When is the right time to consult with an investment banker? For Sellers (Corporate and Entrepreneurial)
As soon as business owners open the doors of their business, they should begin planning their exit strategy. One of the key components of such a plan is remaining aware of the potential market value of their business, the acquisition/consolidation activities taking place in their industry, and their business’ relative attractiveness to third-party buyers and/or investors. Periodic discussions with investment bankers/mergers and acquisitions (M&A) professionals are one way to remain current and up to date on such issues, even if there is no short-term need to engage a consultant.
Many business owners wait too long to educate themselves about their various exit strategy options including, but not limited to: (1) a sale of the business to a third party; (2) pursuing an internal buyout [either by straight management buyout (MBO), or by an MBO with a private equity fund]; (3) implementing an Employee Stock Ownership Plan (ESOP); (4) divesting of part of their equity in a business via a Recapitalization (Recap); or (5) facilitating a transition to the next generation management team. Then, when the need to choose an exit strategy is thrust upon them due to illness, death, divorce, business reversal, or if the timing of their exit strategy coincides with an economic downturn, those business owners wind up with a limited number of options and/or a low transaction value.
Minimally, when a business owner eventually begins to consider the prospect of a sale of their business as a plausible idea, other than just early Monday morning, it is necessary for them to begin educating themselves. The best time to sell is when there is no time pressure. Accordingly, at least 1 or 2 years before the business owner wants to exit the business, he/she should begin interviewing and selecting the firm they would like to engage. Assuming the business owner has begun the process early enough, the investment banker can often provide suggestions as to strategies for improving the business to make it more attractive to potential buyers and maximize its ultimate value. Further, to the extent a transfer to the current management team, or the next generation of family members, is desired, a multi-year process is often necessary to produce the best result for the current owner.
Even if the owner does not take these steps before their need, or desire, to exit becomes imminent, at an absolute minimum, they should at least make sure they contact an investment banker before they: (1) share the fact they are considering a sale with anyone who is not an equity owner in the business, or one of its professional advisors; or (2) respond to any buyer inquiry, especially before sharing any information with them about the business, particularly if the potential suitors are competitors. In no event should a business owner begin soliciting offers from buyers before they have assembled their professional team and: (1) committed themselves to the divestiture process; (2) developed a clear understanding of how buyers are likely to value their business and the tax implications such a divestiture may have; (3) determined how to protect confidential and proprietary information; and (4) developed a detailed list of their financial, employment, real estate, and other goals.
For Corporate Buyers
To some extent, the best time for a corporate buyer relates to how aggressive the acquisition program is and the importance of its timetable. If acquisitions are merely being considered as one of several parallel strategies to attain the business plan and are viewed as attractive only when opportunistic (ie. low price, attractive terms, a large company divesting itself of a non-core business, death/disability of key management team members that render the business unattractive to other buyers), it may not be necessary for a buyer to prioritize consulting with an investment banker. Generally, such buyers will employ a passive approach that occasionally results in an acquisition. Typically, this approach involves some combination of: (1) responding to direct investment banker solicitations; (2) alerting their professional advisors, lenders, and suppliers that they are interested in exploring acquisitions; (3) attending industry functions; and (4) calling up their friendly competitors. These passive approaches typically result in senior management time being wasted on unattractive candidates, and rarely develop compelling acquisition targets. However, at least consulting with an investment banker periodically can surface precisely the type of opportunistic acquisitions, which such buyers find the most desirable, but, assuming the seller is represented by a competent investment banker, at a higher price.
If, however, the principal determinant(s) of the near and long term success of the company’s business plan is/are: (1) near term acceleration of financial performance growth; (2) expansion of the business’ distribution channels and/or product offerings; (3) the need to absorb excess overhead; (4) significantly increasing the business’s capabilities and skilled personnel; or (5) access to certain cutting edge technologies/processes, which are not a part of the current business, but are needed to enhance its competitive posture, a buyer should immediately consult with an investment banker. Ideally, that consultation should take place in the early stages of the development of the buyer’s acquisition criteria. The investment banker’s knowledge of prevailing pricing, deal structuring techniques, and financing trends, coupled with the buyer’s operating and marketing knowledge will typically result in a more realistic assessment of suitable acquisition candidate availability and financial results.
For Entrepreneurial/Private Individual Buyers
Most entrepreneurial buyers that are interested in acquiring a business adopt a passive approach similar to the one that is often employed by corporate buyers. These buyers typically employ a combination of aggressive networking with their professional advisors, lenders, and former co-workers, and direct contact with a large number of business brokers and/or investment bankers. Many such buyers spend most of their time responding to advertisements in the Business Opportunities section of their local newspaper. Further, they typically develop only the most generic acquisition criteria and the most rudimentary business valuation metrics. Consequently, many of these buyers wade through a tremendous number of businesses that: (1) have little or no documentation available to support the seller’s assertions; (2) are ridiculously overpriced; (3) are not even close to the type of business they would like to acquire; (4) are rapidly self-destructing; (5) require financial resources well in excess of the buyer’s means; or (6) require specialized knowledge/skills the buyer does not possess.
