#exit planning

Anyone who has sold or bought a business has probably run into Form 8594 at some point, usually handed over by an accountant with a request to confirm a list of numbers. This guide walks through what the form is actually asking for, step by step, so the categories make sense before you sign off on anything. It's an educational walkthrough only, not tax advice, and it doesn't recommend any particular way to fill in the numbers for a specific deal.

Step 1: Understand what the form is trying to capture

Form 8594, the Asset Acquisition Statement, exists because a business sale is treated for tax purposes as a sale of a bundle of individual assets, even when everyone involved thinks of it as "selling the business" as a single transaction. The form asks both the buyer and the seller to report how the total purchase price was divided across a defined list of asset classes.

Both parties are expected to file consistent numbers. A mismatch between what the buyer reports and what the seller reports is one of the more common triggers for follow-up questions from the IRS, which is one reason the underlying allocation is usually negotiated and agreed to before either side actually files.

Step 2: Learn the seven classes before you look at the numbers

The form organizes assets into classes, generally ordered from the most liquid to the least. Cash and general deposit accounts sit at one end. Actively traded securities and certificates of deposit come next. Accounts receivable and similar debt instruments follow. Inventory held for sale to customers has its own class. Furniture, fixtures, vehicles, equipment, land, and buildings make up another class. Intangible assets other than goodwill, such as customer lists, patents, licenses, and covenants not to compete, form their own class. Goodwill and going concern value make up the last class, and it picks up whatever value is left over once the other classes have been filled.

Knowing this order before looking at a completed form helps explain why the numbers are sequenced the way they are: earlier classes are filled based on more objective values, and goodwill absorbs the remainder.

Step 3: Check that the classes reflect independent values, not guesses

For classes tied to physical assets, equipment, real property, and sometimes inventory, the values reported should generally trace back to something concrete: a depreciation schedule, an appraisal, or an agreed fair market value negotiated as part of the deal. If a number on the form doesn't have a clear source you can point to, that's worth asking your CPA about before signing, not after.

The IRS publishes the official instructions for the form, and reading through them once, even briefly, makes the individual line items far less mysterious than they look at first glance.

Step 4: Pay close attention to the intangibles and goodwill classes

The intangibles class (other than goodwill) and the goodwill class are usually where the most judgment gets applied, since these values are harder to pin to an objective, external source. A covenant not to compete, for example, gets its own reported value in this section, and that value has real tax consequences: payments allocated there are typically taxed to the seller as ordinary income rather than the capital gains treatment that usually applies to goodwill.

The Wikipedia entry on non-compete clauses is a useful general reference for understanding how these agreements work before digging into how one is valued in a specific form.

Step 5: Confirm the totals actually add up to the purchase price

It sounds basic, but it's worth checking directly: do the values reported across all seven classes sum to the total consideration reported for the sale? Small transactions sometimes have side agreements, escrow arrangements, or contingent payments that complicate this reconciliation, and it is easy for a total to be off by an amount that traces back to one of those side arrangements rather than a simple math error.

Step 6: Compare your copy against the other party's, where possible

Since both the buyer and seller are expected to report consistent figures, it's worth asking, through your respective advisors, whether the numbers on your form actually match what the other party is reporting. Inconsistent filings between the two sides are one of the more avoidable issues that can surface well after closing, when it's harder and more expensive to fix.

Step 7: Keep the supporting documentation, not just the filed form

The form itself is a summary. The documentation behind it, appraisals, valuation reports, the negotiation history of the allocation schedule, is what actually supports the numbers if a return is ever examined. Filing the form and then discarding the backup documentation defeats much of the point of having done the underlying work carefully in the first place.

Step 8: Understand what happens if the two filings don't match

If the IRS notices that the buyer's and seller's filings describe a meaningfully different allocation for the same transaction, the mismatch itself can trigger a request for clarification from either or both parties. This isn't necessarily a sign that anyone did anything wrong. Allocation schedules sometimes get finalized late, close to a tax filing deadline, and one side's paperwork ends up slightly out of sync with the other's.

The more useful habit is to confirm, before either side files, that both sets of numbers are drawn from the exact same negotiated schedule, rather than each party's advisor working from an earlier draft. A short confirmation email between the two sides' accountants, agreeing on the final figures before filing, is a small step that avoids a much more time-consuming conversation with the IRS later.

Step 9: Ask what happens if the deal includes contingent payments

Some transactions include earnout provisions, holdbacks, or other contingent payments that aren't fully known at the time the original form is filed. Depending on how the deal is structured, an amended form may be needed later if contingent amounts are ultimately paid or forfeited, changing the total consideration reported for the sale.

This is a topic worth raising with your CPA at the time the original form is prepared, not waiting until a contingent payment actually resolves. Knowing in advance whether an amendment will likely be needed, and what triggers it, makes that later filing far less of a scramble.

