When we have a client who presents a premium offering to market, we have structured a two-letter sequence with prospective buyers. The two important milestones in this type of a sale process are the Indication of Interest (IOI) and Letter of Intent (LOI). Here’s what to look for in each document, as well as important considerations for you and your business at the time each of these are presented.
An IOI is a non-binding assertion from a potential buyer demonstrating their interest in purchasing your company. It typically outlines the buyer’s preliminary terms and valuation but doesn’t guarantee a transaction will occur. It allows prospective buyers to advance to the next round for consideration. An LOI is a more definitive non-binding agreement outlining the understanding between two or more parties which they intend to formalize in a legally binding agreement. The goal is to identify the most appropriate buyer whose transaction details provide the best results relative to the seller’s goals and objectives. Think of IOI as speed dating and LOI as traditional dating.
How It Works
In marketing any client’s business, we distribute a teaser to prospective buyers with a high-level snapshot of the company while keeping the seller’s identity confidential. It’s not intended to provide enough information for detailed financial analysis. If a prospective buyer is interested in the company, they will request more information as a next step. An NDA is sent to the prospective buyer to ensure confidentiality as more detailed information is released. Once the NDA is received, a Confidential Information Memorandum, CIM, is sent to the prospective buyers with comprehensive and thorough information about the seller’s business. The CIM provides greater insight into the company’s operations, financials and provides details about the management team, operations, technology, sales and marketing strategies along with details about industry trends and why this target is an attractive opportunity.
In a competitive case, a process letter is included with the CIM with detailed instructions on submitting the indication of interest (IOI), the criteria for advancement to the next stage and the related timeline. Not all cases are formally competitive, and each case is personalized to its own unique situation. The two-step process is the basis for identifying and evaluating which potential buyers will be invited further into the process; to meet with management and to submit a formal letter of intent (LOI) serving as the foundation for the formal agreement beginning the negotiations to purchase the company.
An IOI provides guidance on the businesses’ valuation for acquisition and outlines the general conditions for completing the transaction. The process of using an IOI (speed dating) and LOI (formally dating) allows for competitive tension to discover the best few buyers. The purpose of an IOI is to reveal who has genuine interest in purchasing the company and who is willing to be aggressive enough to move into the next round.
A process letter is sent to invited prospects detailing the specific requirements for prospective buyers advancing to the LOI stage. There are typical items sellers want to know about a buyer’s intentions and how the case is to be transacted prior to going deeper into the process. An IOI process is about results and relationships and an opportunity for advisors to have another touch point with a potential buyer giving us early feedback. This gate is our first opportunity to negotiate on price and terms with potential buyers, and we now have a market read on what the company is worth in their eyes.
The 50,000 Foot View
The IOIs will provide the buyer’s valuation for the business on a cash-free, debt-free basis. It reveals whether the proposal is stock- or asset-based, which makes a significant difference in liability assumptions and tax implications – read, how much net cash proceeds in hand. In the IOI, prospective buyers will specify the form, timing, associated payment terms and conditions that frame the proposed acquisition structure.
There are various forms of purchase consideration, and it’s important to understand them to determine which offer is most beneficial for our clients’ goals and objectives. The purchase consideration being the total payment made by the buyer to the seller based on the agreed-upon enterprise value of the business including cash and non-cash considerations. Non-cash considerations can include securities, financial instruments, equipment, and other agreed upon assets based on the transaction structure. Clearly interpreting the details guides the decision of which buyer is the best candidate to negotiate final terms with. For example:
The approximate price range may be expressed in a dollar value range, such as $10MM to $15MM. Some cases will be stated as a multiple of EBITDA, 3X to 5X EBITDA and the proposed elements of the transaction structure (asset vs equity, leveraged transaction, cash vs equity, etc.). They will include general availability of funds and sources of financing, necessary due diligence items and the associated timeline. We look for their commitment to reps and warranty insurance, premiums, retention and underwriting which helps strengthen their bid.
