The Indication of Interest (IOI)

An Indication of Interest (IOI) is a non-binding formal letter written by a potential buyer to express genuine interest in purchasing a company during the M&A process. It serves as the first written offer and helps the seller determine serious buyers from those who are not genuinely interested.

The key elements typically found in an IOI include:

1. Approximate price range: This can be expressed as a specific dollar value range or as a multiple of EBITDA (earnings before interest, taxes, depreciation, and amortization).
2. Buyer’s availability of funds: The IOI may mention the general availability of funds for the acquisition and also specify the sources of financing that the buyer intends to use.
3. Due diligence items: The IOI may outline the necessary due diligence items and provide a rough estimate of the timeline required for due diligence activities.
4. Transaction structure: Potential elements of the transaction structure may be proposed, such as asset vs. equity, leveraged transaction, cash vs. equity, and so on.
5. Management retention plan: The IOI might discuss the plans for retaining the current management team post-transaction and the role of equity owners in the future.
6. The time frame for closing the transaction: The IOI may indicate the expected timeline for completing the deal.

It’s important to note that an IOI is typically based on limited information, as the buyer may not have visited the company or conducted in-depth due diligence at this stage. Sellers should use the IOI to filter out non-serious buyers and focus their time and resources on those who value their company within the target range and possess industry experience relevant to the business.

Furthermore, it’s worth mentioning that an IOI should not be confused with a Letter of Intent (LOI). While both serve a similar purpose, they differ in their level of formality and binding nature.

“Think of an IOI as the first written offer for your company.”

The Letter of Intent (LOI)

A Letter of Intent (LOI) is a more formal document compared to the IOI and outlines the final price and deal structure for the acquisition of a company. Unlike the IOI, which provides a general price range, the LOI presents a specific bid for the company in terms of an absolute dollar value or as a firm multiple of EBITDA.

The LOI indicates the buyer’s desire to engage the company exclusively during a specified period in order to conduct a thorough due diligence process. If the seller accepts and executes the LOI, it prevents them from engaging with other potential buyers (unless otherwise specified). The issuance of an LOI does not necessarily require a prior IOI; different deals may follow different paths, with some directly entering the LOI stage.

Typically, an LOI follows one to three meetings with a prospective buyer. In structured sale processes involving multiple buyers, several discussions will take place, narrowing down the prospects to one to four potential buyers for more detailed negotiations.

When both the business owner and the prospective buyer(s) are interested in continuing the M&A process, the buyer(s) will submit an LOI outlining their proposed deal structure and terms. Receiving an LOI is a clear indication that the buyer is serious about the acquisition, although it doesn’t guarantee full commitment. Some buyers may issue LOIs for multiple deals but only close the top few.

The LOI should include a summary description of all the significant deal terms that will later appear in the purchase agreement. The level of detail in an LOI can vary, ranging from two to over ten pages. Some argue that shorter LOIs expedite the negotiation process by focusing on the primary terms: price, consideration, and timing. If agreement cannot be reached on these fundamental aspects, there may be no need to delve into other deal terms. On the other hand, longer LOIs address various issues upfront, preventing surprises in the future, such as representations and warranties or treatment of unvested options.

OTHER TERMS THAT MIGHT APPEAR IN AN LOI 

Additionally, an LOI may include other terms, such as employment agreements, retention bonuses, treatment of option pools, and fee responsibilities. It is important to consider all critical terms in the LOI, as inserting new terms into the purchase agreement that were not included in the signed LOI can come with consequences.

While the LOI itself is non-binding, it is advisable to include all crucial terms in it. Addressing any issues upfront during the LOI stage is better than having them uncovered during due diligence. Seeking legal advice from an M&A attorney, consulting with tax accountants and wealth managers, and involving professional investment bankers are recommended steps when approaching the LOI stage.

Overall, the LOI represents a significant milestone in the successful sale of a company, and careful consideration should be given to its contents before signing the agreement.

1. Employment Agreements: This clause pertains to management compensation and agreements with favored or long-time employees. However, requiring the buyer to provide such agreements or maintain current compensation structures may go beyond their standard post-deal integration practices. The buyer may refuse or require the seller to compensate accordingly.
2. Retention Bonuses and One-Time Payments: Similar to employee agreements, buyers may not want the added administrative or financial responsibility associated with providing retention bonuses or one-time payments.
3. Option Pools: The treatment of unvested options or vested but underwater options is not standardized in an LOI. Buyers may choose to honor the existing option plans by converting them into their own plan or a similar structure.
4. Fees: Generally, the party that incurs charges pays the fees. However, there may be circumstances where ambiguity arises. For example, if the buyer requires reviewed or audited financial statements from the seller but the deal falls through, the seller may request the buyer to cover the audit fee.

It is advisable to include all important terms in the LOI, even though the finalization of the transaction terms occurs in the purchase agreement. Adding terms to the purchase agreement that were not included in the signed LOI is possible but may come at a cost.

Disclosing any issues that may impact valuation or the buyer’s decision to proceed with the transaction, such as unresolved equity disputes or litigation, is crucial before signing the LOI. It is better to address these concerns during the LOI stage rather than having them uncovered during due diligence.

Engaging an M&A attorney, consulting with a tax accountant and wealth manager, and seeking assistance from professional investment bankers can be beneficial in ensuring the best deal and navigating the sale of the company successfully.