S1-E4 | Phase 3: From IOI to LOI — Negotiation and Relationship Building

Transcript

SPEAKER_00 0:02

Hi everyone, this is Joshua Johani. Thank you for listening to our podcast, The Technical Founder. This is episode four in our six episode MA Framework series. I'm here with your host, Ricardo Overlander, and we're going to talk to you about getting IOIs or from IOI to LOI negotiations and relationship building. Ricardo, I think this is one of those topics that this is where the MA process has more stakeholders involved. Prior to this, it's really, you know, one, two, maybe three groups, but now we've got the external party, we've got the opposing party, we've got a party that has things to gain when the other side has something to lose. And this is really where the game theory begins. Do you agree?

SPEAKER_01 0:45

I fully agree. And that's, as we mentioned in the first episode, is one of the most critical phases across the MA process.

SPEAKER_00 0:56

Yes. When I look at evaluating indications of interest, it's important for our audience to understand the purpose of the document first. It's usually a one-sided letter. Infrequently is it signed by the receiving party? It's a buyer that says, Hey, I got information about this business. I think the business is worth A to B, and I'm going to finance it through these sources. And here are some of my references, and here's why I'm a great buyer and why you should sell to me. Right. It's relatively short, very rarely more than three pages, often less than three, one or two. And it just gives the seller something to react to. And this can be in a sell-side-driven process or a buy side-driven process. For corporations to issue a letter like that, it is a big deal. They're not binding. There's very rarely any kind of contractually binding elements in an IOI. Those usually come in the LOI. But uh it is hard, right? Because you can't, in most cases, you can't just unilaterally draft a letter on company letterhead and just send it to somebody. You've got to have an internal discussion, you've got to have approval. And these things do come back in negotiations. And people are going to want to know that, you know, you're on the same page. So if you submit an IOI that has a business valued at 100, and then you come back and try to buy the business at 20, you will get a bad reputation in the market, even though there's no real legal ramification to that. And that would have to be such a drastic change in the purchase price would have to be due to something highly material that's discovered during diligence. When you look at IOI's Ricardo and think about the technical founder, what is it that they really they'll rely on their lawyers for the legal ease of it, but what is it that they really need to think about from a strategic perspective when receiving this?

SPEAKER_01 2:42

First of all, to understand that IOI is not validation, is not commitment, is not momentum, it is information. It tells you who is curious, who understands your positioning, who is signaling seriousness, who is anchoring low, who is positioning for repricing. And that regrettably is a combination that often leads an experienced professional uh to misread the situation. Uh, once an effective professional may read behavior, not just numbers, an experienced professional can be misled by different readings of the situation.

SPEAKER_00 3:26

I agree. And I would add to that that the buyers sometimes take the IOIs too seriously. So, you know, buyers, I think they look at it from their perspective that generating a document is, you know, a lot of effort. And they they are getting kind of anchored to some numbers, and maybe they wish they had more information prior. But I think that buyers often discount how important such a document is to the seller, because we have almost always a seller that's running a business, right? Their full-time job isn't to talk to this buyer, no matter how much the buyer would like to talk to them. And so the seller is going to get distracted once they receive this information and they need to know that the buyer is serious and that they're kind of, you know, dating along the same lines of what the final relationship needs to look like. And that's something that, you know, we get a lot of pushbacks from buyers sometimes, particularly smaller buyers, or we get a lot of delays in trying to get IOIs. And, you know, I think that trying to communicate to the buyer the importance of that is something that that can also move the sell-side process along uh highly materially.

SPEAKER_01 4:28

Yeah, and and from the buyer perspective as well, managing expectations is absolutely critical because if we received only one indication of interest, you're negotiating on the dependence at the end of the day. If we receive multiple, you're negotiating on the comparison. And that difference is huge. Yeah. Uh multiple indications of interest allow to test the valuation logic, evaluate seriousness, compare structure, measure responsiveness, create discipline tension. And without tension, negotiation weakens, uh, which actually may lead to an unfavorable outcome for the whole deal. And leverage is not created at the latter of intent stage, it's created here at the end of the day.

