12 Oct Pre LOI and Post LOI Information Requests
In this episode of Shoot the Moon, we’re talking about information requests between parties during an M&A deal process and what you should expect before the LOI and after the LOI.
Considering M&A? Let’s talk.
Mike Harvath 00:04
Hello and welcome to this week’s shoot Moon Podcast, broadcasting live and direct from Revenue Rocket world headquarters in Bloomington, Minnesota. As you know, revenue rocket is the world’s premier growth strategy, and m&a advisor IT services companies. Today, I have my partner Ryan Barnett with me, Ryan, welcome.
Ryan Barnett 00:26
Hey, good morning, Mike. Thanks for having me today. I think we’re well into the hundreds podcast here, so thanks for recording this and sharing all your knowledge with the IT services firms that are out there.
Mike Harvath 00:37
You bet, Ryan. Today’s an interesting topic, we’re talking about what’s warranted for pre loi, diligence and support of getting a offer, versus post loi due diligence motions that are needed in order to validate and certify cash flows.
Ryan Barnett 00:58
Yeah, let me set this up, Mike. So at Revenue Rocket, we represent both buyers of IT services firms, as well as companies and we’re fortunate enough to help take them to market and find the right suitor, we help them as well. So we have a unique view in which we are on both sides of the table when it comes to a deal. And in this context, a company when you typically take yourself to market or and put yourself for sale, you can prepare for a few, I would say big moments, big milestones to think about. And a few of them are fairly early, but big like you’re going to create a teaser for your company. And that one page teaser is going to get enough information to have some interested, as the name suggests a teaser, we’re gonna give a little tease in order to get to the next stage. And that next stage might be a nondisclosure, it might be a, it might be just a meeting with a broker for so for example, for us, we’ll send out a teaser, we’ll set up a meeting to see your interest and you say, Hey, this looks great, we’ll have a screening call, and if that screening call is great, and there’s a mix there, and you feel that the buyer thinks there’s good synergies with the seller, we’ll move to like a nondisclosure and after to get through that non disclosure, you may distribute a confidential information memorandum. And that, as we call them, a SIM that seems gonna have a little bit more information than the teaser, it’s going to disclose the company name, it’s going to walk through the services that you offer, to talk a little bit about your management team, your intentions, talk about your cap table, it also have some financial information. So you might see a bit more of a p&l or balance sheet may not be everything. But it might be enough to move things forward. With that information, most companies should feel pretty confident issuing indication of interest. And in IOI indication of interest is, you know, we looked at the firm, there’s enough information that’s interesting. Here’s a price range of where you may be at. And many deals, we don’t see ROI. Sometimes we do see allies, assuming that those are done, you might get through that place. So what I’m getting to the point here is there’s a number of stop gaps, and information requests that move buyers through a process that allow them to gain comfort in putting forth an offer. And what we want to talk today today are what are fear questions that are pre loi, and post loi, and I just want to talk about it, Mike, if you wouldn’t help me just understand, you know, what an LOI is, and what are the key points to an LOI? And what, what can be changed in an LOI? And what can’t be?
Mike Harvath 03:54
Absolutely. So, first of all, we’ll start sort of setting the stage there. And I think just also add some clarity. When Ryan says that as wherever I can here we represent both buyers and sellers. We don’t typically represent them on the same transaction. I know sometimes there’s questions about that, well, like can you facilitate, you know, deal or whatever your case is we do that when he says that we’re doing representing buyers, we’re typically representing buyers on a specific transaction. And then separately, we may bring our companies to market and represent sellers on a different transaction. But you know, to answer the question about LOIs more directly, a letter of intent is non binding agreement that outlines the terms of a transaction. It’s issued by a buyer to a seller pursuant to some level of initial or what we call pre loi due diligence. Pre LOI due diligence should be enough if you’re the buyer to get too comfortable with the business, the business financials, the health of the business. and help you drive to, you know, getting your valuation done. So you can offer, make an offer that is consistent with fair value. And, you know, it is non binding in the sense that in many ways it works like a handshake. There are binding provisions, typically the binding provisions have to do with a nondisclosure just reemphasizes, an NDA or non disclosure that no one can talk about the transaction publicly or to competitors or other folks. Likewise, there’s generally a no shop clause a no shop has to do with, this isn’t always the case, but I would say it’s not the case probably 99% of the time, If you’re going to undertake going into a substantive due diligence effort, post loi, you know, both sides are going to incur some costs. So it’s warranted that the buyer would say, you agree to this, generally, you’re off the market, why is a seller why we do due diligence and sort of put the deal together. And, that’s fair and reasonable. And so, you know, however, you should know that the price in terms as outlined in the LOI are non binding, you can’t go back and hold a buyer to those price and terms, particularly if the discover in due diligence, some material, negative impact to the financials or the values of the cash flows. Or maybe they might find an error in the financials or something as presented, that could impact value and valuation and that’s part of why material and post loi due diligence is done.
