First Conversation to LOI Session 3

We recently hit 1 million downloads on this podcast, all thanks to avid M and A scientists like you. Looking back seven years ago, I never thought it would grow into what it is today. To celebrate, we want to feature our listeners over the coming months on social media. If you're a big fan, we'd love to hear about your favorite episode or something valuable you learned from M and A Science. You can send me an email directly at Kisan K I S o n a science.com again kisan k I s o n a science.com look forward to hearing from you and onto the interview. I'm Kisam Patel and you're listening to M and A Science where we talk with deal professionals and learn valuable lessons from their experience. This podcast focuses on stories, strategies and what actually happened during M and A deals.

Welcome to M and A Science where we curate knowledge from the best in M and A to continuously improve. If you're interested in keeping up the latest from M and A Science, subscribe to our free newsletter@mascience.com Every week we share highlights from interviews, invitations to events, M and A role openings and other resources as we build the greatest community of forward thinking M and A practitioners. And that's mascience.com I'm your host Kisan Patel, CEO and founder of M&A Science here with Michael Frankel, Founder and Managing Partner at Trajectory Capital, an investment firm that focuses on growth businesses. Today we're going to talk about how to balance speed and accuracy during the bidding process. Really take you through first conversation to Signed Loi Michael, how's it going?

Good. I'm excited to talk to you about this. It's something I think is super important in the deal process. Sort of sets the table for the whole rest of the process.

We got you back on. We haven't had you on a full time podcast. We always had you co host something.

And it's true a little of me goes a long way.

Well, can we kick things off with a little background?

Yourself Very diverse M and A career done sort of M and A from every direction. I started out my career as an M and A lawyer at Scadden M and a Banker at Merrill, then did large company M and A corporate development jobs at VeriSign, at GE Capital, at IRI and at LexisNexis. I've also been the CFO of some high growth tech companies. Most recently was at Deloitte where I ran an internal team that developed the strategy for doing acquisitions of tech businesses and then helped operate those businesses and improve them and grow them. And then I left Deloitte about a year ago and founded Trajectory Capital with two partners. Trajectory Capital is an investment firm and we invest in growth businesses where we can provide operational support to make them better.

What's your total body count?

About 110 transactions, most of them M and A and then the minority of them venture equity and debt.

Take me through this. When I find a company I'm interested, I want to get this first conversation. Walk me through that getting that first conversation and how does that progress to.

Assigned loi I'll start with a caveat, which is when I'm an active corporate development officer, I hate cold calling. I hate having the first conversation be you have no idea who I am. You may have heard of my big company. We want to talk to you about M and A. I encourage my business leaders to think holistically about their ecosystem and think about companies they might want to buy. And the best way to get free secret due diligence is ecosystem partnerships. Sell their stuff, put their stuff into our broader solution, even just co develop marketing strategies. It's an amazing way to figure things out in advance. In a perfect world. That initial conversation is with a business and with a leadership team we already know really well and we're picking up the phone and going, I know we were friends but now I want us to be more. If you can't do that and you're cold calling somebody, I'm a big believer in doing your homework. Because that first conversation, if you don't have an established relationship, they already like you, they already know they like working with you. That first conversation is really critical, especially with the founder owned business. Financial sellers are going to be a little more rational. They just want to maximize purchase price. But a founder or a management team that's going with a business is going to be very sensitive to the nature of the relationship. If you are cold calling, I believe in doing as much intelligence gathering as you can so you know who's in charge. Who really has authority to drive a deal? What are their priorities? Is the founder ready to go or is the founder ready to grow the business for another five years? All that kind of stuff you want to know before you have the first conversation. And then I like to come in with a warm introduction. I know if you're a large company corporate development officer, most CEOs will answer your call, but they'll answer your call suspiciously. I always prefer to use my network and my management team's network to find an in, find somebody who likes me, who Knows the founder, the CEO of the target company, and we'll go look, Michael wants to talk to you. Michael's a really good guy. You should take the time. Just that little smoothing of the introduction, I think is incredibly powerful because then they're not on their back foot. They're not like, what's going on here? Who is this? And I think it's important to put this in context. If you're a decent company, if you're growing, if you've got a brand in your space, you are getting these calls all the time. Maybe fewer M and A calls, more venture capital investing calls, but you're getting dozens of them. Your LinkedIn is filled with, hi, I run a fund, and we'd like to invest in you. So getting out from that noise and having somebody credible say, these guys are real, you should talk to them. Makes a world of difference. Tee up that first conversation. So it sounds like a lot of work before the first conversation, but I think it makes all the difference. And then once you get that introduction or you reach out to them, planning the first conversation very carefully. To do more listening than talking is also really critical. The foundation of all good M and A is having a very clear understanding of what your priorities are and an even more clear understanding of what their priorities are. In my mind, yeah, M and A is about, there's $10 on the table, and I want six and you want six. And we're going to go back and forth. But really, M and A is about, how can I turn the $10 on the table into $15 on the table so everyone thinks they're a winner? And in order to do that, you really have to understand, what does the seller want? Yeah, they want money, but they may care about what happens to their employees. The management team may care about their job and their upside. The seller may care about being able to spin good PR out of the sale. Look at how well we did on the sale of the business. If it's a strategic seller, they may care about customer relationships, stuff like that. Sussing that out in advance or sussing it out on the first call will help you to cut a deal way more. So I do a lot of on the first call, despite me rambling on this interview, on the first call, I actually tried to do a lot of listening and a lot of, where do you want to take the company? What are your plans for you and your management team? What are your shareholders thinking? And I suck in all that information because that way I'm going to be able to frame something to them that makes them want to talk to me, want to go exclusive with me, and want to cut a deal with me.

