By: Patrick Ungashick
Business owners contemplating selling their company need to understand a host of important concepts and issues associated with the sale process and transaction. During the sale process, it is likely you will encounter two similar acronyms: IOI and LOI. While sounding nearly the same, these two terms represent very different steps in the sale process, and it is important to understand what each acronym stands for and how it is used. This article explains the meaning of IOI and LOI, explains the difference between these steps in the sale process, and offers guidance to business owners on how to use this knowledge to help prepare themselves and their company for a potential sale.
Let’s start with explaining the two acronyms. IOI stands for Indication of Interest and LOI stands for Letter of Intent. To understand their meaning and purpose, we must examine the process commonly used in the sale of privately held companies.
When a company is being marketed for sale, early in the process there is usually is a period of initial conversations between the seller and potential buyer(s). (If an investment banker or broker is representing the seller, that advisor usually handles these inquiries on the seller’s behalf.) After these initial explorations, both the seller and the potential buyer(s) want to determine if there is sufficient interest and common ground on key topics—including price—to warrant spending further time and resources pursuing a transaction. To determine if sufficient mutual interest exists, at this point it is common for the seller to issue an IOI, or Indication of Interest.
To use a dating and marriage analogy, the IOI is like the moment when a romantically involved couple openly declare to each other how interested they each may be in deepening their relationship toward a potential engagement or marriage. They are not engaged yet, but they both want to know if they share sufficiently compatible objectives before going much further. Similarly, the IOI is a chance for the potential buyer and seller to determine if they are mutually interested and aligned around pursuing a purchase/sale at a given price and set of terms.
Usually, the IOI is issued by the potential buyer. (If multiple potential buyers are involved, such as when an investment banker is running a process to market the company, all the potential buyers may be asked to submit their IOI by a certain deadline.) The IOI provides a preliminary, non-binding statement of how interested that potential buyer is in acquiring the company for sale and what they might pay. The IOI is usually communicated in writing via email or letter, but it may be simply verbal. The IOI usually states the price the potential buyer is contemplating paying for the company based on what it knows at this point. Or, in some cases the IOI may include a price range that the potential buyer is considering offering based on what it knows at this point. The potential buyer’s IOI can include other details such as deal terms, financing information, and a suggested timeline to close.
With the IOI(s) in hand, the seller can gauge its interest in continuing the process and will communicate its interest level back to the potential buyer(s). If multiple IOIs have been submitted, the seller may opt to continue the process with only the most favorable IOIs.
Example: Dwayne owns Acme Distributors Inc. and is considering a sale of his company. He seeks to get at least $20 million for his business. Dwayne’s investment bankers marketed the company to a pool of several dozen potential buyers, and have received six IOIs for the following valuations:
- “$30 million to $35 million”
- “$30 million”
- “$28 million”
- “$20 million but with 50% cash paid at closing”
- “$18 to $20 million”
- “$15 million”
Based on these results, Dwayne and his investment bankers agree to continue discussions with the first three potential buyers because they submitted the strongest IOIs. The bottom three potential buyers are informed that they are out of the process.
Of course, it is possible that a business owner seeking to sell the company might receive no attractive IOIs, or no IOIs at all. If that should occur, that owner needs to reconsider his or her options and situation.
It is important to remember that IOIs are informal, non-binding and non-exclusive. They are not an offer to buy the company. They create a moment in the process for both the potential buyer and seller to determine if there is sufficient mutual interest and broad agreement on price to proceed before going further down the road.
If the seller has received one or more attractive IOIs, then the sale process resumes. Now that the seller and potential buyer(s) believe there is sufficient interest and agreement to possibly reach a purchase/sale, at this point the conversations accelerate and deepen.
The potential buyer(s) now expands its efforts to understand and verify the target company’s financial performance, operations, team, business plans, market potential, customer mix, and products and services. The potential buyer may put more of its team on the project and involve outside resources and expertise to evaluate the acquisition opportunity. The seller often must expand the time and resources it spends supporting the process. A major milestone during this stage is the management meeting, at which the potential buyer’s team and the seller’s team meet, usually in person and for at least a half-day or longer.