SPEAKER_00 5:16

I think about indications of interest and things that buyers are planning to renegotiate or not. An area where we've been very successful, which has led to a rule at Jahani, is in getting multiple IOIs and being able to empirically get a seller, which in many cases our client, uh, the best offer possible. But there's two rules within that. One rule is that you don't bluff, it does not work. If you have one IOI and you try to pretend like you have two or three, it just doesn't work. So we we never bluff because it it ultimately just leads you to negotiating incorrectly. And then the second rule is that we don't get too aggressive. We've had deals collapse or buckle significantly later on in processes, post-IOI, LOI, and purchase agreement, et cetera, when a greater financial commitment has been placed by the seller. We've had these collapse because we overnegotiated the IOI. And we may have strong armed a buyer to put forth a purchase price that made our client smile, but ultimately it wasn't something that the buyer was going to be able to close at or didn't want to close at. And leads to a massive waste of time. So we're also, you know, we kind of have to play both sides in a transparent way, but we've got to tell the seller, hey, listen, this is an offer. It's fair for A, B, C, D reason, and you need to not negotiate on these two or three components, because if you do, even if we get it, we think it creates a massive risk for the deal later on when you're incurring significant legal expenses. Have you seen situations like that, Ricardo?

SPEAKER_01 6:55

I did. And I think we're what you're practicing are very good examples of diligence, good governance, and stakeholder management at the end of the day. And of course, fairness. Because two indications of interest can look similar on paper, but they rarely are. An effective profession is examined. The assumptions embedded in evaluation, the clarity of structure, the tone of engagement, the pace of response, the depth of strategic rationale. Some buyers lead with aggressive pricing, but fragile logic is exactly the point that you referred to. Some others lead with slightly lower numbers, but strong structural commitment. And at the end of the day, judgment means understanding which is which. Yes.

SPEAKER_00 7:45

Yeah. You know, I uh before we go to conclusions, I have an example that I think our audience will find interesting. So I'm a big audiobook guy. Big, big guy, big audiobook. I two and a half times speed, just tearing through, you know, sometimes one audiobook a week. Um, and I recently listened to Donald Trump's Art of the Deal, which I think was published in the 80s. And one of the things, you know, politics aside, that I was impressed with in that book was how entrepreneurial our current president is. But he gave many examples of deals he had done where, you know, he would constantly get out bid, but these people who were bidding were just overbidding, and he knew they were never going to be able to close for some kind of specific real estate asset. And it was something that he never did in these examples, he didn't do that. He would just, you know, bid what was fair and what he could close at, and then he would sort of keep it there. And then two or three years later, the sellers uh would come back to him. Um, and so you know, that's a character, an individual that we're all very familiar with. So for takeaways, Ricardo, what are the takeaways that the technical founder should take from this episode?

SPEAKER_01 8:59

First of all, that indication of interest is a signal, not a success. So you should treat it as information, not validation. Second, uh optionality is leverage, commitment without alternatives, weakness negotiation. So beware of that. Thirdly, exclusivity is strategic decision, not a procedural step. Once granted, power shifts. This is where maturity becomes visible. This is where we want you to get better prepared, more effective, more useful.

SPEAKER_00 9:35

I also would want technical founders to be aware of that this is kind of the first time uh, you know, people always talk about the baby, right? The business being their baby and whether or not the baby is cute. So this is the first time that a third party is giving a formal indication of how cute your baby is or is not. And um, despite the fact that it's non-binding, and despite the fact that, you know, this is fairly commonplace in MA deals, it is a very strong signal about the way they need to think about the likelihood of them getting this particular value. The banker will be able to advise the seller on how serious the profile of the buyer is, how much to trust certain elements of the indication of interest. But the indication of interest itself at a macro level is very important and should be taken very seriously and uh used to make continued financial decisions, which is what we will get into when we get into the next episode letters of intent and talking about entering exclusivity and getting closer to that purchase agreement. I'm your host, Joshua Johani, here with our co host Ricardo Oberlander, and we look forward to seeing you in that episode.