Let's recap this here for a second. Number one step is get a warm introduction that way.

Yep.

Explore, think of the different avenues. Can you tell me on that, too? How do you do it in a good way? I get personally hit up often from people I don't know requesting introductions to people I don't know. If you're listening to this, please don't do that. But it is a powerful way obviously to get an introduction because you're right, I respond to them. If you don't mind grabbing a call on the weekend or something.

Exactly. The key is to find someone in your network or your management team's network or your company's network that is trusted by the other person. That could be one of their investors, that could be one of their advisors, could be their lawyer, could be somebody they know from prior companies. If the founder used to work at intel, do you know anyone who worked with them at Intel? To your point when you get a request for a cold call, Kisan, my guess is what you're trying to assess as quickly as possible is will this be helpful to me and will this be annoying to me? The message I want people to get is they're serious about doing a deal. This could be significant for you. Won't necessarily, but it could be. And they're nice and reasonable people. This guy Frankel's not going to waste your time. He's reasonable. He's not a jerk. And he's serious about doing deals and he's done deals. If I can get that message across to somebody to go, okay, who knows if this goes somewhere, but it won't be unpleasant and it could be productive.

This is trust circle. And I want to get to the closer trust circle of that person's.

Yep, exactly. And that's why I go back to the ecosystem point. I know it's hard as a corporate person to influence this if you can at all avoid it. You do not want the first conversation you have with the target to be, we would like to buy you because your chance of getting them to go exclusive with you and not turn it into a big process is much lower. Even if you can't do an ecosystem deal. I'll give you a case study example of this. When I was at Lexus, there was a company that was not for sale. They told everyone they weren't for sale, but we all knew they were attractive, we all wanted them. And all I Mean all the big players in the space. So one of the guys on my corp dev team made a point of reaching out to the CEO once a quarter just to chit chat, gossip, trade market, intel, stuff like that. Never asked him about selling his business. Just said, I wanted to keep in touch. I want to know what's going on with your business. Let me tell you what's going on with Lexus. And he built a relationship and they ended up talking about kids and talking about other stuff. He did that for two years. So when we heard rumors that the company might be up for sale, my guy reached out and said, hey, I heard you might be thinking about selling. Finally he goes, yeah, we might be said, look, you know that we're interested. You know that you'd be a good fit with our culture. Can you give us 60 days to just take a look before you run a giant process? And because he built up a relationship, the guy said, yeah, okay, give me 60 days. And we ended up doing the deal. Never went to anybody else. Nobody had a shot at it. Figuring out some way to build a relationship outside the sales process. Not to be crass, but this is what real estate brokers do. They build relationships long before the person has decided to sell their house. So that when they decide to sell their house, they go, why don't I just use Bob or Susan? Because I know Bob and Susan. So I think it seems like a tough investment of time and you can't do that with every company, but you can do it with the ones that you're most attracted to.

I got step one, get a warm introduction.

Yep.

Step two, listen. Yeah, walk me through that first meeting because you mentioned that starting with like, where they want to take the company. Do you have an outline? What are the things you try to hit on in that first meeting?

If I'm talking to an 85 year old founder, I'm going to ask different questions than if I'm talking to a 35 year old founder. And I'm going to ask different questions about talking to Kesan Patel, who owns and built his business and is young, versus Fred Smith, who was hired on as a CEO by a private equity fund. There's a little bit of crafting to it, but roughly speaking, what I do is just ask them a bunch of questions about their business and where they think it's going and what they want to do with it and what they think the opportunities are. Maybe I'll get into how could one plus one be three if we were building the business together? Things like that as evidenced by this conversation. If you ask people questions about stuff they're interested in, and people are always interested in their own business, they will talk a lot and you have to be very sensitive to make sure they understand. You're not trying to delve into proprietary information. I'm not trying to get something competitive I can use against you. We're not at that stage yet. We haven't signed an NDA. Maybe I'll ask you about financials in a very vague sense, but what I'm really trying to do is get you to talk about your business so I can understand where do you think it's going, what do you think the opportunities are and what do you want out of it? I'll talk about the business and I'll go, kisan, so what about you and your team? Do you think you're gonna run this business for the next five years? You've obviously done a great job of getting it to here. Is your vision that you're gonna hyper accelerate and keep going or is your vision that you're gonna pass it on to another team? I wanna hear about you personally. So my goal at the end of that call is to know enough that I can start to craft an offer. An offer, vaguely speaking, like rough terms, that optimizes my result and their results. Give them stuff that has very little value to me and get from them the stuff that has very little value to them. That's the way you create one plus one equals three.