A quick reference before you file

Confirm the seven asset classes are populated in the correct order, with goodwill as the residual

Trace physical asset values back to a depreciation schedule or appraisal

Pay close attention to how intangibles and any non-compete payment are valued and characterized

Check that class totals sum to the reported purchase price

Confirm consistency with the other party's filing where possible

Keep supporting documentation on file, not just the completed form

None of this replaces a CPA's review of your specific transaction. It's meant to make the conversation with your CPA more productive by demystifying what the form is actually asking for before the numbers land in front of you.

Purchase price allocation is one of those topics that gets handed to a seller mid-negotiation, usually as a draft schedule from the buyer's accountant, without much of a plain-language explanation of what the categories actually mean. Here's a roundup of free, publicly available resources worth reading before that conversation starts. This is an educational roundup, not tax or legal advice, and it doesn't recommend any specific allocation for a specific deal.

The IRS's own instructions for the governing form

The most authoritative starting point is the IRS's own site, which publishes the instructions for the Asset Acquisition Statement that both buyers and sellers are generally expected to file after a business sale. Reading through the categories described there, even briefly, demystifies a lot of the vocabulary that shows up later in an allocation schedule prepared by an accountant.

It's not the most engaging reading in the world, but it is the actual source document the categories are drawn from, which makes it worth at least skimming once before a substantive conversation with your own CPA.

The instructions also walk through which party is responsible for which section of the reporting, and what happens if the allocation changes after the original filing, which is a scenario that comes up more often than sellers expect when a deal includes any contingent or deferred payments.

A general reference on the allocation concept itself

The Wikipedia entry on purchase price allocation covers the general framework in plainer language than the IRS instructions, including the idea that goodwill functions as a residual category, picking up whatever value is left once the other, more specifically defined categories have been assigned their amounts. It's a reasonable primer before digging into the more technical source material.

Reading it alongside a real, even if simplified, example of a completed allocation schedule makes the abstract categories click into place much faster than reading the definitions alone. Ask your CPA if they can walk through a redacted example from a prior transaction of similar size, if one is available to share.

Background on non-compete and consulting arrangements

A meaningful part of many allocation negotiations involves how a covenant not to compete, or a related consulting arrangement, gets valued and taxed. The Wikipedia entry on non-compete clauses provides general background on how these agreements are typically structured, which is useful context for understanding why buyers and sellers often disagree about how much value belongs there versus in the goodwill category.

This distinction matters most in transactions where the seller is staying involved with the business for some period after closing, whether through a formal consulting agreement or informally helping with a transition. The tax treatment of that involvement is a separate question from the non-compete itself, and both are worth understanding before either gets valued in the allocation schedule.

Professional standards for the accountants involved

The American Institute of CPAs maintains professional guidance for accountants working on transaction-related engagements, including allocation and valuation work. It's not written for a general audience, but it's useful for understanding the kind of professional standards your own CPA is expected to work within when advising on an allocation schedule.

This kind of guidance is useful even for a seller who isn't hiring an accountant directly for the allocation work, since it gives a sense of what a properly documented allocation process is supposed to look like, which in turn helps evaluate whether the process your own transaction is following seems thorough or rushed.

A directory for verifying a financial advisor's background

If a wealth advisor or financial planner is part of your broader advisor team for the sale, particularly for the post-close planning side, FINRA BrokerCheck is a free, independent way to verify that advisor's registration history, disciplinary record, and professional background before relying on their guidance for a transaction of this size.

Checking BrokerCheck takes a few minutes and costs nothing, which makes it one of the easier due-diligence steps to skip under time pressure near a closing date. It's worth doing anyway, particularly for any advisor being brought in specifically because of the sale rather than someone with an existing, longer relationship with the seller.

A membership directory for fee-only fiduciary advisors

For sellers looking specifically for a fee-only, fiduciary financial advisor to help with post-sale planning, the National Association of Personal Financial Advisors maintains a membership directory of advisors who have committed to that fee structure and fiduciary standard. It's a useful starting point for narrowing a search, separate from the transaction-side CPA and attorney conversation about the allocation itself.

Fee-only and fiduciary are specific terms with real meaning, not marketing language, and confirming that an advisor's stated fee structure and standard of care actually match what's listed publicly is a reasonable step before a longer-term relationship begins, especially one starting right after a significant liquidity event.

A federal resource for general investor education

The SEC's investor education site covers broader investor protection and education topics, including how to research an investment professional's background before working with them. It's more relevant to the post-sale investing conversation than to the allocation schedule itself, but it rounds out a useful set of independent, non-promotional resources for a seller assembling an advisor team around a transaction like this.

It's also a reasonable place to bookmark for later, since the questions that matter most tend to shift from "how does the allocation work" during the sale itself to "how do I handle the proceeds" in the months afterward, and the site covers both kinds of topics at a general, educational level.

How to use these resources together

None of these seven resources, taken alone, replaces a conversation with your own CPA and attorney about your specific transaction. Read together, they give a seller enough vocabulary and context to walk into that conversation as an informed participant rather than someone seeing the categories and the terminology for the first time.