Depending on the time frame in which the buyer will be able to mobilize its financial resources and begin working in the business, it may be best to engage an investment banker to: (1) assist the buyer with acquisition criteria development; (2) provide insight into the potential size and financial and operational characteristics of acquisitions the buyer may explore; (3) develop a list of specific companies to be approached on buyer’s behalf and approach them to explore the possibility of a divestiture; (4) gather information on those candidates which the buyer selects; and (5) assist with opportunity analysis, offer development and negotiation.
How to locate an Investment Banker?
There is a wide variety of potential channels through which a seller or buyer can locate an investment banker. The following are just a few of the potential ways in which one can locate an investment banker:
- Referral – Often, a seller or buyer’s professional advisors, financial institutions, or friends who are active in the business community can refer them to an investment banker. Also, Chambers of Commerce, Manufacturing Associations, and quasi-governmental economic development groups will frequently be aware of skilled investment banking firms in the area. The referral source should have had specific experience with the recommended firm and will be familiar with its resources, industry and size focus (if any), and past performance. Referrals are the best way to locate qualified investment banking resources because referral sources are usually well connected in the business community and familiar with the scope and relative quality of services provided by the various firms in the area.
- Direct Solicitation – Most businesses with Revenues over one million dollars will be contacted at one point or another by one or more investment bankers or business brokers. While many of those contacts may be “fishing trips” designed to provide an opportunity for the investment banker to convince the business to engage them, some of these contacts will be actual timely situations in which the investment banker is engaged by a specific buyer to perform a targeted search on their behalf. As always, one of the real challenges is selecting the most appropriate firm for the assignment. Obviously, third party resources who can independently vouch for a particular firm’s ethics and competence can assist with the evaluation process.
- Professional Associations – There are a variety of professional associations to which many of the top investment banking firms tend to gravitate. The following are just a few examples of such organizations: Association for Corporate Growth (ACG), Association of Mergers and Acquisitions Advisors (AMAA), Institute of Mergers and Acquisitions Professionals (IMAP), and M&A International (MAI). Typically, these organizations can provide interested parties with a list of potential advisors. Often, these associations will maintain websites that will allow interested parties to locate investment bankers in their geographic area. Even if an association does not have such online search capacity, it will have programming staff who can direct interested parties to appropriate firms. In most cases, these organizations (as well as others like them) do not have particular standards for membership. Accordingly, membership in one or more of the aforementioned associations is not a guarantee of competence. However, such associations may provide a target rich environment for interviewing potential advisors.
- Yellow Pages and Internet – Although most of the top investment banking firms rely primarily on their reputation and past successes to generate new clients, most will have a website and at least a small listing in the Yellow Pages. The only problem with this type of ground zero research is that it generally does not provide even a minimal level of qualitative information regarding the firm’s capabilities and appropriateness for the particular assignment. However, assuming a business owner has had extensive experience in, and has had success with, interviewing and engaging professional advisors, they may very well be able to develop the requisite comfort level through the interview process.
How to decide which investment banking firm is best for you?
- Trust – Do not engage a firm unless you trust them to protect your best interests and to advise you accordingly, even if that advice is in conflict with the investment banking firm’s interest in earning its fee (this is an important issue for both sellers and buyers).
- Client Advocacy – In addition to engaging a firm that will protect your interests and help you to avoid the pitfalls in the mergers and acquisitions process, the right investment banker for you is the one who will fight “tooth and nail” to get you the best deal. Since your investment banker’s job is to promote your interests and negotiate on your behalf to secure a superior transaction, even when those interest are diametrically opposed to those of the other party, finding an investment banker who is aggressive, confident and firm, without being obnoxious or arrogant, is likely to enhance your chances of securing a transaction that will meet, or exceed, your expectations.
- Industry or Business Type Familiarity – Some investment bankers specialize in specific industries, others specialize by business size, and still others take whatever businesses they can get. Obviously, the latter type of firm is not the one you want. It is not necessary that your investment banker have specific experience with your type of business, but, at a minimum, they, or someone in their firm, should have had experience with similar types of businesses. For example, a firm with experience in representing a variety of manufacturing businesses, but no specific experience with plastic product manufacturers, could very well be more than competent to represent a business which manufactures injection molded products. Conversely, firms that specialize in one particular may be a bit less likely to push the horizon and explore buyer candidates outside of the business’ immediate industry. Often, optimal prices and deal structures will be secured from firms who are not already in the business’ industry, but, by adding the targeted business to their business, will be able to achieve results well in excess of what either business could independently achieve.
- Location – In today’s world of international mergers and acquisitions and increased connectivity, it is certainly not a requirement that your investment banker be located near your business. However, there is a reason why most investment bankers tend to find their clients within an hour or two drive time from their offices. Quite frankly, it is easier to service a client’s account when it is within a reasonable drive time. Further, especially with respect to businesses that are likely to sell for under $10MM and would thus be candidates for entrepreneurial buyers, it is important that the investment banker have contacts with entrepreneurial buyers located near (within 1-2 hours) the business. Also, since almost all business divestitures and acquisitions require some form of third party financing, the investment banker, especially on a financing under $10MM, will typically be in a position to recommend local and/or regional commercial lenders who can “fast track” a deal. Commercial lenders generally tend to follow their buyer relationships wherever they go for larger financing needs.