We're going pretty far. I'm still trying to get it into how do you get the numbers from them, when do you sign the NDA?

But I think a lot of that early stuff allows you to start to send messaging that makes them want to sign the NDA. Think about it from their perspective. Again, this is scenario based, but they're starting with a position of this is a distraction for me and my team and I'm giving away competitive information that these guys can use against them. The starting position is, unless I've hired a banker and launched a process, in which case you're not talking to me, you're talking to my banker, which you want to avoid. Prove to me that I should sign an NDA and I should give you information. Usually the fact that you're some big company with a big balance sheet is not quite enough. What I try to do early on is paint a conceptual picture for them of how this could be great. So I'll come back to them relatively early on and go. Based on our conversation, I think our two Businesses, one plus one equals three. We can create a whole bunch of extra value. I think we can find a home for your team. I think we can find a leadership position for you, or I think we can find a good landing for the team so that you can move off as you said you want to. So I sort of paint a picture of a deal that not only maximizes financial returns but also meets their other needs. And then I say to them, look, in order for me to sharpen my pencil on this, I got to have information from you, but I'm going to give you a little teaser as to what this could be to justify why you want to distract your team and put yourself at risk by giving me your P and L information on your customer base, information on your product. These are all things that you're hesitant to do. I think people are much more successful at getting that out of the seller. If you give them a little candy, you give them hope of something really exciting, then there's a basis. I'm not just asking for your financials because I'm curious. Oh, Kisan, I'd love to give your business a proclogical exam for my own entertainment. Instead I'm saying, look, I have this vision of a thing that you would like based on what you've told me you would like the outcome to be. I think we might be able to get to that outcome. Help me to help you. And then you go in for I need this information. And by the way, the NDA, I think the NDA is such a red herring because I don't think it really protects anybody. So I Never leave Volunteer NDAs but I'm always willing to sign them. So I think you then get to give me some information. You're smart. You know what, I need to be able to put a real offer on the table. And the more information you give me, the more real the offer will be. The more you give me free diligence, the more the LOI I put in front of you is going to be really rock solid. That's my ask to get to an alloy. You got to give me information so that I can really sharpen my pencil.

I got step three, paint the picture. Step four is your NDA slash info request.

That's right. I would say coupled with the NDA and info request is an exclusivity request. I want a period of time where this is a one on one conversation.

That said loi or come later.

Yeah, well, you can put it into the NDA. So in a perfect world, I either want an informal or a formal. You're not going to talk to anybody else right now, I'm not saying you get that. You probably get that a quarter of the time. But it's nice to get it because I want to create as much acceleration of my own bid ahead of anybody else's. In a perfect world, I want a short period of exclusivity to get to the loi. Now, part of this depends on how rigorous your diligence is pre LOI and post loi. I've worked at companies that go both directions. I've worked at companies that basically say, sign an loi, we don't care, we'll negotiate it in post. And those people will sign an LOI based on a P&L and one phone call. I've worked at other companies that view the LOI as almost a moral commitment. Like, I've worked at one company where the conversion rate from LOI to closed deal was above 80%, but they did a lot of diligence upfront. So part of this is going to be, how does your management team and board view signing an loi? But either way, I want to keep exclusivity, whether it's formal or informal, as much as I can. If I can get them to give me exclusivity pre loi, I'll do it. Otherwise, I will push my management team to let me sign an ally faster and then get exclusivity in the loi.

How about between this NDA and loi? Who's involved? Who are you getting involved? How do you put together your model to put a bid together?

