Wonder what investment bankers do to sell a company? How long it takes, how much they’re paid, whether they’re worth it? How to choose one?
Wait, Should I Use a Business Broker Instead?
The simplest distinction between an investment banker (IB) and broker is based on the size of deals they do. Brokers generally handle businesses valued well under $10 million with some doing deals worth less than $100,000. But the differences go deeper than deal size alone.
For more detail on those differences – and to determine which of the two types of intermediaries best fit your needs – see WHICH TO USE — INVESTMENT BANKER OR BUSINESS BROKER? Should you decide to sell your company without any sort of advisor, Investopedia offers some advice.
And How is “Sellside” Different from “Buyside?”
In sellside M&A engagements, IBs seek buyers while in buyside engagements they pursue sellers. In both types of projects, the IB must understand the client’s circumstances (especially the company’s financial characteristics); what would motivate a buyer to buy and a seller to sell (i.e., strategic drivers); what the ideal target or counterparty looks like and why; and what the deal is worth.
And in both cases, the IB must find, attract and qualify targets, then assist the client in negotiations through to closing the deal.
But otherwise, sellside and buyside campaigns are quite different. It’s only for sellsides that IBs:
- Conduct deep due diligence on the client before going to market in order to represent them accurately for sale and to anticipate and resolve issues that ding seller value.
- Use that due diligence to write and circulate a “book” to qualified potential buyers that describes the seller in detail.
- Herd buyers through a series of tightly scheduled stages that ideally culminate in an auction where they compete to purchase the target. In contrast, buyside campaigns are a series of one-off encounters with potential sellers as the IB finds them. We’ll now go into more detail on the sellside process below.
Aligning the Interests of Client and IB
Another distinction between sellsides and buysides is how the IB is compensated. For sellsides it’s usually a straightforward matter. Since the seller is mostly interested in maximizing value on exit, paying the IB more to do that puts both of them on the same side of the table. They do that with a success fee calculated as a percentage of deal value. The percentage may be fixed or declining as deal price rises.
But that structure may be unwise for buyside engagements. Who wants to incentivize their IB to promote a purchase price higher than necessary? A partial work-around to this problem would have the buyside IB earning a success fee that is:
- A declining percentage of the deal’s value up to a maximum or capped amount.
- A flat amount regardless of purchase price;
- A flat amount plus some percentage of the amount saved compared to the seller’s first ask.
But know that in general, the more complicated the IB’s compensation scheme is, the more prone to misunderstanding and tedious accounting it becomes.
What IBs Like
While most IBs will accept both buyside and sellside projects, they tend to prefer sellsides despite the fact that they demand harder and longer work. That’s because sellsides are more likely to close, do so within a more predictable timeframe, and typically pay more.
As the saying goes, potential buyers very rarely must buy, but all sellers must eventually sell. The reasons could be a desire to retire, pass the business to the next generation, health issues, burn-out, a particularly attractive offer, financial pressure, etc. The phenomenon is captured in the phrase “that company is in play.”
The Sellside Journey
We describe below what we here at Kuhn Capital do in a typical sellside engagement broken down by stages and the time elapsed between them. We can’t speak for all investment banks but competent ones follow similar processes.
Stage -1: Valuation (2 weeks)
We complete a valuation first because nobody wants to go into the market only to find that pricing expectations are unreasonable and so closing a deal is unlikely. To value a business the IB must conduct at least preliminary due diligence on the potential seller and use several techniques that ideally converge on a tight value range. For more about valuation techniques see HOW TO VALUE A GOING BUSINESS and HOW TO VALUE A START-UP.
Stage 0: Investment Banking Agreement (IBA) (2 weeks)
Assuming both parties have a shared expectation of value and how long a sale could take, next they agree on what services the IB will provide and how the client will compensate the IB for them. That compensation consists of two parts: 1) A retainer to defray the IB’s expenses pre-close and confirm the client’s commitment to the process, and; 2) A success fee contingent on close. For IB fee details again see WHICH TO USE — INVESTMENT BANKER OR BUSINESS BROKER?
While the stages below may appear to unfold in a strictly sequential fashion, in fact they overlap with portions of different stages underway at the same time. In addition, how much time a stage actually takes depends heavily on the complexity of the business, how quickly management makes company data available, and how quickly they complete certain tasks necessary to become market-ready
Stage 1: Internal Due Diligence (4 – 6 weeks)
Conducting internal due diligence (DD) is a tedious step but for several reasons a critical one that the IB must complete before marketing the client’s company. During it, management and IB work together to gather all company data that the IB anticipates – based on experience – buyers will want to see including the company’s history, market, customers, operations, staff, financial performance (both historical and projected) and reason for sale.
Sellers typically find this stage to be the most demanding and may wonder why so much is asked. Then they remember that the point of all this probing is to find problems before a buyer does and fix them where possible.
Examples of the sorts of problems uncovered: gaps in operating and financial data, accounting errors, incomplete corporate books, potential tax or legal issues, loan covenant violations, weak intellectual property protections, an unclear or fragmented cap table (stock ownership registry), etc.
See a detailed list of common, fixable issues at HOW TO INCREASE YOUR COMPANY’S VALUE: A CURB APPEAL CHECKLIST
More positively, the exercise can also expose facts that support previously unknown arguments for value. These often have to do with customer characteristics and behavior, or the growth and margins of certain products.