Ryan Barnett 06:45
I think we’re a key portion I want to just an narrow going on here is that the non binding portion. So if I hear this, right, the terms of the deal may have some change. And we just recorded a another podcast in which it was really about retrades, and so you want to have it, no one really wants to go through a retrade at the end of the deal, the terms radically changing. But there’s going to be things that are adjusted to get to a definitive of agreement and a deal closed. But the the terms are essentially the nine binding in nature. And can can you help two parties get to agreement on what that close actually is? The non disclosure is is always important, that’s going to be actually that’s the one part of the non binding as binding. As well as that typically, the no shop clause, I think that no shop is really important for buyers to understand. So the reason why this starts to become important, the faster you can get to someone to know shop means that the you get to get your deal looked at faster. And I will tell you, we’ve worked with buyers, and we’ve worked again, as the sellers we see this as well- there’s a few different philosophies on submitting an LOI. One philosophy is, let’s make it quick, get the lockout in and get something in place. The other philosophy is we want to kind of know everything before putting the LOI in place. Mike what have you seen work for buyers when it comes to getting the deal closed? What levels are appropriate in that and that it maybe it’s not so much a dichotomy, but what do you think?
Mike Harvath 08:38
Well, I think it’s important to understand that it is in your best interest as a buyer to get to a signed letter of intent if you have interest in doing this transaction as soon as possible. Sometimes buyers confuse the level of diligence that they want to do post loi with pre loi motions, we think that’s a mistake. Because if you spend a lot of time doing what can be done post loi before the loi, you run the risk that that firm will sell to someone else. And we see this happen all the time, where IERS go down a rabbit hole and say, you know, we need an analysis of you know, very what would be appropriate things post loi as part of validating cashflows pre loi, and then they lose the deal, because they’ve spent weeks and weeks analyzing data. Or they asked for an exhaustive list of pre loi information in order to either get it through their investment committee if they’re a private equity firm or their big strategic, I mean, you have to go through multiple levels of bands when approval for which, you know, there’s a lot of information requests. And I think, you know, particularly when it comes to private equity, investment committees, you know, if you’re bringing a deal to an investment committee, you want to make sure that you’re not caught flat footed, right, so I think, folks, analysts, partner staffers and private equity want to kind of overdo it, or have a tendency to overdo it for pre LOI, so that they’re when they go to investment and get approval for the loi, that they’re not, you know, one of those partners doesn’t have to question that they’ll have a plausible answer for it, I think, in some ways that can slow down the process, or it may just be, you know, confusion on behalf of a buyer about what’s needed pre loi and what’s needed post, I would tell you that we advise lots and lots of buyers and have for many years, that you really only need to analyze enough information to validate the offer, and the structure prior to the LOI. And, you know, there may be differing opinions about this, but I certainly would think that, you know, understanding sort of the nature of the staff, and maybe if there’s any concentration risk of customers very broadly, were the two other things that need to be understood, pre loi, but much more granularly, you just need to be able to validate, based on the reported financials, that the cash flows, support the valuation of the offer, and then issue the LOI. Because, remember, it’s non binding. And if you’re under loi, you then have the time and reach and scope to do much more material diligence, and everyone feels more comfortable in that situation, providing the information as well. So there’s a level of comfort that if you’ve come to a signed loi, or handshake agreement, that you’re going, you’re serious, right that you’re committed. And I would expect that seller to also begin to do diligence on you at that time. So you need to make sure as a buyer, you’re prepared that you have your financing order in order that you know how you’re going to do this deal. Because there’s certainly going to be material diligence done upon you as a buyer as well. But much more importantly, you know, our advice to buyers would be don’t overthink what you need to see pre loi, just make sure you have solid numbers, that you may have asked them questions that could discount evaluation, like you know, customer concentration and potentially employee census blinded, of course, and then, you’ll want to get on and get that out.