It depends on how rigorous we want to be in our diligence for the loi. So it depends on, to some extent on the philosophy of us as a buyer. But at the minimum, I will want the business leader who's going to own the P and L heavily involved because I want to remain totally aligned with that business leader through the process. I don't want them agreeing to an LOI because they haven't thought through the business and then backing off of terms later on because I end up with egg on my face. So the business leader, at a minimum has got to be heavily involved. I would say the specialties that are critical to the acquisition basis, I want involved. So if we're primarily buying it for technology, I want a tech leader involved. If we're primarily buying it for customer base, I want a salesperson involved. So we're not going to do diligence pre loi, diligence on everything, but we're going to kick the tires on the stuff that would be deal breakers for us or could radically impact the valuation. And I want those people really committed. I'm going to do sort of a look me in the eye thing with them and say this is serious. Because there's a tendency on the business people's part to go, eh, a little I Shmuel, we'll look at it all later. And I try to force them out of that because I don't want my time wasted as well. Those are probably the critical people you need. In my mind, there's a difference between fundamental diligence and confirmatory diligence. Fundamental diligence is make sure we understand what the thing purports to be and what we would pay for a thing that was what they say it is. Confirmatory due diligence is spotting lies. If I spot a lie, I don't mind if it's late in the process because that's going to be your problem, not my problem. You lied to me. All bets are off. I'm less worried about financial due diligence, legal due diligence, even detailed code due diligence. Those can wait until post loi because, listen, if you gave me a set of financials and I relied on it and then I discover that your accounting is wonky or just false, I don't feel bad about resending the loi. But if my business people go, oh, we thought it did X, but it actually does Y, then shame on us. We should have known that before we signed the loi. So it's the leaders that are going to sign off on the thing and it's the functions that own the reason we're buying it. Whatever that reason is. Those are the people who have to be involved pre loi. And then the other thing I'd say is the leadership, and this will depend on deal size, the leadership that has to advocate for it. Right? Because in every organization, if you think about as you go up the ladder, you go from advocators to approvers. For most deals, the board is an approver. They're not going to feel one way or another about it. They're going to listen. They're going to go, yes, we're comfortable. Depending on how big the deal is, the advocator could be the CEO of the company, could be the CEO of the division, could be the CEO of the business unit. Whoever that advocator is, they got to be on sides with me up front. Right? I'm not bringing them this idea. I'm not the advocator for the deal because I don't have a P and L I'm not going to move a deal through my process unless Kisan, the GM of the $500 million business unit goes, yeah, I want this. And in fact I'm going to make sure that Kisan's name is on all the documents. This is not Michael Frankel, the corp dev guy. I'm deal structuring, I'm deal process. But the person who says we should use a bunch of the company's capital to buy that can't be me because I don't have P and L. Figuring out who that is in your organization early and really having a very direct conversation with them, especially if they've never done deals before. So they understand you're not the passive participant. You're the owner of this exercise.

Really well said. Okay, so we had a number of people and the thing I'm struggling to understand is speed and accuracy on the bid because I saw a lot of people in the tent so far. And the big factors I look at, it's capital expenditures and your synergies, those are your big assumptions on this whole deal. How do you do that? How do you make sure you're accurate on your assumptions, even your model overall? Use that to get a bid out there fast. Accurate.

Number one for core large scale assumptions, you need the business leaders to own them and they've got to understand the business well enough so they've got to know what it looks like when this comes together with this for a bunch of the other assumptions. If you've done a bunch of deals as a corp dev officer, you have simplifying assumptions. So you know what happens when a little business enters your business in terms of back office operations, enabling areas, technology support, real estate, stuff like that. So you should be able to rough those out and be pretty accurate about them. But with the core assumptions, yeah, you got to go to the business leader and the business leader's got to be serious. Now this goes back to my whole how much due diligence are you doing before loi versus after loi? I would say if you're trying to move super fast and you're going to throw some stuff at the wall, get under loi and then do most of your diligence. I'm a big fan of valuation ranges. Sellers don't like them because they want to know for certain. But I think it's a good way to say, look, we're in this neighborhood. If you're happy with this neighborhood, show us why we should be at the top of the range. We need to see all this stuff and every time you show me something good, we tick up towards the top of that range. Some sellers are willing to go along with that. That gets back to the trust thing. Do they trust that you really want to do the deal? That's where being an existing ecosystem partner with them, having a long relationship helps. But I think that the biggest thing I'd say about financial modeling pre loi is don't be pennywise pound foolish. Understand what levers are actually likely to change the trajectory of the business. And that's where you focus all your attention. So if you have their P and L and you look at it and go, okay, once we merge it into our business, what's going to change? All the enabling areas is going to roll over to your enabling areas unless they're a massive business. But if they're small compared to you, you're going to over time swap out their finance function for your finance function structure. Hr, talent, real estate. The core stuff is where you should spend all your time. That's why I like using simplifying assumptions on those sort of more standard cost areas and focus all your attention on revenue and big cost areas that are variable like product management and product development. That's where you're going to figure out most of your synergies. The other thing I'll say is there should be enough meat on the bone in any acquisition for you to be a little off on all that stuff. Nobody should do a deal because they will make the business 1% better. If you can only make the business 1% better, you're not the ideal buyer for that business. So you just have to accept the fact that you're going to take your best shot at that synergy model. You're going to scare the business people by pointing out to them that model is going to survive and come back to haunt them so they're not overly aggressive to get the deal done. And then you're going to live with errors in that model, which they'll inevitably be. But if you're doing good M and A, there's enough synergy value for you to be wrong on some of the synergies and still have it be a good deal.

