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The Path to Exit
33 | The Do's & Don'ts of Hiring an Investment Bank When Selling Your Business
00:20:00
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- [00:02]
Podcast Host
Welcome to the Path to Exit, a podcast to help software and Internet founders understand the process to raise capital or sell their business.
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Mike Lyon
Hello and welcome, everyone. I'm Mike Lyon, founder and managing director at VistaPoint Advisors, and this is the Path to Exit. This show is dedicated to helping founders of software and Internet businesses understand what it takes to raise capital or sell their business and how to do it well. My guest today is Miles Lacy, managing director of VistaPoint Advisors. In this episode, we'll discuss best practices and mistakes to avoid when selecting a bank, negotiating fees, and determining the right time to engage. Please enjoy my conversation with Miles. Miles, thanks for joining us.
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Miles Lacy
Absolutely. Happy to be here.
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Mike Lyon
Before we get into the details here, let's just talk a little bit about the reasons founders should think about hiring a bank to help them sell their business. What's the use case for using a bank?
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Miles Lacy
So while I think there's a lot of different use cases, first and foremost is just going to be that selling a business is incredibly complex and at times can be a bit of a volatile process. And so whenever you're going through something that's complicated and frankly that lasts quite a while.
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Mike Lyon
Right.
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Miles Lacy
This isn't like a one day or one week process. It's months and months. It really helps to have someone who's been there before and ultimately an expert that can guide you through that process, not only in terms of what to expect, but also when you're negotiating with a buyer or an investor, what is market? So I think that's probably the most consistent feedback you'd hear from founders that have used banks in terms of the value that they add. I think if you hire a good banker, that banker should also be able to demonstrate their outcomes on the valuation of the process. So driving better valuations, better deal terms, using competition to your advantage to ultimately get a better outcome, those are all things that good and great bankers are able to do. But I think that's primarily why you would hire a banker. And then lastly, the amount of resources that comes with engaging an investment bank. Right. So having four or five professionals on your team working around the clock, you're able to just do more by having more manpower than you would if you were trying to do something yourself or even with a small internal team of executives.
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Mike Lyon
I think when we're talking to founders, there are some situations where it doesn't make sense to have a bank. To us, that's usually like the 10, 15 million and below capital raise, where there's not really any liquidity. Those transactions seem to make more sense Both from the size of the fee that a banker would get and how much time they'd be willing to put into it. But generally we see if it's a majority recap or a minority recap or certainly a full sale. Those are the situations that make the most sense. And I would just say hiring a bank is basically like hiring any other type of services professional. There's some fantastic bankers out there, there's some pretty good bankers out there, and there's some bankers that don't add a lot of value. And sometimes if you have a board with like maybe five or six board members, they might have had vastly different experiences with bankers. Right? Some have had really good experiences, some have not had great experiences. So just know that like anything else, there's a diversity of types of bankers and how much value they can add. Miles, let's start talking a little bit about some of the do's and don'ts they should look for when considering hiring an investment bank. Maybe start with like product and vertical expertise, sector expertise. How important is that and what are some of the other things founders should consider as they're starting to engage with bankers?
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Miles Lacy
So to understand how your business will be valued and really how to position it in the most attractive light, you really have to understand the sector, which means knowing the buyers and investors in that sector and in that category and exactly what they are looking for in businesses that they invest in and want to acquire. So for us, obviously that's software and Internet. We would not be the best bank at all if you had an industrial manufacturing business. And I think most folks here would probably have a difficult time knowing where to begin positioning those businesses. And I imagine the same is true if you were a generalist banker and you worked in CPG one day, cleantech another, you're not going to have, outside of what makes an attractive financial profile, very good insight into how to position and frame that business. So I think working with a bank that has extensive experience in your sector, working with strategic buyers that are relevant to you as well as investors that are relevant to you and your business is crucially important. And sometimes when you speak to founders and they've had suboptimal experiences with investment banks, quite often it is where they've worked with some type of generalist banker or a banker that just did not understand their sector or category very well. And that's a quite common experience for folks that have had poor outcomes. I also think the product here is important. So for us, once again, we only work on sell side fundraising and M And a transactions. If you were, let's say, going to raise a very large debt round or if you were thinking about even an ipo, we would not be the right fit. And the same is true for a lot of bankers that work on IPOs and debt capital markets. They would not be very good at helping founders raise capital or exit their business. So it's really about finding bankers that have experience in your end market, but also on relevant transactions and transaction sizes that make sense for your business.
