Receiving a written offer letter from a buyer is a significant milestone in the process of selling your company. Offer letters come in different forms, however, so it is important to understand the distinction between them and when they are used.
The two primary types of offer letters used in M&A transactions are the Indication-of-Interest and the Letter-of-Intent.
What is an Indication-of-Interest?
The Indication of Interest (IOI) is an offer letter from a buyer that presents the basic terms that the buyer is proposing based on the information that they have received so far. The IOI is light on details, but it is useful in determining if the buyer’s estimate of value and proposed deal terms warrant further discussions. IOIs are often between 2 to 4 pages and generally address basic deal terms such as valuation and deal structure. The IOI is often used by investment bankers to reduce a large field of interested parties down to a more limited number of serious buyers. In an M&A process, after the buyers have executed a non-disclosure agreement, reviewed the Confidential Information Memorandum, and had follow-up discussions with the investment banker, they will be asked to submit their IOI. IOIs are not a commitment in any way. Think of them as proposal to further discussions and as a stepping-stone to get to a more formal offer called a Letter-of-Intent.
What is a Letter-of-Intent?
After reviewing and evaluating the IOIs, the next step is to select the top 2 to 4 buyers and invite them to continue in the process. These buyers will be invited to meet with the seller, tour the facilities, and request additional information about the company. At the conclusion of this stage, the buyers will be asked to submit a best-and-final offer in the form of a Letter of Intent (LOI).
The LOI is a more formal document than the IOI and provides more specific details on the proposed transaction. LOI’s are generally between 4 to 8 pages. The investment banker together with the seller will evaluate the LOIs and select the best overall offer based on valuation, deal terms, and certainty of closing. When the final buyer is selected and the terms of the LOI are agreed upon, the LOI is signed by both parties. This formally kicks off the due diligence and closing process which generally takes about 90 days.
Although the LOI is signed by both parties it is “non-binding” meaning that there is no obligation on either party to complete the transaction. Rather, it acts as the blueprint from which the final purchase agreement and other purchase documents will be drafted.
Buyer Exclusivity
One important term in an LOI that is binding, however, is Exclusivity. Once the LOI is executed, the buyer will begin an expensive due diligence process incurring hundreds-of-thousands of dollars in legal and accounting fees. The Buyer will want a commitment on behalf of the Seller that the Seller will not continue to shop the deal to other parties while the Buyer is trying to close the deal. The duration of exclusivity, called the “Exclusivity Period”, is negotiable but generally runs about 90 days for mid-sized transactions. This coincides with the approximate time that it takes to close the transaction.
Balance of Power
One important point to note is that in an M&A process when negotiating with multiple buyers, the Seller has the most leverage before the LOI is signed. Once the LOI is signed and the Seller has committed to exclusivity to the Buyer, the balance of power in the transaction shifts toward the Buyer. It is important, therefore, to include the most critical deal points in the LOI rather than delaying the negotiation of these points to the post-LOI stage when you will have less leverage with the buyer.
Want to learn more about Indications of Interest, Letters of Intent, or the M&A process in general? Give us a call or send me an email at scott@centerpnt.com. We’d love to hear from you and discuss your situation on a confidential basis.