Understanding the difference between an IOI and LOI, or knowing what to expect from either, can be difficult for anyone new to M&A. I have shared the definition of both of these in an earlier post, but I thought it would be worth going into a little more detail on the pros and cons of an IOI. You can read many posts on the differences of an IOI to an LOI, so we won’t touch on those aspects here, but instead focus specifically on an IOI.
Sometimes also referred to as an Expression of Interest (EOS), an IOI or Indication of Interest is a non-binding letter prepared by the buyer to express an interest in purchasing the seller’s company. The IOI really helps determine who is serious and what they are willing to pay. It also helps the seller to narrow the field of buyers and avoid wasting time on people who are not willing to pay a reasonable price. “Reasonable,” of course, varies by seller, but everyone usually has a number in mind, and is just waiting for a prospective buyer to validate or exceed that number.
The difference between an IOI and Letter of Intent (LOI), which comes later in the process after further due diligence, is that the LOI is much more specific as to the deal terms and other aspects, such as non-compete period, type of purchase (asset or stock), calculation of working capital, escrow accounts, etc. The Letter of Intent also includes lock up periods – the period of time that you cannot talk to other buyers while you are providing due diligence and reviewing contracts.
Here are the most common items you MIGHT find in an IOI:
- Sales paragraph on the acquiring company
- Approximate price range – either in EBITDA multiples or dollar value
- Proposed structure – stock vs asset
- Funding sources – debt vs equity or backing by PEG
- Management retention plan
- Timeframe to close
I have seen some IOI’s to be very detailed, even including an exclusivity period, and others to be very short on details. It really varies by buyer.
Keep in mind, not every prospective buyer issues an IOI in advance of an LOI, but it is more common in a competitive buying situation, especially with hot technology companies like security advisory and consulting firms.
The Good – Positive aspects of an IOI
As you can see by the bullet points above, an IOI should be able to give you some idea of what your company is worth. It can also provide you with the following:
- Who is really interested and who is just window shopping (there is a lot of that going on these days)
- A range of what your company MIGHT be worth
- Who has money, and who is backed by outside investors – this really tells you who is making the decision (i.e. not always the CEO)
- How long someone expects you to stay with the company post-sale
- What type of transaction to expect (asset vs. stock)
- A timeline to close – especially important if you are trying to get a deal done by year end
The Bad – Negative aspects of an IOI
The IOI, though, is exactly what it says: an indication of interest. It is no guarantee that a given buyer will progress through the process or will present a LOI with similar terms. And that is where I believe the negative aspects of an IOI really show up. Let’s face it: if it is non-binding, the IOI can give you the best picture of what a transaction might look like, even though the buyer really might not carry through with those terms on the LOI. Too often I have seen prospective buyers set unrealistic expectations with sellers that they ultimately cannot meet (usually not on purpose) because they either didn’t look through enough prospective data or ask enough questions before issuing their IOI.
Unfortunately, this anchors the price and terms in the seller’s mind, so if anything else comes in lower or less appealing, it seems like an undesirable offer, when in reality it may actually be very good. Here are some examples:
- Setting a price with very favorable terms: lots and lots of cash up front, little-to-no earnout, or lots of equity – when, instead, the LOI comes back with less cash, a more common earnout period, and a chunk of cash sitting in escrow for 18 months.
- Issuing an IOI that’s not yet blessed by either the board or the buyer’s equity partners (I call this the “CEO jumping the gun offer”). This results again in a complete change in price and terms, or buyers backing off the deal altogether because they had neither the power nor the backing to complete a transaction.
- Presenting an IOI with an expectation of a close date that cannot be met. Again, the buyer’s management team is so excited to make an offer, but doesn’t have the due-diligence team in place to execute it on a timely basis (i.e., dragging it out for 6 months or more, leaving the seller totally exhausted from the mental game).
- Or worse, a group of investors eager to buy with no cash to back up the offer – meaning they now need to find external investors to fund the deal – which could take months, if it even happens.
Sadly, this happens more often than you might imagine, and the unsuspecting seller has no idea what happened when the LOI shows up with a total change in terms, or worse, no LOI materializes at all*. Of course, now the seller has expectations on price and terms, which are often unrealistic given the strength of the company. The deal becomes a waste of time for all, and potentially dismisses other prospective buyers who actually could have consummated the transaction on a timely basis with a good price and achievable terms.
Obviously, you as a seller are more likely to fall prey to these tactics if you are not represented by a M&A advisor. Even then, though, it will happen on occasion, so just be forewarned. If you are going to go it alone or are using an advisor, please make sure that your IOI contains the following elements to help protect yourself:
- Transaction overview and structure
- Buyer’s availability of fund and sources of financing
- Approvals required – who has to sign off (board and or equity partners) before the deal can be consummated
- Due diligence timeline and timeframe to close
And remember, it’s okay to send back the IOI if it doesn’t contain all of this. It also shows the prospective buyer that you are on top of things and know what to expect as part of this process.
*In fairness to buyers, may times a LOI is significantly changed from the initial IOI because further due diligence was done and the buyer is concerned over one or more items (i.e. unrealistic projections, weak management team, high customer concentration, or the owner being a single point of failure in the business, to name a few). So there are compelling reasons why the LOI changes significantly after the IOI. Remember, the LOI also is non-binding, which means the deal can still change all the way to the end of the transaction. Again, finding a good M&A advisor or Investment Banker to review your data and present it in its best light will help avoid some of these issues.