Typically when a firm goes to market there will be a letter of intent that is engaged upon. The letter of intent outlines the details of the M&A deal including timelines, terms, financials etc. Sometimes, when you enter into an LOI stage, there is something that can happen called a re-trade. We're talking about the benefits and pitfalls of a re-trade and what it means for all parties involved in an M&A transaction.
Mike Harvath 00:04
Hello and welcome to this week's Revenue Rocket Shoot the Moon podcast, broadcasting live in direct from revenue rocket world headquarters in Bloomington, Minnesota. Revenue Rocket is the premier m&a advisor and growth strategy advisor IT services firms worldwide. With me today, are my partners Matt Lockhart and Ryan Barnett. Welcome, gentlemen.
Ryan Barnett 00:29
Hey there, Mike.
Mike Harvath 00:30
Hey, Ryan.
Ryan Barnett 00:32
Hey, good morning, guys. Thanks for having us on here today and appreciate everyone listening. As always feel free to to send any questions that you may have over to info at revenue rocket.com and could be the topic of our next podcast. And also thank you any those who are in our email distribution list if you voted for your favorite podcast, we really appreciate that, and if not, we'd love for you to sign up for that today. But moving on, today, we're talking about something that we see within deals for IT services, companies, and m&a, really around something we would call retradomg, and I'll walk through kind of the process. Typically, when new, a firm goes to market or is for sale, or even for not for sale, there'll be a letter of intent that is engaged upon. And that letter of intent outlines the details of the deal. And it will have typically an enterprise value, it will have some terms of the deal has outlined some timing associated with a deal. That is a non binding loi, in which it means that almost all of the terms can be changed with the loi, with the exception of the non disclosure and the no shop permission. But when you enter into an LOI, typically there's a fairly good faith measure that the terms that you outlined, will be very or closely similar to what is executed when the deal is completed. And if so your loi is going to line up fairly close, there's always gonna be some minor changes, but in theory or the in practice, you want to have the big section of the deal pretty close to the end. If it's not, there may be something called a retrade. So today we're going to kind of dig into what a retreat is, and why it matters and where IT services companies can be careful either when they're buying companies or selling into the pitfalls and benefits of Kate's kind of taking a second look at that loi So, Mike, why don't you just help us out what you know, what is a Retrade?
Mike Harvath 02:42
Yeah, just set the set the stage or retreat is typically driven by buyer, once they're under loi, and unethical buyer will initiate changing the terms or price or price or Terms of the deal, pursuant to things they may have found in diligence that our material and, you know, it could be, you know, something that was different than what they did in their, what we'll call sort of pre loi due diligence, or something that's changed or something and in the details of reviewing the financials in the business that was not as positioned or portended by the seller, you know, that's a warranted retreat, that's something that should occur because, you know, the business just isn't as it was positioned pre LOI and, and or something that may have been discovered in earnest in diligence, it may have to do with a million things, right customer concentration, it could be with a lost customer, it could be a variety things. However, you know, I'd also add sort of throw up a red flag that there are sort of bad actors and m&a that will just want to get too locked up under an LOI kind of oversell their capability or their ability to do a transaction, and then take that time while you're off the market, because there's the so called no shot provision and the LOI that doesn't allow you to look at other offers while you're under that loi to get to the real value that they intended to pay to begin with. And oftentimes, that's below market. And so, oftentimes, the concept of a retreat has had a negative connotation, because there's so many or there's a material number of folks that do try to lock up firms and the no shop and then work down the deal. I think you have to be is a seller you have to be cautious of that. But you also have to be aware that there are real reasons why you know, Retrade makes sense if there's material change in your business, post LOI.
Ryan Barnett 04:51
Well and to that, either from Mike or Matt, who can do the rewrites and why why are or what are a few reasons of why retrades can happen. For example, we're working on a deal now where it's a bit more of a structured process and the information that was completely available, were on the buy side on this one is, is not as clear as we'd like, because there's a kind of a hurriedness, to the deal to get it done. So we're kind of going in a little bit blind, that seems like something where I could see some changes in a deal if there was more access to data in the first place. So, Matt, would love for you to try and in on kind of who and why this can happen.
Matt Lockhart 05:37
Yeah, I think, to Mike's point, the context of a Retrade well, is a negative one. And so let's let's frame the context of a Retrade, as something, you know, typically that a buyer would do, and they always sort of go in with the intent that they're going to, you know, try to chip away at an enterprise value. And, and, you know, that's just their method. And it's, it's not really the right thing to do, it's kind of ugly, we don't see that as much anymore. But that's different than renegotiating based upon changes that are found in due diligence by the buyer, or could be found or changes that happen in in a seller's business, that our material during the due diligence process post loi, I think that the most important thing that, you know, Mike pointed out, is that in an LOI, when done ethically, people are putting their really their best foot forward in terms of what they feel an appropriate enterprise value is, and applicable term structure. Now, in due diligence, lots of things can happen, they can find out that what was understood as the EBITA, at at the time of an LOI was was simply incorrect, there wasn't enough information, that that was readily available pre loi, to verify the EBITA, something materially could have changed in the forecast during the due diligence process, the selling company could have had a major, you know, sales when that was that was unexpected, or an existing customer could come forward and say, hey, I want to triple the business, because of something that happened that you didn't know about. Or conversely, a major customer of the sellers could have dropped a contract, which would have, you know, materially changed the forecast moving forward and the expected EBIT of, you know, in the current year, so, there's, there's real things that can happen, that justify the changing of an expected enterprise value during due diligence, that are, you know, are completely above board. And, you know, that's, that's, in my opinion, different thing on the context of, hey, I'm just going to Retrade the price because I want to, and, and I didn't have any expectation of keeping the enterprise value the same as what I put in the in the letter of intent.
