First Conversation to LOI Session 3

Establishing strong connections with a target company is essential in M&A. Securing deals can be challenging, but a strategic approach can result in mutually beneficial outcomes. In this episode of the M&A Science Podcast, Michael Frankel, Founder and Managing Partner of Trajectory Capital, shares his approach to deal-making from first conversations to LOI.

First Conversation to LOI Session 3

30 Jan
Michael Frankel
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First Conversation to LOI Session 3

First Conversation to LOI Session 3

“Never put an LOI in front of somebody that’s horribly disappointing because then you lose their attention, and it's hard to come back from that.” - Michael Frankel

Establishing strong connections with a target company is essential in M&A. Securing deals can be challenging, but a strategic approach can result in mutually beneficial outcomes. In this episode of the M&A Science Podcast, Michael Frankel, Founder and Managing Partner of Trajectory Capital, shares his approach to deal-making from first conversations to LOI.

special guests

Michael Frankel
Founder and Managing Partner of Trajectory Capital

Hosted by

Kison Patel

Episode Transcript

First conversation 

When I'm an active corporate development officer, I am not too fond of cold calling. I hate having the first conversation when the target has no idea who I am, and I want to talk about M&A. So I encourage my business leaders to think holistically about their ecosystem and think about companies they might want to buy.

The secret to getting free due diligence is through ecosystem partnerships. Sell the target company's product, put them into our broader solution, and co-develop marketing strategies. So in a perfect world, that initial conversation is with a business and leadership team that we already know. 

It makes everything easier because they already know you and like working with you. But if you are cold calling somebody, that first conversation is critical, especially with a founder-owned business.

Financial sellers are more rational. They want to maximize the purchase price. But a founder or a management team going with business will be very sensitive about the nature of the relationship. 

So if you are cold calling, I believe in doing as much intelligence gathering as you can. 

  • Who is in charge? 
  • Who has the authority to drive a deal?
  • What are their priorities?
  • Is the founder ready to go or wants to grow the business for another 5 years ?

You want to know all of this information before you have the first conversation. And then I'd like to come in with a warm introduction. If you're a large company, most corporate development officers will answer your call but receive it suspiciously. 

I always prefer to use my network and my management team, who knows the target company's CEO and introduce me. This introduction is incredibly powerful because the CEO will now be comfortable talking to me. 

A decent growing company with a brand will always get these kinds of calls. Maybe fewer acquisitions but a lot of venture capital & investing calls. Getting out of that noise and having somebody credible introducing you to the target company makes a world of difference to tee up that first conversation. 

And once you get that introduction out of the way, planning the first conversation very carefully to do more listening than talking is very critical. The foundation of all good M&A Is having a clear understanding of your priorities and an even more precise understanding of their priorities. 

If there is $10 on the table, M&A is not about who gets the 6$. It's about turning the $10 into $15, so everyone thinks they're a winner. And in order to do that, you will have to understand what the seller wants. 

  • Do they care about what happens to their employees? 
  • Do they care about their job and its upside?
  • Do they care about good PR and looking good on their exit?
  • Do they care about customer relationships? 
  • Where do they want to take the company 
  • What are there plans for the management team
  • What are the shareholders thinking about 

I listen a lot during the first conversation because that's the only way I'm going to frame something to them that makes them want to talk to me. 

Warm Introductions

The key is to find someone in your network, your management team's network, or your company's network that the other person trusts. It could be one of their investors, advisors, lawyer, or somebody they know from prior companies.

The goal is to get the target company to understand that you are serious about doing deals, are nice and reasonable, and will not waste their time. 

I know it's hard as a corporate development person, but try your best to avoid cold calling. You do not want your first conversation with a target company to be about a stranger buying their company. The chances of getting them to go exclusive with you and not turn it into a big auction process are much lower.

I'll give you an example of this. When I was at Lexus, a company told everyone they were not for sale, but we all knew they were attractive. So all the big players in the space wanted them. 