Ryan Barnett 09:07
I think you’re right on, Mike. And so when I go back to seller and preparing documents, a teaser, that’s certainly not enough for an LOI, the SIM, the confidential information memorandum, if done right and your package correctly, that will have enough information for someone to gain enough interest to ask good questions and get to an introduction meeting. So assuming that introduction meeting is there, and you can align on strategy, and you can align on culture, then typically, you’re going to have a financial packet available for a team to analyze. And I think it’s important for a seller to take control of the narrative when it comes to that financial packet and deliver enough information that someone can make an LOI with a packet. And I would say that the things that we typically see on that are p&l, historical p&l as well as the trailing 12 months, detailed p&l, we look for at least a historical balance sheet and a current balance sheet. We look for a forecast, we look for some management team bios. And then for the other parts, I would say are important pre loi are some kind of redacted employee census to understand the key employees that are coming over with a transaction as well as a redacted revenue by customer for the past three years for I would say the top 10 customers to understand customer risk. So if you’re going to process that I think your Sim needs to have that updated financial packet that has at least that that gets that should be enough for evaluation. We conduct valuations every day that have essentially them this information. I should also say a great overview of the firm what space through the way and what where you’re at strategically at that. Put things in a different light. Mike, I’d love to get your examples, a few examples that you’ve seen even recently, of what’s too much, pre LOI. Well, what’s something we’ve seen in a recent deal that is just like, I can’t believe they’re asking for this.
Mike Harvath 13:10
Yep. You know, we see people ask for some pretty crazy stuff like they want copies of three years of the either corporate or if it’s a past and the personal tax returns of the owner. Right. That’s a that’s a huge overreach pre LOI. Now, certainly you would need to do that post loi as part of a comprehensive diligence review to make sure that, you know, taxes have been paid, and you know, that you’re not potentially inheriting some sort of, you know, off balance sheet liability, right. But it is a wild overreach ahead of a letter of intent, as an example to be asking for copies of tax returns. Because it’s not pursuant to developing an LOI, it doesn’t support the valuation, or the process to create an LOI. Likewise, or maybe, hey, we need to see copies of the top 10 customer contracts. Well, yes, that’s appropriate post loi, but certainly not pre loi, there is no value associated with or purpose even to make that request pre loi, because it doesn’t support the valuation conversation or supports the motions required to create the LOI. If anything, these kinds of requests made by a buyer, make the buyer look somewhat ridiculous. They, don’t build confidence with a seller, or a seller’s adviser, that you know what you’re doing as a buyer, if you’re asking for things that are wildly out of bounds, or what I would call nice to have requests, versus need to have requests. And and I think, you know, understanding of having clarity about every step of the process, and what’s appropriate, at that stage, will build confidence with a seller, if you’re a buyer that you do have a plan and that you’re knowing how to execute it, versus just on a fishing expedition. For information, which you can quickly come to the conclusion, if you’re a seller, pre loi, if you’re asking for highly sensitive information that doesn’t support the LOI creation, tax returns, for example.