A reasonable approach: read the IRS instructions and the Wikipedia overview first to understand the basic framework, then use the professional-standards and directory resources to evaluate whether the advisors already involved in your deal, or ones you're still considering, have the right background for a transaction of this kind.

A reasonable amount of time to budget for this kind of reading is an hour or two, spread across a few sittings rather than one long session. The goal isn't to become fluent in tax law before the next advisor meeting. It's to walk in able to follow the conversation, ask a pointed follow-up question, and recognize when a proposed number seems worth pushing back on.

A note on independence

None of the organizations listed above are affiliated with each other, and reading through their material doesn't commit you to using any particular advisor or service. That's intentional. Understanding the allocation framework and verifying an advisor's background are two separate, independent steps, and treating them that way tends to produce better outcomes than relying on a single source for both.

There is a gap between what sellers think buyers care about and what buyers actually spend their time on once a data room opens. Sellers often obsess over presentation. Buyers spend most of their attention on consistency, and on whether the story the numbers tell matches the story the owner told in the first meeting.

That gap between perception and reality shows up again and again in conversations with people who have been through a sale process before, and it is worth understanding early rather than discovering it mid-diligence.

Photo by Lukas Blazek on Pexels

Consistency Over Polish

This section gets more attention from buyers than any other part of the room, which is exactly why it deserves the most preparation time before anyone outside your business ever sees it.

A data room does not need to look expensive. What it needs is internal consistency. If the revenue figure in your pitch deck does not match the revenue figure in your financial statements, a buyer will notice within the first hour of review, and every subsequent number gets read with more suspicion than it deserves.

The Wikipedia entry on due diligence covers the general categories buyers investigate across financial, legal, and operational review. What stands out reading it with a seller's eye is how much of due diligence is really about verification rather than discovery. Buyers are checking whether what you said is true, not searching for something new.

Customer Concentration, Every Time

Almost every buyer's team asks about customer concentration in some form. If one customer accounts for a large share of revenue, that is not automatically disqualifying, but buyers want to understand the relationship's history, the contract terms, and what would happen to that revenue under new ownership. Sellers who have a clear, honest answer ready move through this faster than those who get defensive about the question.

Working Capital and Cash Flow Patterns

Buyers look closely at working capital trends across multiple periods, not just a single snapshot. Seasonal businesses in particular need to show how cash flow moves through the year, since a working capital target negotiated off a single bad month can create real friction later in the deal.

Contract Completeness

A verbal understanding with a key customer or vendor is not the same as a signed, current agreement a buyer's counsel can review. Missing signatures, expired terms, or contracts that were never formally executed are among the most common gaps that slow a deal down, and they are also among the easiest to fix if caught early, often just requiring a phone call to a longtime customer who never got around to signing the renewal.

Photo by KoolShooters on Pexels

Response Time Sends a Signal Too

Buyers pay attention not just to what is in the room but to how quickly and completely sellers respond to follow-up questions. A slow or incomplete response to a straightforward request can read as disorganization, or worse, as evasiveness, even when the real explanation is that the seller simply has not built an efficient process for pulling additional documents. Having someone dedicated to managing requests, rather than fielding them ad hoc between other responsibilities, tends to keep this part of the impression positive.

Management Depth Beyond the Owner

A question that comes up in nearly every deal, directly or indirectly, is how dependent the business is on the owner personally. Buyers look for evidence that the business can run, at least reasonably well, without the current owner in the room every day. Documentation of processes, a capable management layer, and written procedures for key functions all speak to this, and their absence is one of the more common reasons a buyer adjusts valuation downward or asks for a longer transition period.

Legal Housekeeping That Is Easy to Overlook

Buyers also check for the unglamorous legal basics: are business licenses current, are required permits in place, has the entity been properly maintained with up-to-date filings. None of this is usually a dealbreaker on its own, but a pattern of neglected housekeeping tends to make a buyer's team dig harder everywhere else, on the theory that if the easy things were missed, something more consequential might be too.

How This Connects to the Data Room Itself

Understanding what buyers are actually looking for changes how you build the room in the first place. Rather than uploading everything you have, it becomes an exercise in anticipating the specific questions a buyer's team will ask and making sure the answer is already sitting in the right folder. A longer guide on preparing a data room before a business sale walks through how sellers typically stage that access and what belongs in each tier.

Why First Impressions in the Room Carry Weight

The very first documents a buyer opens tend to set their overall posture toward the rest of the review, whether that is a relaxed, straightforward pace or a more skeptical, line-by-line one. A room that opens cleanly, with organized folders and consistent figures right from the first file, tends to earn a more efficient review overall than one that starts with confusion, even if the underlying business is equally strong in both cases.

