Chapter 9
Properly Expressing Interest in Doing a Deal
In This Chapter
Delving into the indication of interest
Going steady with exclusivity
The indication of interest (also known as the indication or IOI) is a key landmark in any business sale. This document provided by the Buyer suggests a valuation range that he is willing to pay for a company. Typically, a Seller receives indications from numerous Buyers. If the Buyer’s indication is acceptable, the next step is for her to attend a management meeting (see Chapter 10) and submit a letter of intent (LOI — see Chapter 13).
An indication may sound like a teaser (which I cover in Chapter 7), and in some ways it is. A teaser is compiled by a Seller (or a Seller’s intermediary); an indication of interest is created by the Buyer. Essentially, the indication is the Buyer’s teaser. The teaser is document (often anonymous) that explains the basics of the company for sale: products, customers, revenues, profits. The indication isn’t anonymous; it’s a specific Buyer’s first volley, expressing the Buyer’s interest in a written and therefore somewhat formal medium.
In this chapter, I introduce you to the ins and outs of indicating interest in doing a deal.
Understanding the Indication of Interest
As a rule, I don’t allow a client to meet with a Buyer until I know that Buyer’s intentions. An indication of interest is simply a quick way for the Buyer to say to the Seller, “We’re interested in doing a deal.” The document goes on to say, “Based on the information you’ve provided us, we’re interested in buying your company and are willing to pay a price somewhere between X and Y.” The key component of the indication is the valuation range. But other considerations lurk in this short and quick document.
Sellers want to receive as many indications of interest as possible. The actual number is a function of a few factors:
The quality of the company/opportunity
The thesis in the offering document (refer to Chapter 8)
The quality of Seller’s intermediary (that is, how good a job he does at generating interest)
The strength of Seller’s target list (see Chapter 6)
If a company is solid in all these categories, Seller should receive five to ten indications.
My recommendation is to get at least five indications. In most processes, that should give Seller enough potential Buyers to successfully close a deal with one. Sellers should not stop soliciting indications after they reach five, of course — the more the merrier!
Including Key Bits of Information in an Indication of Interest
The indication and its key piece of information, the valuation range, merely set up the next steps for the process: meetings, LOIs, due diligence, and (cross your fingers) the closing. But those aren’t the only aspects of the indication. The following sections outline other important points in an indication of interest.
Preamble, platitudes, and Buyer background
The indication starts as most well-written letters start: with some introductory lauding. In this case, it’s directed at Seller’s company. Buyer almost always mentions how excited she is at the prospect of buying the company. It also states the obvious: “We are pleased to submit this indication of interest . . . .”
Most indications also include some boilerplate information about Buyer. This section lets Buyer do two things: brag and tout. Buyer can chirp about all the company’s office locations, how much money it has made under management, its revenue size, its balance sheet strength — you get the idea. If Buyer thought slapping on some smelly cologne would impress Seller, she’d do that, too.
The intention of the background information section is to afford Seller with a modicum of security that Buyer is a stable, secure, and decisive outfit that can do what it says it’ll do.
The proposed deal: Valuation range and other considerations
Here’s the heart of the indication. Please rub your hands together in gleeful anticipation of learning the valuation range. Because the indication amounts to little more than a “dipping the toe in the water” exercise (Buyer isn’t yet committed to the purchase), the valuation is estimated. Valuation usually appears as a range, largely to allow Buyer to hedge her bets. After Buyer gets more information in the management meetings (see Chapter 10), she can amend her offer and provide a specific valuation. In a practical sense, the Seller usually sees the higher number and focuses on that. Buyer has the wiggle room to offer the lower number.
The following sections give you the lowdown on the valuation range as well as how the indication lays out other parts of the proposed deal.
Bracing for the valuation
The truth of the matter is that most Sellers (or their investment bankers) immediately look for the valuation range. All of the work, including reading this book and going through the M&A process, boils down to one thing: the valuation. Because the valuation range is the first thing folks in-the-know look for after receiving an indication, Buyers sometimes put that bit in bold.
For first-time Sellers, seeing the valuation range is often anticlimactic. Even if the range is favorable, it’s just a simple line that essentially says, “We offer to pay between $X million and $Y million.”
This quick sentence can be a bit disconcerting because Seller immediately flashes back to all the hard work and toil she put in over the years and suddenly realizes that they’ve been distilled into a dispassionate range of numbers.
Evaluating the type of deal offered
After Seller gets over the disappointing shock of a low bid or anticlimactic relief of an acceptable range, the next step is to read the actual document. The indication should contain the other important elements of the offer, including the amount of the company Buyer proposes to buy and what kind of deal she’s looking for.
The percentage of the company Buyer wants to buy can be divided in to two camps: control and non-control. Most (but not all) Buyers prefer to make control acquisitions, which means Buyer acquires enough of the company to have control over it (either by buying more than 50 percent of the company or by changing the company’s operating agreement to give Buyer control over the entity). In this case, if Seller stays on board as president, the new owner has the ability to fire Seller.
The indication should also define whether Buyer wants a stock or asset deal. Most Sellers prefer asset deals due to preferential tax treatment; most Buyers prefer stock deals due to preferential treatment of successor liabilities.
Regardless of whether the offer is control or non-control or stock or asset, the most important question is whether it matches Seller’s expectation as laid out in the offering document (which I cover in Chapter 8). If the Seller wants to sell 100 percent of the business, is Buyer offering to buy 100 percent? Are Buyer and Seller on the same page on deal structure?
Addressing Seller’s debt and any other conditions
The indication of interest usually answers the question of “who gets the cash, who takes care of Seller’s debt?” In most cases, Seller keeps all the cash in the company’s bank account. Buyer usually assumes the current payables (defined by payables within terms; if Seller is late in paying her bills, she’ll have to pay those debts at closing). If Seller has borrowed money, which shows up on the balance sheet as long-term debt, Seller is responsible for paying off that debt.
In some cases, however, Buyer may decide to assume Seller’s long-term debt as part of the purchase price. When that happens, the amount of Seller’s debt tacks on to the deal value. In other words, if Seller agrees to sell the business for $10 million in cash plus the assumption of $3 million in debt, the total deal value is $13 million.
Lastly, any special conditions, such as Seller maintaining or achieving some sort of financial metric such as EBITDA, appear in the indication.
The legalese
This part is usually just a quick sentence where Buyer states the offer is based on information provided by Seller or her intermediary (if she has one). This section gives Buyer an out if further due diligence uncovers issues or problems not disclosed or readily apparent in the materials provided.
In other words, if Buyer makes an offer to by a company with $5 million in EBITDA and due diligence shows the company actually has only $1 million in EBITDA, Buyer has recourse to amend that offer.
Toward the end of most indications, Buyer tosses in some more boilerplate legalese that reiterates the need to confirm everything in due diligence before the deal can close.
An enthusiastic send off
The indication will then conclude with enthusiastic, “Let’s do a deal!” language. It’s a call to action. When I take over the world, I’ll mandate that every bit of correspondence conclude with an enthusiastic call to action.