The Best Bank for Your Buck

It’s like JDate, Match.com and Tinder… only with companies. It’s a lonely Saturday night and the CEO of a company is watching SNL, wishing the show were funnier. Alone. Were the company only public, there would be some raging party with both red AND white wine being served, this time with bottles whose tops were stopped with corks rather than screw tops, the way they were when the company was founded seven years ago.

Our fictional company (let’s call it CouchCo) has $300 million in revenues, $100 million in operating profits and wants another $400 million in the bank to open China, Latin America, and Mars as markets, along with adding Bluetooth to all of its IoT-friendly lines of furniture. It is clearly time for this company to “go public.” It’s just waiting for a bank to swipe right.

Myriad ways exist today in which to perform this waggle dance. “Should we SPAC?” “IPO?” “Sell?” All good questions, but in most cases, the first step revolves around choosing the right advisor (think: investment banker) to open doors, give mathematical foundation to a valuation, and think through the various strategic alternatives available to this American success story.

But which bank? Which banker? Which analyst? How does one choose?

Well, to oversimplify, the larger the offering, the less the above matters. Facebook came public in the mid $50 billion range a decade-and-change ago, with virtually every bank begging Zuck for a piece of the action. FB could have used Joe Bob Billy’s Investment Bank and Golf Club Warehouse and done just fine. It’s the less-well-known companies who need more financial love.

Thirty years ago, Wall Street analysts freely and openly worked with the investment bankers who were their bosses to craft loving bullish “sell reports” lauding the greatness of whatever company their bank was … banking. Yes, colossal ethical friction behind this structure, but it’s how business was for decades. (And in all fairness, the IPO-a-day world fomented by the ’90s dot-com era exacerbated many of these challenges.)

Structurally, investment banks in this sense operate roughly as follows: A sell-side analyst who is deemed to be an expert in their field writes an investment report about a given company. It can be one already trading — or one the analyst discovered in the process of doing his/her normal daily research queries. That analyst produces a report, which the salespeople at the bank carefully digest — and then “market” to buyside buyers of that stock, with the belief that if the sell-side bank (brokerage) enlightened the buysider to a buying opportunity, the people who delivered that report to the investor would receive the commission for buying n million shares of that stock.

That relationship is rarely if ever formalized and is just kind of a handshake relic of the old world of Wall Street when commissions were a dime a share or more and the group of people inside of the bank who make markets in the trading of securities could make a decent living on commissions. But today the world is different. Computer matching of bids and asks changed the margins to buyers and sellers dramatically such that today a “fat” commission on a volume deal hovers somewhere below 3 cents a share. It’s so little money that the capital markets desk that manages this process went from being a profit center to being a cost center at most banks.

So we as venture capitalists have to understand that we are not dealing with the wealthy lavish divisions of the banks when we negotiate for deals. (Most banks of size today have their own proprietary hedge funds or hedge fund/investment platforms that allow for entrepreneurial buyside investors to relatively easily plug in and … start. It’s those divisions that generate the lion’s share of investment bank profits today.)

So back to our little IoT furniture company. We have a complex story. Why on earth would anyone care about yet another furniture company, albeit a high tech one, whose furniture sniffs the phone numbers and other data from everyone who has sat on its pieces and shares it days or weeks later in a fancy blog? “Tom Brady sat here on <date>” has been their most clicked-upon epiphany.

Does this company want a furniture analyst to cover them and to be the “axe” or “hammer” (i.e. largest influencer of buyside Wall Street people)? No. Not at all. Furniture companies trade for 6x EBITDA and have a cadre of investors generally afraid of their own shadows. This company wants a tech analyst with a reputation for breaking new growth companies. Tech companies trade for vastly higher multiples and thus raise capital more “cheaply.” That is, if a company has $100 million in operating profits and it wants to raise $400 million, if it trades at only 6 times that operating profit number or $600 million, it has to dilute itself massively to raise that $400 million, in this case dilution of something like 65%.

But if that company carries a pre-investment money round valuation of 30 times that operating profit number or $3 billion, then to raise $400 million, it has to dilute itself only about 15%. The gist is that company can raise capital way more cheaply via a tech analyst than with a traditional furniture analyst. (This is a bit glib — tech companies win the high valuations because they generally grow many times faster than do traditional old-world, wood-and-fabric builders using human labor, etc.)

But what if this analyst lives inside of a tiny bank with no capital markets desk of means, i.e. that firm has a prestige analyst but only weak relationships with the major buyside shops like Fidelity and Capital World? That’s a problem. It means that the salespeople inside of that small bank will have to beg and plead for meetings with the big players — and many simply won’t do business with them, because in a given $100 billion fund, to even be a 1% position, that fund manager has to buy $1 billion in positions for a given security. For tiny companies like this, it’s just not worth the effort. But does that matter? At this point, the company just wants to raise the capital. It can get on Fidelity’s radar later.

So maybe going with the prestige analyst who really knows the space and is the hammer in the sector is the way to go.

But what if there really isn’t a single hammer? In that case, the bank with the better capital markets team likely gets the swipe-right. That bank, through the sheer muscle of its distribution force, can “will” companies to go public and have myriad players who trade its stock. Said differently, if you can’t get Tom Brady, then go with whatever team won the Super Bowl last year.

But wait! There’s more! What about door number three: a sale?

In that case, we typically look to the investment bank that has done the most transactions with the target we hope to engage. Goldman Sachs brought MSFT public in the early ’80s. It has since sold literally hundreds of companies to the company. Today, they maintain a very tight relationship with Microsoft. So if you engage GS to sell your slightly used company to Microsoft, odds are good that your company will at least get a serious look from the MSFT Corporate Development team.

So what do you do? Or rather, what do we at Prime Movers Lab advise the CEO of CouchCo to do so as to optimize shareholder value and serve the many stakeholders who have helped build this company along the way?

The right answer is always the same. Hint: It’s a diaper company.

Yes, the right answer is… “It depends.”

Prime Movers Lab invests in breakthrough scientific startups founded by Prime Movers, the inventors who transform billions of lives. We invest in companies reinventing energy, transportation, infrastructure, manufacturing, human augmentation, and agriculture.

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