Ryan Barnett 08:42
Are there some methods that could could help adjust a an offer to address some of those market conditions? I'll give an example. If we outline enterprise value and say, here's an enterprise value that is a concrete number, I'm just gonna throw a throw out there $20 million, and there's some terms associated with that, that are cash and maybe an urn out of some sort. Is there a way in structuring a deal that make retraced less based on economic or financial conditions that would be more palatable, for example, staking the deal on the forecast at EBITA or the EBITA of the deal compared to a concrete absolute enterprise value number?
Matt Lockhart 09:33
Yeah, you know, I would say certainly there are and it depends on sort of how you position the LOI, I think also a great way to avoid it as it relates to what indexes the value. Like it could be an even a multiple for example, based on agreed upon approach at a particular time point in time, like, let's say the final purchase price is determined within one month to close and it's based on an EBITA multpile for the trailing 12 months revenue EBITA, then certainly that's one way to sort of have it float and be particularly in a growing business may be advantageous to the seller, and certainly a fair way to do it. I think the other thing, it's important though, as a buyer's, you're thinking about doing a deal to avoid a reputation as becoming someone who returns deals, which I think is a bad thing. You have to do enough due diligence to get to get to comfort and issuing that LOI. Yeah, not so much that the seller is not going to give you the data. Because there is a very delicate balance between how much information you can get pretty high and as appropriate. And versus kind of what you might want to see and due diligence. And you oftentimes get pushback from sellers if you ask for too much pre LOI. And so you need to try to be smart about what you look at as a buyer. So you can do enough due diligence, pre loi to get it solid enough so that you have a high likelihood of getting it done. But yeah, not so much that you can't even get to the LOI. And so I think, you know, using a competent advisor will help you sort of strike that balance, as well as doing a thorough pre loi financial review will also help you have a more fortified document on that is much less likely to require a Retrade. But to your point, Ryan, certainly there's ways of structuring the LOI so that you can minimize the risk of a retreat, particularly in the business, it's growing quickly, that's being acquired, or one that may have maybe gone the other direction, right, that is, you know, lost a customer or maybe in you know, financial, some sort of financial crisis that's looking to sell for a particular reason.
Ryan Barnett 11:58
That makes sense. Going through the negotiation, and due diligence process is difficult for both buyers and sellers. The sellers are putting their kind of emotional heart out there and combing through a lot. Buyers are really want to ensure that the deal is a win win for everyone. And there's a lot of time and thoughtful process that goes into this. If you have a if you're going in as a buyer, and you and you have locked someone up in this process, and sellers, I think at the end can often feel really almost trapped in the deal that they have. That's why some of these unscrupulous retrade can happen. At least that's where we've seen it. What happens culturally, when firms go back and forth, and kind of moving forward, ultimately don't these guys have to work together? And what happens when two firms are are battling over some of these things?
Matt Lockhart 13:06
Well, not always do they have to work together. Think about a there's a strategic opportunity where the buying firm has sort of feels as though they have most all of the operational management capabilities. And they are, they can see the you know, most of the sellers, executive leadership walking away soon, right. And so they feel or maybe have the hubris to believe there aren't real cultural ramifications. Now, we know that that's not true, right, that people talk, if a retreat happens, it's going to talk and create ugliness. The the selling founder management team will you know, we'll probably talk a little bit about it anyways, so So oftentimes the fires may feel like at it's not that big of a deal, wherein the reality is especially in in our vertical in the IT services, space, it's all about people. It's all about the retention of people and and so yeah, I think that it's a really good point, Ryan, that there likely are cultural ramifications regardless of whether or not the you know, executive team of the selling company is is sticking around for for the long term. Now, in the case that they're the buying company is really wanting to leverage and and grow with the, you know, the selling companies executive team, well, then it's just it's a bad move overall, because you're not setting you're not setting a foundation of trust, and we all know that that's that's the number one thing that can erode culture.