One of the guys at my Corp Dev team made it a point to reach out to the CEO once a quarter just to chitchat, gossip, and get market intel. He never asked him about selling the business. They ended up building a relationship, where they talked about other stuff for two years.

When we heard rumors that the company might be up for sale, my guy from Corp Dev reached out and told them we were very interested in them. They already know they'd be a good fit with our culture. We asked them to give us 60 days to look at the business before running a giant process.

Because of the existing relationship, they agreed to give us 60 days, and we ended up doing the deal exclusively. No one else had a shot at it. So, it's all about figuring out how to build a relationship outside the sales process. 

It seems like a tough investment of time, and you can't do that with every company, but you can do it with the one you're most attracted to.

First meeting 

What we try to hit on in the first meeting will vary based on whom I'm talking to. I will ask different questions when talking to an 85-year-old founder than with a 35-year-old founder. There's a bit of crafting to it, but generally, I would want to know

  • About the seller's business and where they think it's going.
  • What the seller wants to do with their business.
  • What the seller thinks their opportunities are.
  • How could one plus one be three if we were to build the business together.

Evident in this conversation, if you ask people questions about stuff they're interested in, they will talk a lot, especially about their business. Be sensitive and make sure they understand that you're not trying to delve into proprietary information, nor were you trying to get something competitive to use against them. 

When you haven't signed an NDA yet, you can only talk about financials in a very vague sense. But the goal is to get them to talk about their business to understand where they think the business is going and hear it from them personally. 

The goal is to know enough so that you can start to craft an offer that optimizes your results and theirs. Give them the 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. 

NDA and information request

Many early conversations allow you to send a message that makes them want to send the NDA

If you think about it from their perspective, it could be a distraction in dating, and they're giving away competitive information that you can use against them. You must prove that they should sign an NDA and give you information rather than just hire a banker. Usually, the fact that you are a big company with a big balance sheet is not enough.

So what I try to do early on is paint a conceptual picture for them of how this business could be great and how we can create a whole bunch of extra value. I'll paint a picture of a deal that maximizes financial returns and meets their other needs.

I'll give them a little teaser as to why this conversation could be beneficial, and I could be more accurate if they give me more information. 

People are more successful in getting information out of the seller if you give them hope of something exciting. The more information they give, the more accurate the offer will be. 

Coupled with an NDA is an exclusivity request. I want a period of exclusivity where this is a one-on-one conversation to get to an LOI. So you can put into an NDA that you either want an informal or a formal exclusivity agreement. It's nice to get that because I want to create as much acceleration of my bid ahead of anybody else's.

Part of that depends on how rigorous your diligence is pre-LOI and post-LOI and how your management team and board view signing an LOI. 

I've worked at companies that didn't care much about signing an LOI because they'll negotiate it post-close. Those people will sign an LOI based on a P&L and one phone call. 

I've worked at other companies that view an LOI as almost a moral commitment and one company where the conversion rate from LOI to close deal was above 80%. But either way, I want to keep exclusivity, formal or informal, as much as I can.

People involved in approaching LOI

The people involved depend on how rigorous we want to be in our diligence for the LOI. But at the minimum, I will want the following people involved and be aligned with:

  • Business leader – who will own the P&L. I don't want them agreeing to an LOI when they haven't thought through the business and then backing off of terms later.
  • The specialties critical to the acquisition basis – If we're buying a business for technology, I want a tech leader involved. For the customer base, I want a salesperson involved.

We're not going to do pre-LOI diligence on everything, but we're going to kick the tires on deal breakers or things that could radically impact the valuation.

I want those people to be committed and serious about an LOI because many business people will take it lightly. So I try to force them out of that because I don't want my time wasted either.

If you think about it, there's a difference between fundamental diligence and confirmatory diligence. Fundamental diligence is about ensuring 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. I don't mind If I find a lie late in the process because that will be the seller's problem. If the seller lied to me, all bets are off.