Vendor Concentration Gets the Same Scrutiny as Customer Concentration

It is easy to focus entirely on customer concentration and forget that heavy reliance on a single vendor or supplier raises similar questions. If one supplier accounts for a large share of your cost of goods, buyers want to know whether that relationship is contractually secure, how easily it could be replaced, and what would happen to margins if terms changed under new ownership. Having a clear answer ready, the same way you would for a concentrated customer relationship, avoids an awkward gap in an otherwise thorough presentation.

The Difference Between a Clean Story and a Perfect One

None of this means a business needs to be flawless to sell well. Every business has some concentration risk, some historical anomaly, some process that depends more on one person than it probably should. What buyers actually respond well to is not perfection, it is a seller who understands their own weaknesses and can speak to them candidly, with a plan or at least an honest acknowledgment, rather than a seller who seems surprised by a question any diligent buyer would eventually ask.

Where to Start if You Are Early

If you have not yet engaged an accountant or an M&A advisor for a future sale, general resources like SCORE, a nonprofit mentoring organization for small business owners, or the International Business Brokers Association, which represents brokers and intermediaries, are reasonable places to get oriented before you commit to paid help.

Understanding the buyer's side of the table, what they are actually checking and why, tends to make sellers better prepared and less anxious once real due diligence begins. Sellers who go in expecting scrutiny, rather than treating each question as an accusation, tend to navigate the process with less friction and build more trust with the buyer's team along the way.

If someone close to you is selling a business and mentions a "basket" or a "cap" in the same sentence as a lawyer, they are not talking about kitchen supplies or a hat. They are talking about two of the terms that decide how much money they actually get to keep after the deal closes.

This is a plain-English educational overview, not advice. Anyone navigating an actual sale should be working with appropriately licensed advisors on the specifics. The goal here is to explain the concepts clearly enough that an interested friend or family member can follow along.

Photo by Ann H on Pexels

The basic idea: a promise with limits attached

When someone sells a business, they make a long list of promises (formally called representations and warranties) about the company: the financials are accurate, there are no hidden lawsuits, the contracts are valid, and so on. If one of those promises turns out to be false, the buyer can come back and ask the seller to pay for the resulting loss. That mechanism is called indemnification.

The general legal concept behind this kind of remedy is described at the Wikipedia entry on indemnity, which is a reasonable place to start if you want the underlying legal background.

Sellers do not agree to indemnify buyers for absolutely anything, forever, without limit. That would make selling a business far too risky. Instead, the purchase agreement puts specific boundaries around the promise, and two of the most important boundaries are the basket and the cap.

The basket, explained

The basket is a threshold. Small issues, below a certain dollar amount, do not trigger any payment obligation at all. The buyer has to accumulate losses above the threshold before a claim becomes valid.

Think of it like an insurance deductible, but for the seller's promises about the business. If the basket is set at $100,000, small discrepancies that add up to less than that amount are simply absorbed, no payment changes hands. Once the total crosses $100,000, the claim becomes live.

There are two flavors of basket, and the difference matters. In a "deductible" structure, the seller only pays the amount above the threshold. In a "tipping" structure, once the threshold is crossed, the seller pays the whole amount, not just the excess. The difference between the two, on a claim that lands just above the threshold, can be tens of thousands of dollars.

The cap, explained

The cap is the ceiling. It is the maximum total amount the seller can ever be required to pay under the indemnification provisions, no matter how many claims come in or how large they are.

Caps are usually set as a percentage of the total purchase price, and the percentage varies by deal. What often surprises people learning about this for the first time is that certain categories of promises, particularly the most fundamental ones (like confirming the seller actually owned the company and had the authority to sell it), are frequently carved out of the general cap and can have a much higher limit, sometimes uncapped entirely.

Photo by serdar barış on Pexels

Why both terms exist together

The basket and the cap work as a pair. The basket filters out small, immaterial issues so both sides are not fighting over a few thousand dollars of discrepancy. The cap protects the seller from unlimited exposure on the promises they made. Between the two, the actual range of what a seller could realistically owe after closing gets defined.

A third term, the survival period (how long after closing a claim can even be brought), works alongside the basket and cap to complete the picture. All three are usually negotiated together, not one at a time.

Why this matters for the seller's actual take-home

The purchase price announced when a deal closes is not necessarily what the seller ends up keeping. A portion is often held back in escrow specifically to cover potential indemnification claims, and that holdback is released over time as the survival period runs without a claim being made, or reduced by whatever claims are actually paid out.

A seller with a favorable deductible basket and a well-negotiated cap has a fairly predictable range of outcomes. A seller who accepted a tipping basket and a high cap on a broad set of representations has taken on more risk, whether or not they fully understood that at the time of signing.

Background on the underlying legal concept of statutes of limitations, which is related to but distinct from the contractual survival period, is available at the Wikipedia entry on statutes of limitations.