By the close of Stage 1, and now armed with detailed information about the company, the IB has likely become more knowledgeable about the company even than the owners themselves, and its best representative to the outside world.
Stage 2: Prep for Market Entry (4 – 6 weeks)
Now the IB can begin work using DD data to compile a presentation of the company’s circumstances, a document known as a “book, “memo” or “CIM” (confidential information memorandum).
But more than a mere compilation of facts, the book should lay out arguments for value by pointing to the factors that drive acquisition multiples in the industry.
Examples of such factors: sales growth, margins, customer or product line diversification, manufacturing economies of scale, etc. (BTW, the IB may also selectively emphasize certain value drivers depending on the buyer.) Alert IBs can use regression analyses to isolate those factors.
We here at Kuhn Capital consider the degree to which a book is clear, error-free and compelling to be a key IB deliverable, one that we take pride in completing.
Stage 3: Market Entry (4 – 8 weeks)
For a client that isn’t among the largest in its industry, the IB creates an initial prospective buyer list of up to 300 initial candidates. (This number and all that follow vary greatly depending on the industry and characteristics of the client’s company.)
Initial buyer candidates are of two types — “strategic” and “financial.” Strategics are operating companies, financials are PE firms. The IB boots maybe half of this initial 300 for various reasons – data errors, poor strategic fit, insufficient funds, possible tire-kickers, close competitors, etc. In any case, competent IBs don’t approach any prospect without advance client authorization.
The IB contacts the surviving 150 with a brief “teaser” describing the opportunity. Two-thirds of them will ignore it. If the IB feels strongly that a target should respond, he/she will make additional efforts to follow up till obtaining a definitive answer and, if it’s no, the reason why.
Follow-up is particularly called for with strategics where who’s responsible for M&A may be unclear, or when several executives must coordinate over an extended period of time before responding.
Finally, the IB sends those who expressed interest — perhaps one-tenth of the original list — an NDA which about half will sign. Buyers must agree to confidentiality as a condition of book receipt and the paperwork may prove too bothersome for some with only idle interest. Au revoir.
Stage 4: Qualify Leads (4 – 6 weeks)
Now we’re down to about 5% or 15 who’ve signed an NDA. The IB’s next objective is to extract from them by a certain date a letter of Interest (LOI) which outlines the terms of their offers. As small as the number of buyers that remain standing may appear to be, it’s enough to argue convincingly that the seller is an attractive entity and that bidders should expect competition.
The ability to make this argument is one of the most compelling reasons to retain an investment banker. Competition clears the market at the best price.
For greater detail on how types of seller auctions vary depending on the nature of the seller, see Wall Street Prep’s article.
After reviewing the LOIs — and after the IB converts apples and oranges to apples so that the client can meaningfully compare them — they select perhaps the two strongest bidders and attempt to improve their offers.
Finally, having alighted upon the “best” offer (best is some combination of terms, chemistry and trust), buyer and seller are set to begin haggling over purchase agreement language in Stage 5. Meanwhile, the artful IB will attempt to keep the second choice on a backburner should the leading candidate falter.
Stage 5: Prep for the Deal (4 -5 weeks)
Of all the stages, this one’s length is the least predictable. That’s because the deal is now largely in the hands of lawyers who are (ahem) on the clock, as are also at least to some degree, accountants. Put another way, neither are explicitly compensated to close the deal.
(Speaking of counsel, to reduce chances of blowing up the deal over minor issues or procedural missteps, hire one with documented M&A experience.) For a catalog of ways to avoid derailing a deal, including that one, see HOW SELLERS KILL M&A DEALS.
If conflicts arise in negotiations as the parties crawl through documents, another value of capable IBs is their ability to act as bad cop while preserving the client’s good cop image.
Stage 6: Close (4 weeks)
A deal may close (defined as the execution of a definitive sale agreement and related documents) before value actually changes hands. That time gap, in addition to a cushion to absorb delays in the rather unpredictable Stage 5, adds another month to the sale process for a total of 6 to 9 months. That may seem like a long time but the average for mid-market deals is 8.5 months. (BTW, we usually beat that average.)
How to Choose an IB
The differences between sellside IBs get down to:
- Persistence over extended periods;
- Financial modeling and valuation expertise;
- Attention to detail;
- Clear, persuasive communication skills;
- Ability to identify and demonstrate sources of seller value;
- Conversely, ability to identify and solve issues that ding value;
- Creative insight into what buyers consider valuable and how to position the seller accordingly;
- Seller industry knowledge;
- While who you know has traditionally been considered important in investment banking, it has become substantially less so in the age of Internet connectivity, especially for mid-market and trans-national deals.
Some IB Value-Add
Are Sellside IBs Worth It?
A flip answer might be that IBs wouldn’t exist if they didn’t create value. But a survey of over 3,000 transactions provides a quantitative response – IBs increase the sales price of their mid-market clients by an average of 25%.
Wrapping Things Up
Most company owners and managers find selling a business to be among the most demanding undertakings of their career. Bankers act as Sherpas, guiding their client through unfamiliar terrain, easing the burden and freeing management to concentrate on the business, anticipating obstacles and optimizing opportunities. Do they succeed at these tasks? The proof is in the sale price.