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Mike Lyon
And one thing you should know as a founder going into this experience is you're at a little bit of a disadvantage because bankers specialize in sales and marketing. Right? We do a lot of sales and marketing to get clients, and then when we get clients signed up, sales and marketing of that business is a big thing of what we do. So bankers are really good at framing and positioning. Try to objectify your analysis of bankers as much as possible. So I'll give you an example. Like we were pitching on a recent deal and the other bank we're pitching against is kind of bringing up all these pie in the sky strategic acquirers who everyone kind of knows won't have interest in this business. It's really flattering to the founder. And I think the question I asked him is, how many deals has that bank done with those strategic buyers? The answer is none, right? So sometimes they're just really good at selling into the things that you are really excited about. So I think you want to objectify things as much as possible. Another thing that bankers never talked about is, so let's say a firm has done a ton of software deals, the team at the firm is turned over three or four times. All the knowledge and process knowledge left with the bankers who left the firm. And so a really important thing is when they're talking about deals like who actually led that deal, who worked on that deal, and are they still at the firm? Because if they're not, most of that knowledge has kind of gone away, right? The bankers working on the deal have the most intense knowledge. So try to get back to objective measures. Another thing to look out for is sometimes bankers will market deals that they weren't really a part of. The easiest way to know if a banker really worked on the deal is go check the press release. Most banks, if they advise on the transaction in the press release, it's not always true, but it's probably true. I'd say we're in about 90% of the press releases where we do deals. Sometimes there's just a buyer who doesn't want to disclose that much in a press release. But I think that's another good thing to check on because sometimes bankers make it seem like they were involved in the deal. In reality, they just got a lot of the down low on a deal from someone else. Let's talk about the average deal size of a bank and how that plays into basically finding the right bank for your deal.
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Miles Lacy
I think a lot of banks, they like to market their largest transactions, which makes complete sense. Right. Those are the ones that generally get the most press. The bankers like it because those are the ones that generated the highest fee, most likely. And so there's a lot of reason banks focus on that. But I think it's important to get a sense for what are also the smaller transactions that they do and then the overall mix between. So for almost any bank, you do not want to be their smallest transaction, but you also definitely do not want to be their largest transaction. Right. In terms of just familiarity with the complexities that come with a larger M and A deal and knowing the buyer and investor universe that plays at those larger check sizes. And the reason you don't want to be their smaller client is because generally from a fee perspective, it's just going to be a little bit less interesting for those bankers. So making sure you align well with the bank and somewhere in their average or median deal size is super important and really valuable.
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Mike Lyon
Absolutely. And I think what you're talking about, when you're talking about average deal size also is somewhat related to the fee. Right. So you don't want to be the biggest fee, you don't want to be the smallest fee at the firm. I would say the area of frustration I've heard from founders the most is let's say they hire a bank where the bank's too small and this is like a massive deal for them. Banker just wants that deal to close. Right. Because it's such a big fee relative to what they normally get. And sometimes that can lead to some not ideal incentives, particularly if the deals that are being presented are kind of marginal and you either want to negotiate really hard, hard to push them up, or maybe consider not doing the deal right coming back to market later. So I think being in that sweet spot is important. I think in general, you don't want to be the biggest, you certainly don't want to be the smallest. And we'll talk about fees later. But that also bleeds into the fee discussion because remember, most bankers, if they're good, are working on more than one deal, they might be working on 2, 3, 4, 5 deals at a time, you could inadvertently be competing with some of the other deals if the fee is too small. So something to think about. When we talked about the actual bankers on the deal, what are the things you should be doing diligence on and some of the questions you're asking. Banks, like other professional services firms are notorious for. They have this sales team that comes in right and sells you on hiring them. They're usually the most experienced folks and then sometimes you can have this completely different deal team that actually leads the deal. We see that a lot with some of the bigger middle market banks. But Miles, talk about some diligence you can do and questions you ask as you're doing diligence on these banks.
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Miles Lacy
Something you absolutely should do is confirm which bankers will be working on your transaction. And to take it even a step further, in the engagement letter, you can request what's called a key man or key person clause, which specifies that banker or bankers by name as being required to work on your transaction. Otherwise some of the terms of the engagement can be null and void. And so it's a great tool for founders to really ensure that the folks that they are speaking with will be a party to their transaction and will be by their side every step of the way. And that it won't be passed off to what is known as like an execution md, which is someone who spends a lot of their time on execution rather than actual client relationship. And then more importantly, make sure that it's not passed down to some of the more junior deal team members where perhaps if the transaction isn't going as well as had hoped or that managing director is preoccupied with other engagements, you're not just passed along to some of the more junior team members and you're able to continue getting a really high level level of service from senior bankers.