Where reps and warranties insurance fits in

In many mid-market and larger deals today, a reps and warranties insurance policy sits alongside the traditional indemnification structure. The insurer, not just the seller, becomes a source of recovery for the buyer if a representation turns out to be false. When this kind of policy is part of the deal, the negotiated basket, cap, and survival terms for the seller personally are often more favorable, since the insurance is absorbing some of what indemnification would otherwise cover. The American Bar Association publishes background material on how this insurance product has become more common in deal structures over the past decade.

A simple example to make it concrete

Imagine a business sells for $10 million. The purchase agreement sets a basket of $75,000 and a general cap of 10 percent of purchase price, or $1 million, for most representations. A few months after closing, the buyer discovers that a customer contract disclosed during diligence was actually terminated the week before closing, something the seller should have flagged. The resulting loss to the buyer is calculated at $120,000.

Because the loss exceeds the $75,000 basket, the buyer has a valid claim. Under a deductible structure, the seller owes $45,000 (the amount above the basket). Under a tipping structure, the seller owes the full $120,000. Either way, since $120,000 is well under the $1 million cap, the cap itself does not come into play for this particular claim, though it would if several claims accumulated over the survival period.

Why the escrow matters for how this actually gets paid

In most deals, some portion of the purchase price, commonly five to fifteen percent, is held back in an escrow account specifically to fund claims like the example above. Rather than the seller writing a check months after receiving sale proceeds, the payment often comes directly out of the escrow, with the remaining escrow balance released to the seller once the survival period ends without further claims.

This is part of why the basket, cap, and escrow terms are usually discussed together rather than one at a time. A seller who understands only the cap, without understanding how the escrow funds actual payments, has an incomplete picture of what happens if a claim like the example above actually arises.

The takeaway for a non-lawyer following along

You do not need to become an M&A lawyer to follow a conversation about baskets and caps. The basket decides how small an issue has to be before it simply does not matter. The cap decides the absolute maximum exposure. Both are negotiated, both vary substantially by deal, and both deserve a specific, early conversation between the seller and their advisors rather than a quick skim during the final days before signing.

For anyone who wants to go deeper on how these terms interact with survival periods and escrow, Capivise's advisor matching resource covers the advisor coordination side of a business sale, and the longer Capivise article on indemnification terms walks through the mechanics in more depth.

The non-advice disclaimer

A letter of intent usually arrives before the seller has engaged full transaction counsel, and the indemnification language in it, if there is any at all, is often high-level and easy to skim past. That skim is a missed opportunity, because whatever gets agreed to in principle at the letter of intent stage tends to anchor the more detailed negotiation later.

This is a plain-language, step-by-step guide to reading that section carefully, aimed at sellers and the people helping them think through an early-stage offer. It is educational, not legal advice.

Photo by cottonbro studio on Pexels

Step 1: check whether indemnification terms are addressed at all

Some letters of intent skip indemnification entirely, deferring it to the definitive agreement. Others include a paragraph outlining the expected basket, cap, and survival period. Neither approach is wrong, but a seller should know which one they are looking at.

If the terms are absent, that is a topic to flag for legal counsel before signing the letter of intent: does silence mean the terms are fully open for negotiation later, or does the buyer expect their standard terms to apply by default? Clarifying this expectation early avoids a surprise during the definitive agreement drafting.

Step 2: identify the proposed basket and cap, if present

If the letter of intent does include specific numbers, note them clearly: what basket amount is proposed, whether it is described as a deductible or a tipping basket (or left ambiguous), and what cap percentage is proposed relative to purchase price.

The underlying concept of indemnification, which these terms all sit within, is described at the Wikipedia entry on indemnity for background before a deeper conversation with an attorney.

Step 3: look for carve-out language around fundamental representations

Some letters of intent mention that "fundamental representations" will be treated differently from general representations, without spelling out exactly what that means. This is a placeholder for a more detailed negotiation later, but it signals that the buyer is thinking in the conventional two-tier structure common in M&A deals.

Flag this language specifically for your attorney, since the eventual scope of what counts as "fundamental" and what cap or survival period applies to that category can meaningfully change the seller's total exposure. Background on the underlying legal doctrine that fundamental representation survival periods are sometimes tied to is available at the Wikipedia entry on statutes of limitations.

Photo by 2H Media on Unsplash

Step 4: note any mention of a reps and warranties insurance policy

If the letter of intent mentions that the buyer intends to purchase a reps and warranties insurance policy, that is worth flagging early, since it often changes what basket, cap, and survival terms the buyer will accept in the definitive agreement, typically in the seller's favor since the insurer becomes a source of recovery alongside or instead of the seller.

Background on how this kind of insurance has changed deal negotiations is available through the American Bar Association, whose Business Law Section publishes commentary on current M&A practice.

Step 5: treat the letter of intent terms as a starting point, not a final answer

Terms in a letter of intent are typically non-binding, meaning they set an expectation but do not lock in the final numbers. That said, buyers and their counsel often resist moving far from what was outlined at the letter of intent stage, so a seller who signs a letter with unfavorable indemnification language has made the later negotiation harder, even though nothing is technically final yet.