Ryan Barnett 16:02
I think that you’re exactly right. And when we look at this, there’s a there is a balance of what is required to make it comfortable, but not so much that it’s burdensome for the seller, that think about the mindset of the seller, here they are, if it’s requests that aren’t in the packet, that means they’re going to pull in something. And if it’s, let’s say the customer, someone has 3000 contracts, they’re not going to pull every single contract to go give you detailed information for when it’s not relevant towards changing the deal, or making or updating the offer. So I will say if I take my buyers head on, I want enough information to feel competent. What we’ve typically done and in cases on the buy side is that if we have a list of questions for the seller, we prioritize the list, we walk through, here’s the request, we have it, and then we verbally walk through with this is why we’re asking for it. So this and oftentimes, if it’s something very positive for the seller, it’s going to increase the valuation. So it’s worthwhile to include, and it’s makes a win win deal for everyone. I would say some things that are completely off limits pre loi are customer lists, and employee lists, is that there should never be we should never see a name of a customer and never seen an employee pre loi. Post loi, it’s gonna be a whole different story. You can get contracts or look of all sorts of things that are, are much more in detail. But pre loi, those are pretty sacred things that that shouldn’t be shared. That’s a a tweener activity starts to become something like your recurring revenue per customer. And it’s something that can materially change valuation. And if you have it can really be helpful. A lot of sellers don’t have that ready. It may be if it’s critical to your thesis, and it’s something that you need to do, I think it is appropriate to, to ask for it. But you may want to limit that ask to let’s say the top 15 customers or the what makes up 80% of your revenue, not what makes up the 20% that can be changed. So, Mike, I think you’ve said a few times the, and you can attribute this quote better than I but the last few percent don’t really matter. So there’s there’s some, you know, getting the deal done and getting it executed is important more important than trying to hash through the minutia, especially pre LOI.
Mike Harvath 17:15
Yeah, I think what’s important to understand there is that there is hundreds and hundreds of things that need to be negotiated pursuant to an m&a transaction. So, you’ve heard me say before that, you know, they are the most unnatural act in business, that is absolutely true. It is why, frankly, companies that don’t use an intermediary or an advisor, on either side of this transaction only have about a 1% chance of actually getting it done. And that’s because of the complexity of what’s involved with the cadence and appropriateness of request for information, discussions on disclosure, and the many, many things that get negotiated into or out of the agreements, the definitive agreement, so legally binding agreements. And so, you know, I think, to your point, Ryan, they’re certainly at the very end of the process, oftentimes, some pushing and shoving. And I learned from a very prolific acquirer, and client in the past, that last 5% or so just just doesn’t matter all that much. Because if you build a strong business case, to do that acquisition around, you know, the deal, and it’s it holds up strategically, culturally and financially, and you’re moving through diligence, and maybe you see something towards the end that just doesn’t play, you know, or you think it warrants a minor change to the deal. You have to make a decision on if this is going to put the deal at risk, because people have what’s called the alpha key, or the end, is it really worth fighting for? Or should we just let it go? That’s, again, where a competent adviser can give you good counsel, and certainly, you know, the same applies to the development of an LOI, you there’s a tendency, particularly if you’re an analytical type, individual, that you want to have everything you could ever possibly need to know in an LOI, things that are much more appropriate to negotiate later, you want to negotiate upfront, because you think you’ll make it easier. But in fact, what happens is the likelihood you get to an LOI goes way down, the more detail and minutia that’s negotiated in upfront. And so it’s counterintuitive, but it just is what it is.
Ryan Barnett 22:18
Like, that’s kind of all the questions I had today. I hope buyers get that sense that immediate immediacy, but have enough information to feel competent, but don’t ask for the world sellers are going to respect that and understand that sellers feel you do have to provide enough that out there to have a credible answer. So don’t expect this as I don’t want to give the impression this is not a question free or dialogue free. There’s certainly going to be back and forth, but understand that it’s perfectly fair and happens all the time for for a seller to say good question, but until we see an LOI, we’re not gonna provide that. That’s fair. So that, Mike, I’ll turn it up for you for any closing thoughts?
Mike Harvath 23:07
Yeah, for sure. You know, I think one thing that we didn’t talk too much about was the other end of the spectrum buyers that don’t really do much diligence upfront and then offer some broad multiple EBITA as purchase price. We think that’s equally a huge mistake. You’re not building confidence with a seller that you’re even looking at their business, materially, you’re making an offer to acquire. And I think those those offers, we certainly don’t see many of them. We saw some a few years ago pretty frequently. You don’t see many of them anymore, because it just sends the wrong signal to a seller and certainly we’d recommend buyers do enough diligence to have confidence in their offer, but not so much that they put getting to a deal at risk. So with that, we’ll tie a ribbon on it for this week’s Shoot the Moon podcast. Feel free to tune in next week. For more advice, tips, and tricks around growing your IT services business or acquiring another one or selling yours. To look forwardave a great week and we look forward to tune in next time. Take care