Yeah, it's interesting how you would put that together. I'm struggling with how do you put it together and still be accurate. How do you make revenue synergy assumption about having your CRO or some head.

Of revenue in the room unless you think it's A simplified sales process. So I'll give you a simplified sales process where you don't need the CRO. If you can statistically say this company is relevant to 50% of your customer base and when they pitch customers, they convert 75% of the time. You can do some math and say that means that over a three. And this is how frequently they can pitch. This is how long it'll take for them to penetrate your customer base. And then you haircut it back 10, 20%. So if it's as simple as this is another thing your salesforce is going to be selling and there's no other complexities or value to the joint sale, then you may be able to come up with a simplifying assumption. But I would still bring in the CRO. The difference is if it's more complicated than that, like you think you can get revenue synergies like the company that I mentioned earlier, where we were able to get exclusives. We built a relationship with them. Part of the reason we wanted to buy them is they were going to generate about 15 million of revenue for us directly. But we thought that owning that capability was going to be a differentiator in about a billion dollars worth of revenue. Over a few years there, it got complicated because how much of that, of those incremental wins do you attribute to this acquisition? That's where you need the CRO to really step in. Because now it's a complicated question. It's not just how much of this can you sell, but how much of the other stuff can you sell? Because we have this and our competitors don't have this. That's where I say, if it's that kind of a hypothesis, you need the CRO involved at the outset. You need them lenient. The reality, though, is everyone thinks projection models are like this science. It's not a science, it's an art. You're never going to get it perfectly right. The key is to get the big things as right as you can get them and the small things in the right neighborhood. That's all you can hope for. Honestly, no amount of diligence is going to eliminate inaccuracies in your projection model. They'll reduce them. But you could diligence a company for 10 years. I guarantee your projection model wouldn't be exactly right once you close the deal.

This is why the integration people don't like ECORP to folks, huh?

Yeah.

These guys just make up some numbers and make us accountable, don't they?

That's why I bring the integration people in at the front end of the process. I bring them in even before the why? Because I want them to own those assumptions. And if they want to challenge it, I'd rather they challenge it up front. I'd rather them go. If you think that we're going to be able to get them all off their finance system and onto our finance system in six months, you. You're smoking crack. I go, okay, great. How many months?

But you don't do that before loi.

I will at least bounce integration off of the integration leader before loi. Absolutely.

Okay. You may not be the majority there, but.

No, no. But I think it's a good thing to do. Now, this assumes you have an integration leader. It's different if you have a pro integration leader. When I was at Lexus Integration reported to me the integration leader was one of my people. So he would do a first look at any deal that we were looking at and submitting an loi. And he would, based on his extensive experience, go, that's going to be really easy. That's going to be a problem. That's going to be a problem. So we at least have a gut sense. The problem occurs when the integration person is taken out of the line, out of the business ad hoc for the deal. Because then no one's going to pull someone out of a role until you're well past loi. So then, yeah, you have to go back and give them a chance to revisit the model. But then I go to my point about how there should be enough meat on the bone. You should be conservative enough in the projection model supporting your loi so that even if it gets shaved down through the rest of diligence and the rest of integration planning, it's still a good outcome. The deal should be a home run so that even if it pulls back one or two bases, it's still a double or a triple.

Let's go back to the loa. Yeah, we got all these business leaders, executives, various key stakeholders, depending on what's driving the value of the deal, brought in. We got a model, we start making our assumptions. Now. We put together this loi.