Typically after the management meetings the potential buyer(s) are invited to submit an LOI—the Letter of Intent. The LOI is a true offer to acquire the company and usually contains binding and exclusive provisions. If multiple potential buyers are involved and submit LOIs, the seller usually must pick one LOI to accept and sign. Returning to the dating and marriage analogy, the LOI is comparable to the couple getting engaged.
Remember that the IOI is broadly worded, lacks many details, and only provides a preliminary price or price range that the potential buyer is willing to pay. In contrast, a well-crafted LOI from a serious potential buyer is a carefully prepared legal document that states the price the buyer is committed to paying and stipulates other provisions that the parties need to agree on to reach a successful closing. An LOI usually includes the following:
- Purchase price and payment terms: The LOI includes the proposed purchase price or the specific method for determining it. It may also specify the form of payment, such as cash, stock, or a combination of both, and any conditions or adjustments related to the price.
- Transaction structure: The LOI outlines the proposed structure of the transaction, whether it is an acquisition of assets or shares, a merger, or another form of combination.
- Due diligence: The LOI may include a provision regarding the scope and timeline for conducting due diligence, which is the process for the potential buyer to conduct its final review of the target company's financial, legal, and operational details to assess its value and risks.
- Conditions to closing: The LOI typically lists the key conditions that must be satisfied before the transaction can be completed. These conditions may include regulatory approvals, financing arrangements, shareholder approvals, and any other necessary consents.
- Confidentiality and exclusivity: The LOI often contains provisions to ensure confidentiality of the information shared during the negotiation process. It may also include an exclusivity or "no-shop" clause, which prevents the target company from seeking alternative buyers for a specified period while negotiations are ongoing.
- Termination: The LOI outlines the circumstances under which the letter may be terminated, such as if the parties are unable to reach a definitive agreement, if the due diligence reveals unfavorable information, or if certain conditions cannot be met.
It is important to note that an LOI does not legally oblige either party to a transaction, but it usually contains provisions such as confidentiality and exclusivity which are legally binding for a period of time. Just like the romantic couple who get engaged because they intend to get married, the potential buyer and seller at this point sign the LOI because they intend to make the purchase/sale transaction happen.
Many business owners do not fully understand the importance of the LOI in the sale process. A well prepared LOI should address most if not all the points and issues that are material to making the transaction happen. LOIs are usually fully negotiated, meaning the potential buyer and seller and their respective advisors have identified and reached agreement on the important points and provisions of the proposed transaction. In this manner, the LOI serves as the outline for the final document used to conclude the transaction, often called the Purchase Agreement (PA) or Purchase and Sale Agreement (PSA).
Once an LOI is signed, both parties typically engage in their final due diligence and preparations to conclude the transaction. This final stage consumes a lot of time and money, and raises everybody’s expectations that this deal is going to happen. An effective LOI reduces the risk that the transaction falls through because of foreseeable or avoidable reasons, and saves all parties time, money, and stress.
It is understandable that the IOI and LOI are often misunderstood and even confused with each other, especially how alike the two acronyms are. While both are important steps in the process to sell a business, they serve different purposes. Understanding how the IOI and LOI function and their usage helps business owners navigate the sale process.
Business owners should note that the above explanations represent common ways IOIs and LOIs are used in the process to acquire/sell a company. However, every process is different. Many buyers (and their advisors) will deviate from the approach described above, sometimes because they are unfamiliar with this process but sometimes, they deviate intentionally. For example, we commonly meet business owners who have a potential buyer pursuing them, taking up a lot of time and asking for large amounts of sensitive information, but without having provided an IOI. Some buyers purposefully adopt this tactic to gain information and leverage over the potential seller without having to disclose how serious they are about paying for the target company. Applying the IOI and LOI tools as described in this article will help business owners avoid this common situation.
This article should highlight for business owners the necessity of engaging experienced advisors to guide them through the process, starting with preparing themselves and their company for exit, all the way up to the final closing if selling the company is the exit strategy. Tools like IOIs and LOIs are important steps in the sale process, and clear examples of the need to conduct the process effectively or risk a wide range of negative outcomes. At NAVIX, we have helped hundreds of business owners plan for and achieve happy and successful exits. Let us know if you want to discuss our exit goals or questions and see if we can be of assistance.