I'm less worried about financial due diligencelegal due diligence, and even code due diligence because those can wait until post-LOI. Because if you gave me a set of financials, and I've relied on it, and I discovered that your accounting is false, I don't feel bad about rescinding the LOI. 

But if my people found out that our assumptions were false regarding the product, then shame on us. We should have known that before we signed an 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–those are the people who have to be involved pre-LOI. Also, depending on deal size, involve the leadership that has to advocate for it.

As you go up the ladder in every organization, you go from advocators to approvers. For most deals, the board is an approver. They will approve when they're comfortable about it. Depending on how big the deal is, the advocator could be the company's CEO, the division's CEO, or the business unit's CEO. Whomever that advocator is, they have to be beside me upfront.

Figuring out who that advocator is in your organization early on and having a direct conversation with them is key, especially if they've never done deals before, so that they understand you're not the passive participant; you're the owner of this exercise.

Accuracy in Bids

For large-scale core assumptions, you need the business leaders to own them, and they've got to understand the business well enough. They have to know what integration will look like.

If you've done a bunch of deals for corp dev officers, you already have simplifying assumptions. You know what happens when a little business enters your business regarding back office operations, enabling areas, technology support, real estate, and other stuff. You should be able to sort those out and be accurate about them. 

But for the core assumptions, you have to rely on the business leaders, and they have to be serious about it. 

If you're trying to move fast to get to LOI, I'm a big fan of valuation ranges. Of course, sellers don't like them because they want to know for certain, but it's an excellent way to let them show you why you should give them top-of-the-range.  

Some sellers are willing to go along with that, but that gets back to trust. That's where building a relationship with them helps. But the biggest thing about financial modeling pre-LOI is don't be penny-wise, pound foolish.

Understand what levers will change the trajectory of the business and focus all your attention there. So if you have their P&L and merge it into your business, understand what will change. The core stuff is where you should spend your time. 

Use simplifying assumptions on those more standard cost areas and focus all your attention on revenue and variable cost areas, like product management and product development. That's where you're going to figure out most of your synergies.

Also, 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 have to accept that you have to take your best shot at that synergy model. You're going to scare the business people by pointing out that the model will survive and come back to haunt them so that they're not overly aggressive in getting the deal done. 

And then you'll live with errors in that model, which there'll inevitably be. But if you're doing good M&A, there's enough synergy value for you to be wrong on some of the synergies and still have it be a good deal.

Revenue Synergies

I'll give you a simplified sales process where you don't need the CRO. If you can statistically say that the target company is relevant to 50% of your customer base, and when they pitch to customers, they convert 75% of the time. Include how often they pitch; you can do some math and haircut it back 10 to 20%. 

If it's as simple as this is another thing your salesforce will be selling, and there are no other complexities or value to the joint sale, then you can come up with a simplifying assumption, but I would still bring in the CRO. 

If the difference is more complicated than that, if part of the reason we want to buy them is they are going to generate about 15 million of revenue for us, 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.

It got complicated because of those incremental wins you attribute to this acquisition. So that's where you need the CRO to step in, because now it's a complicated question. It's not just how much of their product you can sell, but how much of the other stuff you can sell, because we have the new product. 

If it's that kind of a hypothesis, you need the CRO involved right at the outset, and you need them leaning in. 

The reality, though is that everyone thinks projection models are a science. It's not a science–it's an arc. You are never going to get it perfectly right. The key is to get the big things as right as you can, and the small things in the right range. That's all you can hope for. 

No amount of diligence is going to eliminate inaccuracies in your projection model, they'll reduce them. But you could diligence a company for ten years, your projection model wouldn't be exactly right once you close the deal.

That's why I bring the integration people in at the front end of the process because I want them to own those assumptions. And if they want to challenge it, I'd rather they challenge it upfront. I will at least bounce integration off of the integration leader before LOI. I may not be the majority there, but it's a good thing to do.