I wouldn't just go straight to putting together the loi. I would instead start to formulate what I think the winning terms are. So now I've got my model, I've got my views on the business. I've got my views as to how strategic it is. Right. Is it a must have or a nice to have? If I'm doing a roll up and this is one of 20 companies that I'm buying. It's a nice to have. I'm not going to give away most of my synergies because I know I got 19 others I can go after if it's a must have, I'll feel differently. So I put all that together in my mind. And most importantly, I assess what the seller wants. I think too many buyers focus on what makes them happy, and the answer is, that's great, but if you don't make the seller happy, you won't get the deal. So I try to assess those, and then I love to test the waters. I love to have an informal conversation where I bounce ideas for terms off the seller so I can get a little bit of a gut reaction. Now, I know they're playing a little bit of a game too, so they're never going to just give me total transparency. But I can usually get some body language out of them if they're overjoyed at my valuation. I got a problem. I'm overvaluing the business. Something's wrong. But what I'm trying to tell the difference between is slight frustration and extreme frustration. But more importantly, all the other terms of the deal, I'm trying to suss out whether or not I've got other things on the table that are exciting to them. I'll give you a great example from my personal life. The house that I'm sitting in, I bought three months ago. I found out through the broker that the seller was very focused on certainty of clothes. And so when we put in our bid, we made sure to tell him we've already sold our other house and we're moving here because our daughter goes to school eight minutes away. So your certainty of clothes with me is way higher than with other people. And that was more important to him potentially than purchase price. So I want to field test with the founder or the CEO different ideas for two reasons. One, because then I can refine my offer to make it better for me and more likely to be accepted. I'm giving you a goofy example, but it's happened. If I say to the founder, we're not planning on changing the brand of the company, we love your brand. And the founder goes, I'm so excited about that. I want the brand to survive. Okay? Now, I know that actually has some incremental value. Now, my business leaders got to be okay with it if my business leader is okay with making that commitment. Now, I've created value for the seller, cost me nothing. Maybe I can squeeze that out in purchase price. So I like to have those Testing the waters conversations and get as much feedback as possible before I put a piece of paper in front of them. Because for two reasons. One, I want to make sure I've explored every way of creating value. And number two, you never want to put an aloi in front of somebody that's horribly disappointing because then you lose their attention and they get pissed off. You never want to offer them what they expect, but you don't want to offer them 10% of what they expect because then they'll go, screw you and the horse you rode in on. I'm hiring a banker. You clearly don't know the value of my business. It's really hard to come back from that. I want to try to get to the place where they're slightly disappointed. That's a good starting point to the negotiation. A medium disappointed but still willing to engage with me. And that's what I want in the loi when I send it to them so that I'm getting as much value as I can for myself. But I'm also ensuring that the deal doesn't run away. Because once you slide that loi across the table, then there's going to be a period of silence. There'll be a call where they ask questions and stuff like that. But then they're going to go in a hidey hole and they're going to talk to their advisors, they're going to talk to their board. You want to make sure that they think they're close enough that they come back to negotiate. If somebody doesn't mark up my loi, I overbid. But if I sandbag them too much, they'll just walk away from me. Or they'll use my loi as a stalking horse to go find another bidder. I want them to see the light at the end of the tunnel and go, I can probably negotiate with this guy. I should stay engaged with him.

I'm going back to my little steps here because we're at step six was the model assumptions. Step seven, figure out what makes the seller happy.

Yep, I call it testing the waters. And then you have to draft the loi. So you actually have to reflect. And you're going to have to bounce around with your lawyers, especially if you're really creative. So if all you're doing is saying X dollars, your lawyers will get that loi done quick. But if you start to do things like, we'll retain the brand, we'll maintain your employees on similar benefit systems, you will maintain a leadership position similar to the one you've had burnout all that stuff makes lawyer's hair stand on end. So you'll have to spend more time cycling with your lawyer to get something that reflects your business goals, but that doesn't create some kind of unanticipated liability. And then the last thing I'd say is, even as you're sliding the loi across the table, I think messaging is really important because you want to maintain this tone of trust and honorability. So when I share an loi with somebody, I believe you want to message your intent. Show them that what you are trying to do is respect the value they've created. Structure something that addresses what they told you. Remember that conversation we had three weeks ago when we first talked and I listened a bunch? I heard what you said. It's in this piece of paper. Look at items number seven through nine. They are my attempt. Maybe I got it right, maybe I got it wrong. They were my attempt to reflect what you want. Kisan out of this deal. I have to do what's best for my business. But I want this deal to happen. I think there's value to be created by this deal happening. So I'm giving you my best intent. I would love to hear your feedback. I want to position this in a way that they know I heard them. I tried to reflect their interest. I'm open to being flexible and I'm open to negotiating so that you maximize, number one, their reaction to something they don't like. You don't want them thinking that you didn't hear them or you're trying to put one over on them. You want them to attribute good faith to everything you've done because that's going to bring them back to the table to correct you on stuff.

Okay. I like the part about putting what they want into this loi. How's the presentation of this? Do you fax machine or do you hand deliver it?

I personally prefer to walk people through it live. And the reason is, number one, legal language is hard to digest. If you walk them through it live, you can tie a string back to the things they've said. So what I prefer to do, if they'll accept this, is I get on a zoom with them and then I screen share the loi and I go. Let me talk you through the sections. Here's the purchase price. Here's how we valued your business. I came to a $112 million. Here's why I came to $112 million. Maybe I'll even share some comps with you so you can see where my Thinking is we can all debate, but at least I put some work into this. Here's the earn out. Here are the drivers of the earn out. Remember we talked about how you think that you can do A, B and C. I heard you and I think we'd like you to do A, B and C. So we've struck them in the earnout. You walk them through. So they not only understand the terms, it serves two purposes. The first one is they understand your intent, your good faith behind the terms, the logic behind the terms. The other thing, I hate to say this but you sometimes have business people who really, if they've never done MA before, don't understand some of the legal structures and you don't want to leave it to them and their lawyers to sort it out because you don't know who's talking to them. I like to explain an earn out if I can to make sure that the other side actually gets, oh, this is an earnout and here's how it works. Here's when I get my money. So my preference, if at all possible, is walk them through it live. If they want to give feedback right there, that's fine. But I almost encourage them not to do that. Sit with it, talk to your advisors about it. We're now going to send it to you and let's set up a call in a few days and you can give me feedback. I don't want to pressure you to give me feedback right now.

