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June 29, 2020

When Do I Need an Investment Banker?

A Great Question Since it Is NOT Business as Usual

Engaging an investment banker or financial advisor is often foreign territory to a business owner. Common first-time questions are: a) What do they do? b) When should they do it? c) How do they add value? and d) How is the right one selected?

Key Takeaways

  • When it comes to selling a company or raising capital, going it alone is ill-advised.
  • The need for an advisor typically arises long before a transaction occurs.
  • Good investment bankers drive a selective, proactive process to maximize value.
  • The best investment banker is less a broker and more a trusted advisor.
  • You get what you pay for!

The Misperception that Going it Alone Saves Money

Public company boards have a fiduciary duty to maximize shareholder value. This legal obligation means that public companies have little choice but to engage an investment banker or financial advisor to sell, acquire or raise capital. Sometimes third-party valuations are also required.

While there are also fiduciary duties to act responsibly in private companies, owners have more flexibility around this particular issue. For the lower end of the middle market, often the choice is not which investment banker to engage but whether to engage one at all. This flawed mind-set underestimates the complexity of the transaction and overestimates potential cost savings – how hard can it be? … think of the money we’ll save! Private companies generally tend to be smaller, so owners can, understandably, be more frugal. But in the world of transactions, being penny wise and pound foolish carries enormous risks.

An investment banker is not necessarily any smarter than an owner. However, having completed hundreds or thousands of transactions over the years, he has experience on his side. The owner certainly can perform some of these functions himself, but the right advisor is likely to be far more efficient and successful in producing a superior price and favorable terms. And, if an investment banker’s compensation is outcome-based, incremental proceeds will usually amount to several times the negotiated fee.     

When Does the Need for Expert Third Party Advice Arise?

Suffice it to say, the need for an investment banker arises much sooner than most owners recognize. One of the most common owner errors is to inadequately prepare, since an acquisition or sale is mistaken for an event when, in fact, it is a process. Owners often find themselves in the undesirable position of being reactive versus proactive, responding to an unsolicited inquiry and doing all they can just to keep up. The key to achieving the best result in a transaction is to control the timing of events, maintain momentum, have data and facts at the ready, and keep all parties honest through a discrete but competitive process. This is a full-time job in and of itself. A qualified advisor has the expertise and processes in place to ensure proper preparation and develop a sound marketing strategy.

There is also a lot to say for having a third-party in the mix to convey difficult messages and hold those on the other side of the table accountable. If an owner decides, for example, to sell control but maintain a minority stake, a sound relationship with the buyer is important. However, negotiations can be tense and generate hard feelings. An investment banker can wear the black hat and take the brunt of the friction. Incidentally, if at the conclusion of a transaction there was never any tension, then perhaps an owner should be concerned they did not push hard enough and may not have landed the best possible deal.

Having an Investment Banker is Advisable When:

  • An owner receives unsolicited offers for the company that begin to look attractive.
  • An ownership group is expanding or transitioning, even internally.
  • A business moves from owner-operator to non-owner management.
  • Capital is a constraint.
  • An owner worries about having too many financial eggs in one basket.
  • The succession plan calls for exploratory action to be taken.

Hire Qualified Professionals – Trust is Paramount

There are many different types of investment bankers and business brokers. Boards often apply the “CYA Rule” in deciding who to engage and select a big name (e.g. bulge bracket firm). After all, even if something goes wrong, they are not likely to be blamed for hiring the name brand. But like most other smart decisions, it’s best to start out with the end in mind by defining what is needed and determining selection criteria accordingly.

Simply rushing to retain the industry specialist is a common mistake. But it makes sense to bring in a firm that knows the industry and all the players in it, right? Not necessarily. Much like engaging an attorney, the skill-sets needed to advise on an M&A transaction are transferrable across multiple industries. More important is situational expertise. Are they familiar with private, closely held and family owned companies, which have entirely different issues and dynamics than other ownership structures? And there is significant circumstantial risk that most owners overlook. With whom is the sector specialist more likely to be aligned? The seller who exits the industry after closing or the buyer who represents a source of future business? It’s an easy answer.

The investment banker operates as the liaison between buyer and seller. In this structure, it is natural for there to be conversations in which the owner is not present. The owner must be able to rely on his advisor to accurately represent his position and know the limits of the negotiation – how hard to push. It is critical that not only the owner trusts the experience and integrity of the banker, but that the other side does as well. Mutual trust leads to optimal results.

Less Broker…More Advisor

At the most basic level, business brokers and full-service investment bankers serve a similar function – to bring together a buyer and seller and facilitate a transaction. But this may be where the similarities end. Conventional business brokers have one set of skills and full-service advisors another. Brokers are adept at representing smaller businesses and reaching a large number of individual buyers. However, the practice of casting a wide net comes at a price for a more established private company. Rumors that a company is for sale is bread on the water for competitors and recruiters going after that company’s clients and executives. For many owners, the desire for a confidential and non-disruptive process is paramount.

For middle market companies, choosing the right advisor is about making sure the investment banker is deliberate, puts the time in, and is willing to find and create new solutions. If the only criteria for selecting an investment banker is their fee, it spells trouble – because you get what you pay for. A qualified and accomplished advisor is willing to base their fee on the results they create. Force them to put their money where their mouth is. Incentives are a good thing. But in the end, an owner should follow their gut instincts and ask, is this firm qualified to represent my company, do they understand my circumstances and objectives, and will they always look out for my best interests?

For more insights from the series, The Path to Private Company Liquidity: A practical guide to M&A for business owners, click here.