Big Deal Small Business: We’re Under LOI!
November 28, 2021 | Issue #52
Finally under LOI! I last went under LOI literally 14 months ago, so this has been a long time coming. I definitely didn’t anticipate it taking this long to get the second one under LOI.
I’ll talk more about the deal in the coming weeks, but today I wanted to quickly outline my diligence plan to give you the “ride along” perspective that I’d always hoped this newsletter would provide.
Before getting into it, one personal note - I’ve recently directed the majority of my charitable giving (both in terms of time & money) in the direction of a new independent girls’ high school in Seattle called The HATCH School. They are launching with their first cohort of 9th graders in Fall 2022. I’ve been helping them model out their financial plan & budget in addition to financial donations.
This school is led by top-notch educators and is focused on empowering young women with best-in-class education while making it affordable and accessible to all students via a family-individualized tuition model.
If you’ve found this newsletter helpful and are in the giving spirit around Thanksgiving, I’d be honored if you’d make a donation to the school. No amount is too small. Here is the donation link, thank you!
Now, back to the main content.
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Blow-By-Blow Post-LOI
The Sellers sent back their signatures on the LOI late on Friday afternoon, just as I was heading out to dinner with my girlfriend. I could feel relief/stress releasing out of me, and then I went and ate a silly amount of pasta.
Later that night, I sent a thank you email to the sellers expressing excitement over the transaction and next steps, with the promise to send a work plan the next day.
On Saturday, I put together that work plan and the initial set of requests and flipped that over. I had the requests ready to go thanks to some key prep work I outline later in this post. I also asked for a couple in-person meetings to go over discrete business DD questions.
Then, radio silence until Monday. I got a little antsy and checked in with the broker. He assured me they'd read everything and were putting together initial responses to the DD list before responding to my emails.
Sure enough, come Monday, the DropBox was uploaded with all the financial requests I needed to get the Quality of Earnings process launched. We also got our meetings scheduled, and we're off to the races on DD.
All that to say communication norms you're accustomed to may be different when working with SMB sellers. I was worried the lack of response to either email for 48+ hours indicated a lack of engagement.
Quite the opposite - they just wanted to have made substantive progress against my request list before responding, which I appreciate and respect.
Key Workstreams
My view on diligence work plans is that they're obsolete the moment you put one together. That's okay - you just need to get organized, but then allow the DD process to take you where it needs to go.
My philosophy with deal-making is Never Be the Bottleneck. To be clear, I hated this mindset in PE - it made my life hell as a junior person on the deal team.
Now as the "Deal Partner" (and MD and VP and Associate), the importance of maintaining deal momentum is clear. Time kills deals, so you can't allow yourself to be a timewaster. Do everything in parallel.
Here's who is allowed to be the bottleneck, in order: Seller > Lender > Advisor > Searcher. You can push the pace on Sellers lightly, lenders a bit harder, advisors even harder, and yourself hardest.
There are two buckets of workstreams: Due Diligence and Financing
Due Diligence Workstreams:
Quality of Earnings ($15K-$25K for <$5 million revenue deals)
Insurance Review (generally free)
Vehicle Inspections (TBD, looking for a good mechanic/auto shop)
Business Process Diligence (free)
Employee Diligence (free)
Financing Workstreams:
Build a financial model
Pull together bank information requests
Build an investment deck and lender presentation that includes a transaction summary, an investment thesis, a business plan, and financial projections (based on the model)
Being ready to launch all this immediately requires pre-LOI preparation. I've outlined the prep required for each workstream bucket to hit the ground running.
Hitting the Ground Running - Diligence
It can often take 7-14 days to get the details of an LOI figured out. At that point, you have line of sight that an LOI is going to get signed, you're just negotiating small points.
Use that time well.
During that time, I lined up each key advisor (other than vehicle inspections):
Legal: reference from a friend who works in BigLaw in my area
QoE CPA: reference from an investor
Insurance: Oberle Risk Strategies, the go-to for self-funded search deals
I had my CPA and insurance reviewer send me their initial request lists so that I was ready to send them over as soon as the LOI signed.
One note of caution here - don't send over the CPA/insurance lists without reviewing yourself first. You don't want the Seller to feel over-burdened or feel like they've explained stuff to you already that you're asking for again.
I still send the full list, but add a column of comments from me that say things like, "Already Have This, Done" or "Don't worry about this for now" and so on.
It shows the Sellers that you're being considerate of their time and not just throwing the kitchen sink at them. It also guides them to what you need ASAP - figure out what you need to get the QoE going, and highlight that as the top priority. Don't make everything a "high" priority on the request list.
Once you've gotten that first set of requests back and kick off the QoE process, then you can go back and ask for the secondary items. Now, you're running the QoE process and second request process in parallel.
You'll note that I don't have a plan yet for vehicle inspections - I'm running behind on that. Need to get it figured out this week.
Hitting the Ground Running - Financing
On financing, I already knew what banks will need, so I was ready to send that request list to the Sellers as well. I've written about the 7(a) process in the past if you want to dig in deeper.
Different banks will need different items from the Seller, but here's a pretty exhaustive list:
Last 3 years business tax returns
Last 3 years P&Ls and balance sheets (already had)
Latest interim period P&L and balance sheet, along with the prior year
Last 12 months monthly P&Ls and balance sheets
AR/AP Aging Reports
Most of this you should get pre-LOI anyway if possible, even if just to have it ready to go for lenders. Otherwise, it should be on your first request list.
On my end, I needed to prepare the following for the banks:
Business & transition plan (part of lender presentation)
Financial projections (part of lender presentation)
Personal Resume
Last 3 years personal tax returns
Several SBA-related forms
Just like getting advisors figured out, I'd been building an investment deck and financial model as soon as it became clear we were going to get an LOI signed.
The investment deck & model is constantly evolving throughout the diligence period. As you learn more, you adjust it for your investors.
The early benefit of an investment deck is that it's easy to convert into a lender presentation. They are largely the same, just a bit more streamlined and efficient.
Lenders care less about potential upside, they care more about downside protection, so you have to tailor the lender presentation for their benefit.
Your loan process will likely be the deal bottleneck assuming diligence progresses smoothly. They will need 60-90 days, so if you have a 60-day exclusivity in your LOI, getting the lender going right after the LOI is imperative.
Conclusion
Hopefully, that gives you a taste of the days after the LOI signs. I'm now 10 days into DD (though only 3 business days due to holidays/weekends), but I'm happy with the progress so far. The Sellers have been great at turning around requests. It also pays to be prepped in advance of signing the LOI.
The initial QoE and insurance requests have been provided, so the QoE and insurance review are underway.
All information for the bank has been submitted except AR/AP Aging Reports (Sellers don't use them so have been a bit confused about it), but that's the least important one anyway.
I'll continue to provide updates as we progress through diligence! If you have any smart ideas for vehicle inspections other than calling around to body shops, please let me know, that's the one thing I'm behind on.
Lastly, one more plug for donations to The HATCH School. Thank you!
As always, I'd love your thoughts & feedback. You can 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, located in Seattle or the Bay Area).