You're going to try to get them to sign and close right there.

If somebody wants to sign the piece of paper that I've just shown them on a screen without thinking about it, I probably overbid.

Fair point. Any time based incentives, that's a new sales term I learned. But do you put like a, an expiration date?

I'm hesitant to put an expiration date on it because I'm not trying to be abrasive. So I sort of hold them to a reasonable standard and part of it depends on the control structure. So if we're talking to Kisan, who owns his company, you're going to go talk to your advisors, but you're the decision maker, probably going to expect that you can get back to me within a few days. If you have private equity owners and you have a board and you have 10 shareholders who each have more than 5%, I'll be more sympathetic to you going, I need a couple of weeks, I need to go talk to different people and stuff like that. I think it varies, but I definitely don't put a. This will blow up on this date kind of thing because it doesn't serve any purpose. Anybody unless they're desperate, unless they're about to go into bankruptcy, they're running out of money, anybody's going to react negatively to that. So instead I have a reasonableness standard where I go, Kisan, how long do you think you need to be able to talk to your advisors, talk to your board, come back, let's set a date now for when we can have that conversation. Frankly, if you go, how about a month? I go, come on, you really need a month. Then I may be talking to other targets. Then it sounds like you've got some.

Other stuff you do like a follow up call. Basically I presented this loi to you, hey, let's schedule a follow up a week out.

I try to schedule that while we're still on the call. So I've just presented you the loi. I understand you need to go off and think about it. How about next Thursday? Can we book 9:00am Good for you, next Thursday. That way we've created a time slot. It's not that like I will officially withdraw the loi. It's an alloy, it's non binding anyway. But we set expectations between each other about when you're going to get back to me.

Okay, I like that. Plant next steps. Anything else on the loi? The negotiations do you think that through ahead of time? Of hey, I'm going to need 10% padding over here and when I'm bidding or Yep.

I think about all the cards I have, I think about all the different variables. This is a lot like compensation negotiation. When you get a job offer you go back and think I could ask for more base, I could ask more bonus, I could ask more vacation time, I could ask for more equity. You think about all the different stuff you have and you come in with a strong offer but you come in knowing you can go best and final. Before I send an loi, I always have a best and final conversation with my management team so that we know where we'd be willing to walk away. And this comes back to the is this a must have deal or is it a nice to have deal? But either way there's a best and final somewhere. So yeah, I know what that best and final is. More importantly, I know which variables I'm more comfortable giving on. So I'll often have a conversation with my management team where I go the core purchase price, we're not willing to go much higher on but we would go a lot higher on the earn out. Because the reality is if they hit these numbers will be okay, giving them the extra money. Okay, there's a bunch of different ways to skin the cat, but yeah, you definitely want to have thought that through. You don't want to think that through in flight, because what if they come back to you a week from now and they go, here's our counter. Yeah, in theory, you can go. We need some time to think about it. If they're countering, you've got momentum. You're heading toward an agreement. You want to move that fast. So you want to have already had. And because you're the big organization, you're less nimble and agile. So you don't want to have to go back up the ladder to all these different leaders, maybe even up to your board, and go, okay, now we want to offer 10% more. You want to figure that out in advance so that the authority to negotiate is either exclusively with the corp dev officer or with the corp dev officer and the business leader that's going to directly own this business. But the two of you should have negotiating power already. Otherwise, if you're a big organization, it'll just move too slow.

Can you take me on the putting a range as a price on loi? Can you walk me through how to do that?

It's most effective when you're doing a very quick loi, so you haven't done a lot of diligence. And when you can keep the range small enough that effectively you're showing the seller that they would want to do the deal even at the bottom of the range. But it makes sellers nervous because they assume once you've got them under exclusivity and you've got a little power over them, you'll always go to the bottom of the range. But sometimes it's a great way to solve for either getting to an LOI super fast before you've done complete diligence, or situations where there's certain critical information they don't want to share until you've gone through diligence. I'll give you a really good example. Let's say they don't want to share the identity of their top 10 customers. But if their top 10 customers don't overlap with yours, there are these huge additional synergies you would get because you've been trying to penetrate certain Fortune 500 companies. And if they have an in with those companies, you would attribute a bunch of extra value to the deal. But they don't want to tell you who they are until you get into Diligence, that might be a good scenario of going, look, we understand you don't want to tell us. That's totally fair. It's hard for us to nail down exact synergies. So we're somewhere between X and Y. If there is zero overlap between our customers and yours, we get to Y. If there's a lot of overlap, we still want to buy your business, but we're probably a little lower at X. X and Y can't be that far apart. The further apart they are, the more baloney your LOI is. So if your LOI is somewhere between 50 and $100 million, it's not an LOI. It's a we'd like to keep doing due diligence piece of paper. But if your LOI is 57 to 64, okay, now we understand that you're giving yourself a little bit of room because there's certain critical things. I think it's more helpful if you can tell them what it is that will determine where you end up on that range. So I'm not just saying 57 to 64, I'm saying I'll get to 64 based on this and this.