Now, this assumes you have an integration leader. It's different if you have a professional integration leader. For example, when I was at Lexus, integration reported to me as the integration leader was one of my people.

He would first look at any deal we were looking at and submit an LOI. Then, based on his extensive experience, he can point out what will be easy and what will be a problem. So we had a gut sense. 

The problem occurs when the integration person is taken out of the business ad hoc for the deal because then no one will pull someone out of a role until you're well past LOI.

So, you have to go back and give them a chance to revisit the model, but then I go back 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 due diligence and integration planning, it's still a good outcome. 

Formulate the winning terms

Now I've got my model, my views on the business, and my views as to how strategic it is. Is it a must-have or a nice-to-have? 

If I'm doing a roll-up and one of the 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. 

I put all that together in my mind, and most importantly, I assess what the seller wants. Too many buyers focus on what makes them happy. 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 of the seller, so I can get a little bit of a gut reaction.

Now, they're playing a little bit of a game too, so they're never going to give me total transparency. But I can usually get somebody's language out of them. If they're overjoyed at my valuation, I have a problem. I'm probably overvaluing the business. 

I'm trying to tell the difference between slight and extreme frustration, but more importantly, all the other terms of the deal. I'm trying to suss out whether I've got other things on the table that are exciting to them. 

I want to feel-test different ideas with the founder or the CEO, because then I can refine my offer to make it better for me and more likely to be accepted. 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.

  1. I want to ensure I've explored every way of creating value.
  2. You never want to put an LOI in front of somebody that is extremely disappointing because you may lose their attention. 

You never want to offer them 10% of what they expect because then they'll reject you since you clearly don't know the value of their business, and it's tough to come back from that. So I want to try to get to the place where they are slightly disappointed. That's a good starting point to the negotiation.

A medium disappointed, but still willing to engage with me. Get as much value as you can, but also ensure that the deal doesn't run because once you slide that LOI across the table, there will be a period of silence. There'll be a call where they ask questions, then they will talk to their advisors and their board. 

You need to make sure that they think they're close enough that they come back to negotiate with you. 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.

How to draft the LOI 

When drafting the LOI, reflect and work with your lawyers, especially if you're creative. So if all you're doing is saying X dollars, your lawyers will get that LOI done quickly. But if you start to do things like:

  • Retain the brand
  • Maintain your employees on similar benefit systems
  • Maintain a leadership position similar to the one you've had
  • Earnouts 

All that stuff makes a lawyer's hair stand, 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. 

Even as you're sliding the LOI across the table, messaging is really important. Maintain a tone of trust and honorability. When you share your LOI, message your intent and show them that what you are trying to do is respect the value they've created. Structure something that addresses what they told you.

Show them that you listen to your first conversation and put that into paper. Even though you have to do what's best for your business, you need to show them that you want the deal to happen, and you see that there's value to be created if it does. So give them your best intent and listen to their feedback.

Position the LOI in a way that they know you heard them, and you tried to reflect their interests. You're open to being flexible and negotiating so that you maximize their reaction to something they don't like. You want them to attribute good faith to everything you've done because that will bring them back to the table to correct you on stuff.

Delivering LOI

I prefer to walk people through it live. Legal language is hard to digest, and if you walk them through it live, you tie a string back to the things they've said.

If they accept this, I get on a Zoom with them, and I screenshare the LOI and talk them through the sections. Walking them through the LOI sections serves two purposes: 

  • So that they understand your intent, your good faith behind the terms, and the logic behind the terms. 
  • For business people who have never done M&A before to understand some of the legal structures and how it all works

If they want to give feedback right there, that's fine, but I don't want to pressure them into giving feedback right away. They can sit with it, talk to their advisors about it, and then we can set up a call in a few days to hear their feedback. 

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

Time-based incentives

I'm hesitant to put an expiration date on an LOI because I'm not trying to be abrasive. I hold them to a reasonable standard, and part of it depends on the control structure.