Topic to raise with an attorney before signing: whether the proposed indemnification language in the letter of intent is favorable, neutral, or already skewed toward the buyer, and whether it is worth pushing back on before signing rather than waiting for the definitive agreement.

Step 6: bring the letter of intent to counsel before signing, not after

The most common mistake at this stage is treating the letter of intent as a formality to sign quickly so the deal can move forward. Even non-binding terms benefit from a careful read by an attorney with actual M&A experience before signing, specifically for the indemnification language and any exclusivity or timeline provisions that could limit the seller's options.

For sellers who are still building out that advisor relationship, Capivise is a starting point for the advisor verification process, focused on confirming actual transaction experience. The longer Capivise guide on indemnification caps, baskets, and survival periods covers how these terms typically develop from letter of intent through the definitive agreement.

Step 7: compare the language against what a typical letter of intent includes

Not every letter of intent uses the same level of detail for indemnification terms. Some include only a sentence acknowledging that "customary" terms will apply, without defining what customary means for this deal. Others include a full paragraph with specific proposed numbers. Neither is inherently better, but a seller should recognize which type they are looking at and ask counsel to clarify what "customary" would actually mean if that word appears without further definition.

A vague reference to customary terms can work in the seller's favor or against it, depending on how the definitive agreement negotiation unfolds later. Flagging the ambiguity early, rather than assuming it will resolve itself favorably, is the more reliable approach.

Step 8: ask what happens if the parties cannot agree later

Letters of intent occasionally include a fallback mechanism for what happens if the buyer and seller cannot agree on indemnification terms during the definitive agreement negotiation, such as a specified exclusivity period that expires or a right for either party to walk away. Understanding this fallback before signing the letter of intent gives the seller a clearer picture of their actual leverage if the later negotiation becomes contentious over these terms specifically.

A brief word on why this section is easy to overlook

Letters of intent are exciting documents. They often represent the first concrete validation that a business is sellable at a real price, and the natural instinct is to focus on that headline number rather than the more technical language further down the page. Indemnification terms, when present at all, are usually a few sentences among many, competing for attention with price, timeline, and exclusivity provisions that feel more immediately consequential.

The practical reality is that the indemnification language, even in an early, non-binding document, deserves the same careful read as the price term, since it directly affects how much of that headline price the seller actually keeps once the deal has closed and the survival period has run its course.

Step 9: keep a copy of every draft, not just the final one

As the letter of intent goes through revisions, keep a dated copy of each draft, particularly any version where the indemnification language changed. This creates a record of what was proposed, what was pushed back on, and what was ultimately agreed to, which can be useful later if a dispute arises about what the parties actually understood at the letter of intent stage versus what ended up in the definitive agreement.

This habit is simple to maintain and is often skipped entirely by first-time sellers who assume only the final signed version matters. In practice, the negotiating history can matter if there is ever a disagreement about how a term evolved from the letter of intent to the definitive agreement.

A final word on managing the emotional side of this stage

Receiving a letter of intent is often the most exciting moment in the entire sale process, and it is easy to want to sign quickly and move forward. Slowing down specifically for the indemnification language, even by a few days, rarely jeopardizes a genuinely interested buyer, and it meaningfully improves the seller's position heading into the more detailed negotiation that follows. Buyers who withdraw interest over a reasonable request for a few days of attorney review were unlikely to have been reliable counterparties through to closing regardless.

What this guide is not

Most people who read about business sales in the popular press focus on the deal value. It is the number that shows up in the headline. But sellers who have been through the process, and lawyers who advise them, will tell you that a bigger determinant of the seller's outcome over the following decade is a section that rarely makes the news: the restrictive-covenants block.

Buried in the middle of a purchase agreement, usually a few pages long, these provisions determine what the seller can and cannot do professionally after closing. They cover non-competition, non-solicitation of customers, non-solicitation of employees, non-disclosure, and often several related covenants. And they are usually drafted by the buyer's counsel to be as broad as the market will bear.

This is a general-audience walkthrough of what those pages actually do, what to look for, and where the trap doors are. It is educational reading, not legal or tax advice - every deal has specifics that only the seller's own advisors can address.

Photo by Rayia Soderberg on Unsplash

What the block usually contains

A typical restrictive-covenant section covers:

A non-competition provision limiting the seller's ability to compete with the sold business

A non-solicitation of customers provision

A non-solicitation of employees provision

A non-disclosure or confidentiality provision

Related provisions on ownership of investments in competitors, and on cooperation with the buyer post-close

Each of these has scope, duration, and geographic parameters. Each has enforcement mechanics. Each interacts with the earnout, if there is one, and with the transition employment period, if there is one.

The interaction is where the surprises live.

The scope-of-activity trap

Non-competes are often drafted to prohibit "engaging in the business of the Company" for a defined period. What "engaging in the business" means is the question that determines whether the seller can consult, sit on boards, serve as an angel investor, or teach at a university without violating the covenant.