What are other things that you've learned in terms of structures on these? Lois? We think of the obvious. Here's some cash, here's earnout. We're tying to it, but there are other creative ways of doing this.

I'd say the sort of infinity creative ways. As an example, the seller is not a founder, but it's a corporate spin out. There are all kinds of value creation tools. I'll give you one example is transition services is a way to run money through their P and L as opposed to their balance sheet. So they may be willing to take 5 million less in purchase price in exchange for 2 million more running through their P and L. They may care about brand, they may care about their employees, they may care about their customers. You may care about retention of the executive team. They may care about how the deal is characterized. I've seen deals where they actually care. How is this message to the market? Is it messaged as an example as a sale, or is it messaged as a joint venture because the seller is going to keep a small percentage? You have to think about, especially if there's private equity backing economics for the management team. If you are buying a business and the management team has a lot of economics, then you have to worry they're all going to leave and you got to figure out retention for them. If they don't have enough Economics. You're also worried they're going to leave and you have to figure out how to goose their economics so that they want to stay. There are a lot of different variables in the loi. This is why I go back to that first conversation. Keyson, what do you want? What is happy for you and what's happy for me? I take that, I turn that into a bunch of variables and I turn that into an loi. Then I go to my lawyer and I go, I want this to happen and this to happen and if this happens, then this happens. Then they turn in a bunch of language. I say the other thing with Lois is I try to separate and I'm saying this as an ex lawyer, I try to separate the business terms from the legalese as much as possible because my experience is business people get slogged down in legal terminology. Right. The lawyers want to put legal terminology into an loi. You can debate how much you need and how much detail you need but you want to make sure that the business person who reads the loi gets what the deal is. I've even seen structures where you do loi and term sheet. Loi is very high level and is really business terms term sheet. The lawyers get to pour in all their language but you just want to make sure one way or the other the business person gets what's in the document. They understand from a business perspective what's going to happen. There's an infinite number of terms you can put in an loi. I don't even try to start with levers, although I know a bunch of levers. I start with what's the outcome that we want to have? Even like totally non financial outcome. This is going to sound crazy but I've actually seen this in a term sheet. Maybe it's an old. It's something from 20 years ago when this was more relevant. But I've actually seen the founder gets to keep their cell phone and their cell phone number in the term sheet. He really cared about that. It's very important to him. So that's why I don't think of the term sheet as a standard thing. I think of it as what is the end state that the other side wants to achieve and especially what's all the crap they want that costs me nothing to give them or cost me very little to give them. I love that stuff. That's the best thing in the world. I really want the lint from your jacket pocket. Fantastic. Here you go. For me, Lois are really great when the seller reads them and goes oh, this is all. This is what I wanted. This is the outcome I want. And then inevitably, they're going to go, this is exactly the outcome I want. Except I want the price to be 10% higher. Okay, fine. Now we're going to dance.

That's a lot of wisdom you packed there. I'm still hung up on the balance sheet to P and L allocation. We make sure the listeners at M and A Science get their money's worth. You got to keep it coming, Michael. I know we're hitting on time here. What's the craziest thing you've seen in M and A?

I still remember one from a long time ago when I was a lawyer. It was. I swear I'm not making this up. It was Christmas Eve, and we were negotiating an M and A transaction, and we're sitting in the other law firm's offices just banging away. Everyone was miserable to be there. Everyone wanted to be done. And the founder of the selling company, who was going to make an enormous amount of money over the deal, insisted on being there. Okay, fine. But we hadn't seen him in a little while. And then as we were going back and forth on documents, turning drafts, we heard this click pop. And then about 60 seconds later, click pop just kept on going over and over again. And finally, after like, 10 minutes, I thought to myself, I have to figure out what this is. So I stepped out of the room, and the guy was about to make three, $400 million himself, personally. And all these lawyers are trying to make it happen on Christmas Eve, is out in the hallway with a putter and a bag of golf balls and one of those, like, putting targets at the end of the hallway. And it's just sitting there testing his short game.

I should laugh too hard. I feel like that's something I would do.

But I would hope that you'd be at least nice enough to go to the next hallway.

Well, I'm gonna hear what they're doing. Oh, Michael, this has been fun. Thank you so much for taking the time, hanging them out, teaching me a bunch of stuff today, helping me become a better M and a scientist.

It was just fun. I always love these conversations.

Those of you still with us, thank you. And here's to the deal.

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