We also look for their position on governance to understand their perceived operating cadence of the opportunity. Finally, the timeframe to close the transaction will be included along with the management retention plan, management reinvestment or rollover equity and the role of the equity owner(s) post-transaction. (this list is not all-inclusive)
How Money Works
It’s very important to understand sources of financing from prospective bidders. Most financial buyers we engage in have sizable funds and a history of deal making we’re comfortable with as your advisor. The smaller regional PEGs may have a partially dedicated fund and rely upon their co-investors and understanding where the money is coming from is vital.
Financial buyers are more inclined to take CIMs because their job is to review deals. Money needs to be put to work, but it’s not going to be put to work foolishly. Strategic buyers often take longer to review the teaser and have discussions with us before they commit to signing an NDA. We put a little more weight into the strategic proposals because they have internally vetted this case one or two levels higher in their organization, and their letter will carry a bit more weight.
The Analysis
We invest meaningful time analyzing IOIs using their response to ask clarifying questions of each shortlisted potential buyer to then present the seller with a favorable analysis of each submission. We caution the seller to keep their guard up throughout the entire process. as loose lips sink ships. Once we have everyone’s best effort, we perform a workout with our client’s management evaluating the term sheets and sharing our insights with each favorable submission. The objective of these discussions is to bring the best prospects forward.
It’s ultimately the business owner’s decision who they want to move forward into the second stage of the process. However, we invite as many potential acquirers into the next round to maximize competitive friction while minimally impacting management’s time. The IOI process is designed to provide the seller with an accurate depiction of how a final offer might look, to ensure certain defined criteria are met, and to prevent negative, substantive items from emerging during due diligence. Even though the IOI isn’t a binding offer, the process formality elevates a prospective buyer’s offer more substantially than discussions.
What’s in the LOI
The LOI establishes the general conditions and the context of how the business being acquired strategically fits within the buyer’s portfolio. Now we introduce the transaction attorney who will convene with the buyer’s counsel to negotiate the LOI specifics. The structure of the deal is the most important component of the LOI including how payment is made and when. Here is where we lose most sellers. Once they see a number, all they can think about is that number. It’s mental and emotional heroin! The deal structure is finalized with both counsel on the finite details regarding A/R, A/P, and the remaining financial provisions the seller would overlook. The how, when and where the owner of the acquired business will remain in the business and the terms of their employment are outlined.
The buyer’s initial LOI goal and in acquiring a business is to minimize and mitigate potential risks. They will do everything in their power to ensure said risks are reverted to you, the seller – that’s their job! They’re in business to make money for their investors and an acquisition incurs risk. The next component is the seller’s indemnity obligations; possibly the second most important component after the deal structure. These obligations establish the buyer’s recourse in the event the acquired business suffers a significant deterioration post-closing where the seller agrees to compensate the buyer for specific claims or damages.
While the LOI is non-binding, there are binding obligations and indemnities as the best examples of why an LOI cannot be taken lightly. There’s far more to an offer sheet than the number! The closing conditions are usually the next component with regulatory and financial conditions that must be met before the transaction can close. Typical negotiating points to contest will include the time periods and conditions for payment, acceleration, consultation periods, earn outs, rollover equity, issues around working capital target and methodology, caps and baskets, length and proposed scope of due diligence and more. In a competitive process, an LOI is a draft of the pending definitive agreement and now is the time to negotiate the intricacies.
Evaluating potential buyers requires carefully working through all the LOI components with your advisor and M&A attorney. The seller holds all leverage until the LOI is signed, then that leverage shifts to the buyer. Negotiating the highest price and the best terms for the clients is vital so an informed decision can be made prior to entering exclusivity. Ensuring the buyer selected to go forward under exclusivity has a very high certainty of close is crucial. Once all the back-and-forth has concluded and the seller accepts the terms of the LOI, the seller enters exclusivity – no more dating anyone else. Now that the seller is engaged, they are prohibited from engaging with other buyers. And that is the competitive two-step process of an IOI and LOI,