Broadly-drafted scope reaches all of those activities. Narrowly-drafted scope permits most of them. The negotiation between the two is where the seller's post-close options are decided.

The SEC's Investor.gov has general educational reading on how M&A affects executives who continue to be active in their industry. Legal counsel walking through the specific draft is the operational resource.

The customer non-solicit trap

Non-solicits of customers are often more restrictive than the non-compete for a seller who plans to stay active in the same industry. The non-compete may permit consulting; the non-solicit prohibits consulting for the specific customers of the sold business, which is often exactly who the seller would consult for.

Drafts frequently include prospective customers (people the company was pursuing) and affiliated companies of customers (parents, subsidiaries, sister companies). The scope of "customer" can be much broader than the seller initially understands.

The detailed writeup on restrictive covenant provisions covers the mechanics of the customer-non-solicit specifically.

The employee non-solicit trap

Employee non-solicits prevent the seller from hiring away key employees for a defined period. Drafts often extend to any employee, not just senior ones. Some drafts extend to former employees who left the company before the sale.

Sellers who plan to start or join a new venture in the same industry may find their most obvious hiring pipeline (former colleagues) is closed to them for the entire covenant period.

The tax allocation quietly built in

Restrictive covenants are typically allocated a portion of the purchase price under Section 197 of the Internal Revenue Code, and that allocation is ordinary income to the seller rather than capital gains. A large covenant allocation converts what looks like capital-gains sale proceeds into ordinary-income payments, at a materially higher tax rate for most sellers.

The buyer's initial draft often allocates more to the covenants than a seller would want. Tax advisors negotiate this alongside legal counsel. The AICPA publishes technical guidance CPAs reference for the specific accounting.

The timing trap

Non-competes drafted to run "from end of employment" rather than "from closing" can double or triple the effective restriction period if the seller has a multi-year transition employment agreement. A five-year non-compete plus a five-year employment agreement is effectively a ten-year restriction from closing.

Sellers often do not catch this until well after signing. Legal counsel with M&A experience catches it during drafting review.

The related timing question is what happens if you leave employment early. Some drafts accelerate the covenant to start from termination if the seller resigns for reasons the buyer does not consider "good reason." Others hold the covenant to the original schedule. The difference determines whether an early departure is manageable or catastrophic for the seller's post-close plans.

The choice-of-law question

The state law that governs enforcement of the covenants is specified in the purchase agreement. Different states enforce non-competes differently. The Federal Trade Commission has been active on federal non-compete policy in recent years, and state legislatures continue to move. What is enforceable today may be different in three or five years.

Choice-of-law matters most when the seller intends to change residency or when the buyer intends to enforce the covenants across state lines.

Photo by Gustavo Fring on Pexels

What sellers do about it

Sellers who navigate this section well share a few patterns:

They engage legal counsel with specific M&A experience early in the process, ideally before the letter of intent is signed

They coordinate legal counsel with tax and financial advisors before signing the purchase agreement

They read the covenant block themselves after their counsel walks through it, and ask questions until they can explain each provision back

They negotiate carve-outs for specific activities they intend to continue post-close

They understand the interaction between covenants, earnout, and transition employment before signing

None of these are dramatic. All of them make a difference in the outcome years later.

For general educational reading on the seller side of the transaction, the educational resources at Capivise cover the topics sellers typically raise with their advisors, and the walkthrough on restrictive covenant provisions covers the specific block discussed here.

For sellers still building an advisor team, FINRA BrokerCheck provides regulatory records for registered financial professionals, and the SEC's Investor.gov has general educational reading on advisor selection.

Why the popular press misses this

The restrictive-covenant section is not glamorous. It does not lend itself to headline numbers. Its consequences unfold over years, not at closing. And it varies dramatically by state, industry, and deal specifics.

But if you talk to sellers a year or two after their deals close, the topic that most often comes up as "the thing I wish I had negotiated harder" is not the price. It is some element of the covenants. The scope was broader than they realized. The duration was longer than they thought. The customer non-solicit blocks the specific consulting work they wanted to do. The tax allocation cost them more than the negotiation would have.

Sellers reading this before their own signing have the opportunity to avoid those outcomes. That opportunity closes at signature.

Business sellers preparing for signing usually have their M&A attorney do a full walkthrough of the purchase agreement in the days before execution. The restrictive-covenant section of that walkthrough deserves specific attention. It is dense, it is technical, and it has consequences that unfold over years rather than at closing.

Below is a general-audience approach for how a seller can get the most out of that walkthrough. This is educational, not legal advice - your own attorney is the resource for the specific drafting of your specific agreement.

Photo by ron dyar on Unsplash

Before the meeting: read the covenants yourself once

Even if the language is dense, read the covenant section before the meeting. Highlight the sentences you do not fully understand. Note the ones that mention specific numbers (years, geographic radius, percentage ownership).

