Clarification on some simple questions (self-funded search)
August 29, 2023
by a searcher from Duke University - The Fuqua School of Business in Denver, CO, USA
I've been reading up on self-funded searchers, but I still have a few areas where I need some clarifications.
1. Do most searchers send an IOI first with a price range or go straight to an LOI? The more posts I've read on the process, it seems it's more straight to LOIs.
2. I have several templates for LOIs, and while I understand it's non-binding, it does cover some very key parts (price, capital structure, working cap estimates, seller note terms, etc.), does it make sense to use a lawyer to draft the first LOI? I was looking for copy of an LOI that actually lays out terms to see how others have done it. For instance on the capital structure, do I explicitly put down a purchase price of $4m, with a 10% seller's note at x% terms, $700k of my own capital, SBA for $2M, and pref equity for $900k. Would I state it down to that level of detail in an LOI before I talk to the bank & investors?
3. Can you mix financing sources of ROBS and a HELOC for example? Does it ultimately not matter where it comes from as long as the funds are available?
4. Preferred investors: there seems to be a lot of flexibility in terms of how this is structured. I'm just wondering, does the pref always roll over into common once principal/accrued is paid off or is there flexibility there and the standard I keep seeing is a 2x multiplier, is that the rule of thumb or how much wiggle room is here?
5. Let's say the LOI is accepted, during the DD period is there a good timeline on when to get things done? Are you talking to a lawyer and accountant in week 1 to get the legal structure and QOE ball rolling? I was hoping to find a timeline of what a past deal looked like post-LOI to close week-by-week.
I know some of these are probably more on the basic side, but any input would help clarify things on my end. Thank you in advance!
from McGill University in Toronto, ON, Canada
2. Re: lawyer...I would recommend using a lawyer for the first LOI you're truly serious / excited about. Most of what they will provide you with can be used in the future. You can also use the engagement to decide whether you like the lawyer enough to use them for legal DD, definitive agreement, shareholders agreement, etc down the road. It's really up to you. My preference is to have a more detailed LOI so it mitigates the risk of a deal falling apart down the road. Others who may want to move faster might draft their own or use templates to get deals further down the line. To answer your second question - yes, putting in the price, sources, cap structure should be included. My recommendation would be to show your sources of financing to lenders before the LOI so you know the ballpark debt you can use. It may also help you negotiate a better Seller Note/VTB.
3. No comment, sorry...
4. Ultimately, this is completely up to you and who you are trying to raise capital from. If you're going to friends and family / close professional network, I'm not of the belief you need to make things all that complicated when raising $250k - $1m. If you need to raise from 3rd parties or strategics you don't already know, it will require a more formal process. How the pref works is entirely up to you and it should be rooted in the IRR/MOIC you can justify to investors. I would also ask your senior lender what types of pref share classes they're comfortable with as part of your equity.
5. Again, this is ultimately up to you but to reduce broken deal costs I would be conducting as much of the due diligence yourself in the early part of the DD period. You need to go from liking the deal to falling in love with it before you initiate QoE, legal DD, definitive agreement starting, etc. However, I would have my deal team selected before I pursued a deal aggressively and perhaps seek high level guidance from them on where you should be investing your time before involving them, what to look for, etc so you can move expeditiously once they're involved.
from IESE Business School in Waterloo, ON, Canada
#2: I would suggest writing the LOI yourself (e.g. using a template), but having a lawyer review it before you send it. Put the detail in that affects the seller. For instance, they will want to know what portion they will receive in cash, what part would be a seller's note, what the earnout looks like, etc. They are not affected by how much of the cash comes from investors and how much from bank loans, etc., so don't put that in.
#5: this will depend on the deal and the seller's timeline. QofE is expensive. I first did my own due diligence and tried to find anything that would have been a deal killer before moving on to QofE. Have it lined up and ready to go, but once QoE starts, you really start incurring heavy costs.