Mike Harvath 15:10
Right. Absolutely. Are there signs that a seller should look for, to avoid a retrade? It seems like there's we've seen examples of almost too good to be true enterprise values is a leading indicator that they might never get to that number. Mike, anything that you've seen that might be sellers should be just watch out for? Yeah, I think you you hinted pretty accurately about it. If it sounds too good to be true, it probably is. And, you know, understand kind of where market multiples are in the business. You know, I often say this is not a Turkish bazaar when a business is sold, it's not like this is the there is no methodology associated with valuation other than what the seller is asking price is. There's very structured valuation modeling, and comps analysis that goes into a credible buyer making an offer. And I don't often like analogies to real estate in our industry, because it's very different than real estate. But the one thing that is similar to real estate is the way that a house is valued and the way you have analyzed comps for similar transactions in your area, is a function of the valuation process, whether you're applying for a mortgage, or whether you're just a realtor is going to bring you to market they know where that house is typically going to sell based on fair value. And for the buyer to try to sell it wildly above fair value, they don't get sold, and the same sort of thing, or they don't get financed, or they don't there's all kinds of ramifications. Similar things happen in m&a, just because a buyer may be qualified to do a deal or have cash, doesn't mean they're going to pay off or pick overpay or whatever that might be the case. So you know, you need to be pragmatic about that. And if an offer comes in, that seems to be wildly above where you know, the market to be or where your advisor tells you the market is, I think you have to approach that with caution, because it may be a ruse to get you to sign an LOI in an effort to go through a very daunting retraining exercise in order to get you to fair market. And in the end, you'll either agree to that process and sell the fair market, or you'll shut it down and just say, Look, I'm not, you know, kind of wise to your approach and I'm not going to be beat down by you over things that don't make sense. You should know that, and I think Matt mentioned the this is that negotiating post loi is not the same as retrade. There are some activities or things that sounds similar, that are truly similar. But there's many, many things that have to be negotiated in a transaction post loi, some, you know, 200 plus things that need to be negotiated, typically. And when these things are being negotiated, that's not retrade, that it's just part of the reason why you have to have a competent adviser sort of looking out for you because there are things that are warranted to be negotiated, that may impact purchase price or structure on really both sides of the transaction. And that's why knowledgeable advisors are important to have on your side of the of the table. If there's kind of a a non warranted retreat attempt on behalf of a buyer, you know, a knowledgeable advisor can call that out and say, well, you know, nice try, but no, that's not a real objection or issue, and it shouldn't impact purchase price or terms, and they'll have your back, they'll have your best interest in mind. And so, you know, it's been many cases where we've advised sellers to, you know, walk away from deals from buyers and maybe trying to take unfair advantage of of their position after signing an LOI, we're usually brought into those deals late after an LOI has been signed, and they're trying to figure out how to how to get it to work and you know, oftentimes that can't get that done. We generally don't allow those things to occur the LOI process because we just, you know, are knowledgeable enough to know that if an offer is too good to be true, we can start to question, why you think such a crazy premium, and you know that that risk for you as your advisor.
Matt Lockhart 20:09
The other thing I, I would say to look out for is if is if an LOI comes like, very quickly. And, you know, we see this from, you know, some buyers who are like, Hey, I'm gonna, I'll produce loi within two or three days, right? And they're like, Well, have you done enough thinking and diligence even produce a letter of intent? And, and so, you know, we'll be super wary of that. An LOI that is produced without an understanding of, of the adequate funding sources, is another red flag that, you know, I think sellers need to look out for, because, you know, oftentimes, oh, geez, I just, hey, you know, what, I was only able to come up with this much money. And so here's the new, you know, here's the new offer, right? There's there's the there's, there's a number of things that nefarious characters may try to do. I think that there's the people have successfully sold their businesses without the help of an advisor. Sure they have. But it's hard. And yeah, it can be self serving, but really go get an advisor, because they've seen it 100 times before, and they're going to help you to avoid the situation.
Ryan Barnett 21:49
And this is one where both the angle of where you're taking speed throughout the whole process can help, I think, reduce some of this as well. If you are if a process goes 678 months, and due diligence, it's it's very easy to get mired in the details and things materially change, compared to in materially and negotiation changes.
22:15
Mike, Matt I'll turn it over to you for any last kind of closing, closing thoughts here.
Mike Harvath 22:22
Sounds good, Ryan. No, I think I mean that I don't know if you have any further thoughts. But I think in the end, just to kind of bring you up to speed, based on daunting, but certainly there's a great opportunity still exists in m&a. And there's great deals getting done every month, your revenue rocket, and we certainly welcome the opportunity to have a dialogue with you about your business, if you have questions about it. someone approaches you with some offer that you think looks a little too good to be true. Feel free to call. And we can weigh in. certainly happy to do that on a call without any obligation to work with us, and can discuss your situation and see if we can help you make some decisions. Man, any other thoughts on Retrade before we wrap it up?
Matt Lockhart 23:15
No, I think great topic, Ryan. Thank you. Hopefully we we see this lesson less and it's not going to help get deals done and we know how hard it is to get deals done. In any event, so great topic and look forward to the next. Back to you Mike.
Mike Harvath 23:37
Thanks, Matt Ryan, without will tie a ribbon on it for this week. Shoot the Moon podcast here at revenue rocket that encourage you to if you have questions, send us a note at info at revenue rocket.com And feel free to pass on the podcast to anyone you know the benefit here either Apple or Spotify to listen in to the shoot the moon podcast. Look forward to you tune in next week. Take care and make it a great week.