You are not trying to negotiate on your own. You are preparing to ask targeted questions so the meeting is efficient. Coming into a covenant walkthrough having read the section once is dramatically more useful than coming in cold.

Question one: what specifically am I agreeing not to do

Ask the attorney to describe, in plain English, the specific activities the covenant prohibits. Not the language. The activities.

Something like: "So starting at closing, I cannot start or work for a company that competes with the sold business, defined as any business that does X, Y, or Z, anywhere in the United States, for five years. Is that a fair description?"

The attorney's rephrasing is where you catch drafting that reaches farther than you intended. If they say "and it also prohibits you from being an advisor to a competing company," and you did not know that, note it.

Question two: what are the exceptions built in

Even the strictest non-compete typically has some exceptions - passive investment up to a percentage, board service in non-competing industries, charitable activities. Ask for the exceptions in the current draft.

Then ask: what exceptions do sellers typically negotiate for that are not in this draft? Your attorney will have a list. Consider each against your post-close plans.

The detailed writeup on restrictive covenant provisions covers common exceptions and how they are typically drafted, if you want general background reading before the meeting.

Question three: how does the timing work

Ask when the non-compete clock starts. From closing? From end of employment? If from end of employment, is there a defined end-of-employment date, or is it triggered by termination of an employment agreement that may itself run for years?

Ask the same about the non-solicits. They often run on different clocks from the non-compete.

Ask about tolling. If a dispute arises and lands in court or arbitration, does the covenant period stop and restart when the dispute resolves? A "five-year covenant with tolling for disputes" can effectively be much longer.

Question four: how does the customer non-solicit define customer

The word "customer" in a non-solicit can mean many things. Ask specifically:

Anyone the sold business did business with in the last two years?

Anyone the sold business was pursuing at time of closing?

Anyone the sold business was in preliminary discussions with?

Parents, subsidiaries, and sister companies of any of the above?

Sellers who plan to consult in the industry post-close find that the non-solicit is often the more binding restriction. Understanding the scope of "customer" is how you know what your post-close options actually look like.

Question five: what is the tax allocation

Restrictive covenants are typically allocated a portion of the purchase price under Section 197. The IRS treats that allocation as ordinary income to the seller. Ask your attorney what allocation is in the current draft, and whether that allocation matches economic reality.

If the allocation is substantial, coordinate with your CPA before signing. Tax outcome differences at this stage can be significant.

Question six: what happens if things go wrong

Ask about the enforcement mechanics. What court or arbitrator hears disputes? Under what state's law? What is the standard of proof? What are the remedies (injunction, damages, attorney's fees)?

Ask about the blue-pencil provision. If a court decides the covenant is over-broad, does it narrow the covenant to what is enforceable, or does it strike the whole covenant?

Ask about the seller's protections. Can the buyer's counsel enforce the covenant vindictively? What is the recourse if that happens?

Question seven: how does this interact with the earnout and employment

If there is an earnout, ask how the covenants interact with earnout eligibility. If employment is required for the earnout to pay out, how does the covenant work if you leave employment before the earnout completes?

If there is a transition employment agreement, ask how termination (for cause, without cause, resignation, mutual separation) affects the covenants and the earnout separately.

These interactions are where deals go sideways after signing. Understanding them before signing is protection.

Question eight: what if the buyer sells the business

Ask whether the covenants are assignable. Buyers frequently sell the businesses they buy within a few years. If the covenants are freely assignable, they may end up being enforced by an entity you never agreed to grant covenants to.

Ask for language that limits assignment to sale of the whole business, or that requires renegotiation on transfer.

Photo by Pavel Danilyuk on Pexels

After the meeting: write it down

Take the plain-English version of each provision, in your own notes, and read it against the actual drafting the next morning. Do the two match? If any provision surprises you when you re-read it, ask about it again before signing.

The gap between "what the attorney said" and "what the document actually says" is where signing mistakes happen.

Coordinating with your other advisors

The attorney handles the drafting. But the tax advisor should see the allocation, the wealth advisor should see how the covenants interact with your longer-term plans, and any earnout-related financial modeling should account for the covenant timing.

Getting all four (you, attorney, tax advisor, wealth advisor) on the same page before signing is how sellers preserve optionality after closing. This general reader on restrictive covenants covers the topics and how to frame them across the advisor team.

The Capivise educational library has a longer walkthrough of the specific provisions, framed as topics to raise with counsel.

For sellers still choosing or vetting an advisor team, FINRA BrokerCheck provides regulatory records for registered financial professionals, and the SEC's Investor.gov has general educational reading on advisor selection. The AICPA is the credentialing body for CPAs, whose local chapters can point sellers toward M&A-experienced tax advisors.

What the meeting is really for

The covenant walkthrough with your attorney is not primarily about being told what the document says. It is about the seller understanding the document well enough to make informed decisions about which provisions to negotiate, which to accept, and which to seek carve-outs for.