You can talk to your advisors. If you're the actual decision maker, I'm expecting that you can get back to me within a few days. If you have private equity owners, a board, and 10 shareholders who each have more than 5%, I'll be more sympathetic to you as you will need enough time to communicate with a lot of different people. 

It varies, but I don't put up a deadline because it doesn't serve any purpose to anybody unless they're desperate. Unless they're about to go into bankruptcy or running out of money, anybody will react negatively to that. 

So instead, I have a reasonableness standard where I ask them how long they need to be able to talk to their people and come back and when we can set a date to have that conversation. I try to schedule our next meeting while we're still on the call, presenting the LOI. That way, we can create a time slot. 

I will not officially withdraw the LOI right away. It's an LOI. It's non-binding anyway, but we set expectations between each other about when they can get back to me. 


In negotiations, I think about all my cards and the different variables. This is a lot like compensation negotiation. When you get a job offer, you go back and ask for more. You think about all the different stuff you have and come in with a strong offer, knowing you can go best and final. 

Before sending an LOI, I always have the best and final conversation with my management team so we know where we'd be willing to walk away. And this comes back to the question, is this a must-have deal or is it a nice-to-have deal? But either way, there's a best and final somewhere. I know what that best and final is. More importantly, when I know which variables I'm more comfortable giving on. 

I'll often have a conversation with my management team where we're not willing to go much higher on the core purchase price, but we would go a lot higher on the earnout because the reality is, if they hit these numbers, we'll be okay giving them the extra money. 

There are many ways to skin the cat, but 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 in a week and present their counter?

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 headed in. 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 the different leaders and offer 10% more.

You have to figure that out in advance so that the authority to negotiate is either exclusively with the corp dev officer or with 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.

Price range in an LOI

Setting a price range is most effective when you're doing a very quick LOI, where you haven't done much diligence. When you can keep the range small enough, effectively, you're showing the seller that they would want to do the deal even at the bottom of the range. 

It makes sellers nervous because they assume that 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.

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, you would get huge additional synergies because you've been trying to penetrate a certain Fortune 500 company. 

It would be hard for you to nail down exact synergies, so you will have to settle for a certain range. If there are zero overlaps in the customers, they'll get the highest possible. If there are many overlaps, they'll get the lowest possible, but you still want to buy the business. 

The range can't be too far apart. The further apart they are, the more baloney your LOI is. So if your LOI is between 50 and a hundred million dollars, it's not an LOI. It's a keep doing due diligence piece of paper. But if your LOI is 57 to 64, it's more helpful to tell them what it's based on that will determine where you end up in that range.

Creative LOI structures

There are infinitely creative ways to structure an LOI. As an example, if the seller is not a founder but it's a corporate spinout, there are all kinds of value-creation tools.

For example, transition services are a way to run money through their P&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&L. They may care about:

  • Branding
  • Employees
  • Customers
  • Retention of the executive team.
  • How the deal is characterized

I've seen deals where they care; how is this message to the market? Is it messaged as a sale? Or is it messaged as a joint venture because the seller will 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 if they will all leave, and you have 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 they would want to stay.

There are a lot of different variables in an LOI. This is why I go back to that first conversation. What will make the seller happy? I turn that into a bunch of variables, and then I turn that into an LOI. Then, I go to my lawyer and tell them what I want to happen, then they turn in a bunch of languages.  

As an ex-lawyer, the other thing with LOIs is I try to separate the business terms from the legalese as much as possible. Because, in my experience, business people get slogged down in legal terminology. 

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 an LOI and term sheet. An LOI is very high level and is business terms. In the term sheet, the lawyers pour in all their language. You 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. That's why I don't even try to start with levers. Instead, I start with what's the outcome we want to have, even if it's a non-financial outcome. 

Term sheets are not a standard thing. It is the end state that the other side wants to achieve. Give them everything they want that costs you nothing. That's the best thing in the world. And then inevitably, they would want the price to be 10% higher, and that's when you negotiate.

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