- Size – It is important to make sure that the intermediary’s familiarity with transactions of a particular size and their negotiating style align themselves well with the parties involved in the transaction. Although there is little difference between a $5MM transaction and a $30MM one, once the transaction size gets much above $50MM, specialized expertise is required. There is a difference in the sophistication on both sides of the transaction that lends itself to a different approach and negotiating style. In addition, there are different regulatory requirements and often public company issues with which it is important that the intermediary be familiar. Conversely, an investment banking firm which does the bulk of its work in the $50MM+ arena, may be unqualified, or at least unsuited, to handling a $5MM transaction because of the unique issues which arise in smaller transactions.
- Compensation – Fees are always an issue for consideration.
- Guaranteed vs. Contingent: How much of the total fee is contingent on performance/success as opposed to how much is guaranteed in the form of retainers, etc. can be an indication of the investment banking firm’s confidence in their abilities to negotiate and close an acceptable transaction. However, sellers and buyers should be wary of firms who work solely on a contingency basis. Often, these firms take shortcuts and skip the important initial steps that are required to prepare properly and to locate the optimal buyer (or seller) because they are not being compensated to do such work. Further, these firms will typically focus on a warehouse concept wherein their business model is based on entering fee agreements with as many businesses as possible knowing only a small percentage of their engagements will be successful. The preferable approach is to engage a firm who is more of a boutique that focuses on a few assignments it aggressively pursues on its clients’ behalves.
- Magnitude and Structure: In addition to modest retainers (which may be billed in lump sum, monthly, or quarterly), it is typical that the intermediary’s fee be based primarily on achieving a successful transaction for the client. This fee is typically expressed as a percentage of the economic benefit to the client from a transaction. It is common for the fee percentage on incremental millions of dollars of economic benefit to decline as the transaction size increases. Often, people focus on the potential amount of the total fees when they engage an investment banker and forget that, since they have the ultimate right to accept or reject any offer and would only do so after factoring in the fees and their taxes, every investment banker needs to negotiate a transaction for their client that exceeds, or at least meets, their client’s expectations after deducting fees and taxes. Thus, whether or not an intermediary’s fees average 4% or 40%, they know they will have to get a buyer to pay enough for the business to cover their fees, the seller’s taxes and still leave enough economic benefit for the client to be satisfied.
- Acquisition or Divestiture Focus – Some investment bankers only handle seller or buyer assignments and approach those assignments in a particular fashion that might not be appropriate to the other side of the table. Accordingly, it is important to match an intermediary’s experience to the client’s objectives. Obviously, no intermediary can adequately represent both sides’ best interests in the same deal. However, there are firms who represent sellers and buyers, but never both sides in the same transaction. These firms are experienced on both sides of the table and, as a result of that experience, can often anticipate and more easily resolve conflicting interests and hidden concerns on both sides of the table. It is also important to note that there are also firms who refer to themselves as “transaction brokers” that function similarly to a dating service, merely providing an introduction of one party to the other, who seek fees from both sides of a transaction. Interestingly enough, transaction brokers often charge fees similar to those of a full service investment banking firm, even though the level of service is substantially less.
- Team – Regardless of which firm you want to engage, it is important to know which of their employees will be assigned to your project. Buying or selling business is no time for amateur hour, especially when, as it is for most sellers, it is a once in a lifetime chance to maximize the family’s financial security. Accordingly, one of the most important aspects of the process is establishing a comfort level with abilities and ethics of the individuals who will be specifically assigned to represent your interests. With larger firms, there can be a tendency to assign junior level associates to smaller assignments. This is the last thing you want to have happen to you when it is your business that is being sold. If your business is at the lower end of a firm’s stated target client market, you should be especially concerned about this issue because that is precisely the situation in which a junior associate, or senior level analyst is most likely to be your assigned representative.
- Longevity – Although the number of years a firm, or a particular dealmaker, has been in the M&A Field is not conclusive evidence of competence, firms with little or no history/track record of success should be scrutinized even more carefully than normal. One reason for the enhanced level of scrutiny is the depth of the firm’s buyer database. Simply as a result of being active in the M&A Field for a period of time, a firm will become familiar with the criteria and identity of a wide variety of buyers. Firms who have not developed extensive proprietary databases and personal relationships with high level executives of potential buyers start the divestiture process at a substantial disadvantage. These are only some of the issues a business owner/executive faces when deciding which investment banking firm to engage. Others include the process the firm employs, the manner in which it protects confidentiality, international reach, etc. The key factors in maximizing the results of any M&A process are: the right team, the right plan, and the right prospects. Choosing the right investment banker is a key first step in determining and defining these key factors.