When Should VC-backed Startups Hire a Banker/Advisor?
I was a sell-side investment banker for over ten years. I am writing a series of blogs to share with you my experiences as well as to provide my recommendations concerning key elements of the M&A process.
One of the key questions that confronts many Boards is whether or not they should hire a banker/advisor to help with a sale process or inbound strategic interest. This is a decision that must be examined in many contexts to decide the appropriate action for a Board to take. Generally speaking, a good advisor provides a number of different benefits and capabilities that includes some or all of the following:
1) Brand Value
2) Strategic Buyer Reach
3) Due Diligence and Data Room Management
4) Insulation between the Management Team and the Buyer
5) Neutrality for the Investors
6) Negotiation of the LOI
Let me quickly walk through each of these six categories in a little more detail.
1) Brand Value
Each investment bank carries an implied valuation range and the hiring of a banker sends a specific message to the strategic buyer community concerning “expected valuation”. Fundamentally, the bulge bracket banks have a high end perceived valuation but their fee structure and deal minimums eliminate most potential clients. I always said to my clients that if they could get Goldman Sachs or one of the other majors, it would not be a hard decision but the economic reality is that unless the expected outcome is likely over $250 million you are going to need to look elsewhere. Every boutique bank has a range of deal valuations that they expect to work within so it is very important that you consider the median range of the boutique’s transactions in regards to your expected outcome. The boutique’s brand sends a strong message about what you believe your valuation will be so choose accordingly.
2) Strategic Buyer Reach
The fact remains that the best transactions occur when the company is not for sale. At the same time, there is value attached to a banker that has expertise in your space. I am less concerned about a specific buyer and more concerned about industry transactions. My preference always would go to someone who has worked within the scope of the company’s industry and understands the reality of VC-backed technology startups. In many deals that I was involved in, the management team and the board actually did not really know who the buyer was going to be, so having someone with industry experience who has completed transactions in the space is very valuable. Remember one very important fact, you are really hiring the Managing Director and not their firm. So be sure that this is a person that is committed to your transaction.
3) Due Diligence and Data Room Management
There were very few clients of mine that were fully prepared for a due diligence review and normally the CFO or Finance leader was extremely overworked. A good banking team can be extremely helpful setting up the data room and managing it for the company. They generally can be incredibly supportive as well on all the information requests in formatting and reviewing the information to ensure there are no inconsistencies or red flags. Good buyers want to see the data many different ways and 3rd party support to turn around the requests quickly is very important.
4) Insulation between Management Team and the Buyer
The buyer’s Corporate Development team would rather talk directly to the CEO than to a banker. However, my experience is that this is a very dangerous path for investors as in most cases management’s objectives are slightly different. It is very difficult for a CEO to have a tough negotiating session with a group that he or she may be working with when the transaction closes. I like having a banker that can push hard and be “thrown under the bus” if necessary. In addition, management does not want to establish a negative relationship in the deal negotiations as this can often be damaging post-closing.
5) Neutrality for Investors
Most cap tables are complex and often have different stage investors with different priorities and objectives. A good banker has a responsibility to work for all shareholders and can work independently with each of the constituents’ objectives to come to a fair and agreed upon solution.
6) LOI Negotiation
This is where a good banker can really earn their fee. They understand market terms and more importantly the deal term items that need to be negotiated prior to entering exclusivity.
The next layer in the decision making process that we need to consider is the stage of the transaction and the type of process that is going to be run.
a) Full Process
In the situation where the Board is looking to sell a company and begin discussions with a targeted group of potential buyers (Full Process) in all cases you need a banker for this type of detailed M&A process. There is no way this can be handled by the management team. I am also never an advocate of having a Board member who is a former banker leading this effort as you will need a team to get this job done right and it sends a bad, low value “Brand” message to the buyers.
b) Buyer at the Table
It might have just been my bad luck as a banker, but I was never able to find this table. Generally speaking, the management team did not really understand the stage of the discussions and mostly they were more premature than the management team perceived. My general guideline is that you are best off hiring a banker to help uncover other potential buyers while the first conversation develops into something more meaningful. Often, you can attempt to negotiate a small carve out if the existing buyer is truly far along in their evaluation.
c) Late Stage Discussions
In the event that significant due diligence has already been completed and you are just waiting on the LOI to be delivered it really depends on what the alternatives are for the company. If there is really only one legitimate buyer, spending the money to hire a banker at a very late stage is likely not worth it and could damage the interactions that have occurred between the parties. On the other hand, if you find yourself in the fortunate position of having multiple parties at a late stage of discussion, I would engage a banker immediately to handle the interactions as they have a good chance to help create an even more competitive environment where the additional valuation created will more than offset the success fee to be paid.
d) Auction
In the technology world that I operated in, almost no transactions were done using a formal auction process with the exception of some private equity deals. Most strategic buyers will not engage in a formal auction. The requirements around an auction dictate the necessity of having a banker/advisor organize this effort.
The final consideration is around the size of the transaction. The cost of hiring a banker varies quite a bit but with any recognized banker you are going to have a retainer, a success fee and more often than not a deal minimum, the amount the banker will be paid independant of the valuation of the outcome. Obviously, a bulge bracket banks fees are normally higher than a boutique banks in all three categories. My experience is that for transactions below $10 million it is tough to rationalize hiring a banker, between $10 and $25 million, the decision often rests on the value to be created by the banker and over $25 million, the additional cost is worth what an experienced advisor can bring to the deal dynamics.
In summary, Boards and Management need to investigate both the stage of the potential transaction, the value add that they expect from the banker as well as the potential realistic valuation outcome to determine what the appropriate decision should be. Please feel free to reach out to me directly at scott@inovia.vc
