peg at $300,000, you are effectively paying the difference out of your own pocket.
Most owners focus on the total sale price and ignore how the calculation works. If your books are not clean, or if you have seasonal fluctuations, the buyer may push for a higher peg to protect themselves. Always anchor this figure to your actual historical trailing twelve-month average rather than accepting a guess.
A common mistake is treating the peg as a standard accounting detail instead of a price lever. When you define the peg using an average, you preserve your cash flow. If you do not define it clearly, you grant the buyer a right to audit your final numbers and reduce the purchase price at the last possible minute.
02What is a reasonable limit on my liability?
The indemnification section outlines your legal exposure after you hand over the keys. Buyers often draft this section to be as broad as possible, covering every unknown or latent liability they might discover later. If you sign an agreement without a 'cap' on your liability, you are putting your personal net worth at risk for any future problem the business faces.
A standard, fair cap on your total liability usually sits between 10% and 15% of the total purchase price. This provides the buyer with enough security to handle minor errors while ensuring you walk away with a predictable amount of proceeds. If the buyer asks for a cap equal to 100% of the purchase price, they are trying to shift the business risks back to you entirely.
Besides the cap, check for the 'survival period' of these representations. This defines how long you are legally on the hook. Ideally, this should end within 12 to 18 months. Any clause extending your liability for three or more years is an outlier that should be aggressively negotiated down to protect your future peace of mind.
03Why are broad non-compete clauses a problem?
A non-compete agreement prevents you from starting a new company or working in your industry after you sell. While buyers have a right to protect the value of what they purchased, they do not have a right to prevent you from making a living. Watch out for language that is too broad, such as restricting you from 'any business activity' or 'all related industries'.
The most effective non-competes are specific. They define exactly what you cannot do, where you cannot do it, and for how long. A reasonable timeframe is typically two to five years. If the geographic restriction covers the entire country, but you only sell in two states, the agreement is unnecessarily punitive and should be narrowed to your actual footprint.
Always remember that an overreaching non-compete can trap you if the buyer makes changes to the business that you disagree with. If you are barred from the industry, you cannot help other businesses or start a new entity, even if your skills are highly specialized. Keep the restrictions focused on the core services you provided to prevent the buyer from using the legal system to unfairly limit your future career.
04How can I avoid getting burned by earnouts?
An earnout is a portion of the sale price contingent on the future performance of the business. It is tempting to view this as 'extra' money, but it is often the most difficult part of a deal to collect. The biggest red flag here is a metric that you cannot influence or verify. If the target is based on 'Net Profit,' a buyer can easily inflate expenses, legal fees, or management salaries to ensure that profit stays below the payout threshold.
Only accept earnouts that are tied to top-line metrics like gross revenue or units sold. These are harder for a buyer to manipulate. If the buyer insists on profit-based metrics, you must demand a seat at the table to review the financials or a veto right on non-standard expenses during the earnout period. Without these safeguards, you are trusting the buyer's internal accounting to determine your final payout.
Define the term clearly. Is it a one-time payout or an annual payment over three years? Vague timelines allow the buyer to stall or defer payments. If a buyer refuses to put specific targets and payment dates in the contract, they may not intend to pay the earnout at all. Treat an earnout as a bonus that you might never see, not as a guaranteed part of your retirement plan.
05What if the buyer wants to subordinate my seller note?
A seller note is a loan you provide to the buyer to help them pay for your business. It is a common bridge, but it comes with a major risk: you are essentially betting on the buyer's future success. Subordination means your loan is secondary to others. If the business goes bankrupt, the bank gets paid first, and you only receive what is left over, which is often nothing.
If a buyer requires you to be subordinated, they are asking you to take the biggest risk in the deal. Limit this subordination strictly to the senior bank lender. Never agree to be subordinated to trade creditors, equipment lessors, or other third-party vendors. You should remain in the best possible position to collect if the business struggles, as you have already done the work to build the value.
Before agreeing to a note, check the interest rate and the payment schedule. A low-interest note with no regular payments is a bad deal for you, as it ignores the time value of money. Ensure the note has a defined repayment plan with monthly or quarterly interest payments. This keeps the buyer committed and gives you a predictable cash flow instead of a risky lump sum that may never materialize.
Where to go next
Questions people ask about this
Can I remove a non-compete clause entirely?
It is unlikely a buyer will agree to remove it entirely, as they need to protect the goodwill they are purchasing. Instead, negotiate for more specific, limited constraints on geography and industry focus.
What happens if the buyer and I disagree on the working capital at closing?
The SPA should include a dispute resolution mechanism, typically requiring a third-party accountant to audit the financials. Define this process in the contract to avoid expensive litigation.
Is it normal for a buyer to ask for an unlimited indemnification period?
It is a common tactic to ask for, but you should not accept it. Stick to a reasonable survival period of 12 to 18 months, as the buyer has ample time during that window to discover any misrepresentations.
Should I have my attorney review the entire SPA?
Yes, always have an experienced M&A attorney review the final document. Use your industry knowledge to flag business-specific issues, but rely on legal counsel for the technical wording of protections.
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