IOIs (Why, When & What)
July 20, 2021 | Issue #30
Big Deal Small Business: IOIs (Why, When & What)
July 20, 2021 | Issue #30
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Hard to believe that this is Issue #30. The first post went out on April 1st, so it’s kind of crazy that I’ve written 30 issues in 110 days. If you’re new to the newsletter, you can check out the full archive here. As always, please share the newsletter with anyone who you think falls within this niche of SMB acquirers & operators.
Anyway, let’s dive in. Today I want to talk about Indications of Interest (“IOIs”) — why to use them, when to use them, and what they actually look like.
It’s topical for me because 1) I’ve changed my thinking on IOIs in the past couple months and 2) I submitted two IOIs last week.
Obviously don’t take this as gospel — this is just my approach to deal process management in SMB world.
Why
It’s not a given that an IOI is even necessary. You can click through the back & forth below to see the perspectives from someone who doesn’t use IOIs:
Obviously I take a different approach. First, what is the difference between an IOI and an LOI?
To me, an LOI is a detailed list of terms under which you are willing to do the deal assuming diligence checks out.
An IOI is just the rough valuation & capital structure you would use to do the deal, but before you’ve done real diligence or even decided if you want to do the deal.
These serve very different purposes.
My goal in an IOI is to 1) show I’m a serious buyer in order to get access to better information and 2) make sure me and the Seller aren’t wasting each other’s time.
For #2, there’s no point wasting each other’s time if you and the Seller are way off on the value of their business.
And sometimes, the Sellers are right. I just posted an IOI where I indicated at 5.0x-5.7x 2020A & 4.5x-5.0x 2021E. The broker told me that I’ll probably be too low and I needed to be north of 6.5x 2020A / 6.1x 2021E. Turns out, he was right — they accepted an all-cash offer at 6.9x 202A / 6.1x 2021E.
When I’m ready to submit an LOI, it means I’ve determined that I want to own the business at the price & structure shown on the page. I want exclusivity to finish my confirmatory diligence, but assuming everything matches what’s been told to me, I’m going to transact at the levels shown in the LOI.
When
When I started doing search, my process was as follows: Review the CIM, call with the broker, written Q&A. Then I asked for a Seller meeting, did more Q&A, and then finally got to the LOI. I skipped the IOI gate altogether.
Today, I slot the IOI right after the written Q&A.
An IOI is based on the CIM and written questions, and how you think the Seller will answer your more detailed questions. An LOI is based on what the Seller actually said. Finally, the actual purchase agreement comes after you confirm what the Seller said is true.
Said differently, the IOI is the “trust the broker” stage, the LOI is the “trust the seller” stage and the purchase agreement is the “trust but verify” stage.
As a result, the IOI is based on very limited information and you are reserving the right to change everything. When I submit an LOI, I want to stand by it assuming everything the Seller said checks out.
What
When I submit an IOI, it’s just a simple email to the broker. I’ve broken out the main elements below.
My IOI does include:
Price range
Explanation of how I got to that price (example below)
Anticipated capital structure (SBA, seller note, equity, etc.)
Key seller note terms
Any key questions / diligence areas that may materially impact valuation
My IOI does not generally include:
Exact price
Transition plan details
Diligence plan, unless the broker asked for it
Other details that are important eventually but not at IOI (Reps & Warranties, Seller Non-Compete, etc.)
Here is an example of how I format my IOI in the email to include price range & explanation:
Pretty straightforward, but leaves the door open to changing valuation as I learn more. If they can convince me that 2021 SDE is definitively higher than 2019, then I’d be happy to pay more based on the 5x multiple.
In this example I did provide only one price (rather than a range) based on the broker’s instructions. Normally I provide a range by either using a multiple range or using an SDE range (2019, 2021, avg of last 3 years, etc.).
Conclusion
The use of an IOI has helped tighten up my deal processes & turnaround time, which is crucial as a self-funded searcher with limited time.
I’ve outlined my IOI approach above, but clearly different folks have different styles here, so I’d love to hear how you manage IOIs (or skip altogether).
Just hit reply to this email or find me on Twitter.
Thanks,
Guesswork Investing
P.S. I’d always appreciate introductions to potential acquisition targets or brokers (primarily targeting $750K-$1.5M+ of SDE or EBITDA, ideally located in the Northeast, West Coast, or Colorado).
How did you choose the $1.7m and $2.4m numbers as the ranges for forgivability?
It looks like those are the 2019 and 2020 gross profit numbers. I'm doing this for the first time and I am trying to understand.