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Mike Lyon
And I think one thing to be on the lookout for, particularly at the end of the year is bankers generally leave firms after they're paid their bonus. So in the middle of the year, almost no one leaves because they're waiting for that bonus. So a lot of firms are December year end where bonuses are paid out. So you'll see a lot of senior bankers leave January, February, March, if you're signing the engagement letter or the process is going to be pretty heated during that time, it's just something you want to pay attention to. And take a look at how long those bankers typically stay at a firm. If they typically at a firm for two or three years and they're in Year two and a half at this firm, be a little bit worried. Also try to pay attention to how the overall bank is doing, because if the bank isn't doing well, that likely means lower bonuses for folks. And that's what drives a lot of people to leave and go to another firm. And a lot of that's outside of even the individual bankers control. Right. It's how the firm is doing. But those are, I would say, some particular risk points. And then one of the things I always like to do is look at the deal team that's working on the transaction and add up, like, the cumulative number of years they've all worked together. Sometimes you'll be shocked at how little these people have worked together. And there's obviously a direct correlation to smooth execution, how many deals and how many years the team has worked together. So I think it's really important. I would say also, don't forget to do reference calls. But we think founders don't do these the right way. Generally, what happens is bankers push two or three references on them. Everyone has two or three good references, right. The deal just went amazing. I think what you want to do is push for a list of like 10 to 15 and then maybe pick 2 to 3 at random. Don't take the references the bankers want to push on you. And I would also be particularly skeptical if they want you to talk to a lot of buyers, because usually that's the buyers where they're kind of in each other's pockets, Right? They kind of help each other out a lot. I'm not saying buyer references aren't important, but definitely don't take the one or two that they give you. Ask for a broader set of references. One of the things we spend a lot of time on is conflicts of interest. So, Miles, let's talk through that a little bit. I think traditional bankers do a really good job of talking about the buyer relationships in terms of access. And so that feels really good. But sometimes that access crosses the line into, like, a conflict of interest. So, for example, if the bank sells all the private equity firms, portfolio companies, or they do recaps or they work for a strategic buyer a lot, I would argue that actually goes from an asset to a liability. Right. They need to feed that relationship and you can become the food. So, Miles, talk about looking at these conflicts of interest. What do you look for there and how to think about it?
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Miles Lacy
One of the telltale signs, particularly with strategic buyers, if you look at a bank's transactions and you see the same strategic buyer multiple times Listed, there's a really good chance that's a buy side relationship where they're helping that buyer purchase these different entities. And that can range from just doing diligence on the transaction to actually going out and sourcing the opportunities on their behalf. But I think that is a real telltale sign. Investors less so just because a lot of investors are repeat actors. Most banks are above board in terms of disclosing who their client is on a transaction. Some leave that up to the imagination a bit on their website where perhaps they'll show the buyer and the investor, but they won't clearly state which one was their client. And so I think double clicking on that, ensuring that they do not do any buy side work because it's one thing to say, oh well, they don't do buy side work for a specific investor, perhaps they don't sell any portfolio companies for that specific investor, which to be clear is a huge conflict of interest that a lot of banks will claim is not buy side work because they're selling the business. They're still working for that investor. And so that's a really important differentiator as well is ensure they're working for founder led closely held companies, not companies that are majority owned by investors. That's a bit of a nuance, but I think something worth double clicking on for sure when speaking with them.
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Mike Lyon
So just be on the lookout for when access turns into a liability. Right. Because they really have to take care of those relationships and you just want to make sure you're getting the most aggressive representation you can get for the situation to drive the best outcomes. I think if a banker's too positive on a specific buyer, that's a real red flag. There's so many buyers in the universe out there. Like obviously you have your more likely ones or your top tier buyers in your medium tier, but if they're really pushing one to two buyers out of the gate, I think that's a big red flag. We go into it thinking there's many buyers who could prevail in any process. It's up to them to differentiate themselves and prove that they're the right buyer. But if someone's really pushing a couple of buyers or an extremely close relationship, I see that as a red flag.
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Miles Lacy
Yep, for sure.
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Mike Lyon
Let's talk a little bit about the engagement letter negotiation. So talk about maybe the things founders should look out for and then some of the non obvious things as their negotiating engagement letter with the banker.
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Miles Lacy
So one of the things we already touched on in terms of the key person or key man clause. I think that's an important element to an engagement letter to ensure that founders have the right representation throughout as it pertains to the actual fees and fee structure. I'd say spend a lot of time thinking how you want to ultimately incentivize your banker. Is it to get the best valuation possible? Are there other terms that matter a lot to you? Does it take into account maybe like a different security structure, earnout structure, the founder's roles post transaction and try to think about it from as many different angles as possible and ultimately aligning it with what you view as most attractive for your goals and interests. That's the North Star, if you will, that you should think about as you're continuing to have these engagement letter conversations and ultimately think about what makes the most sense for you now in a perfect engagement, as you do better, the bank does better and everyone's happy and incentives are fully aligned in that situation. And there's a lot of different ways to do that. But outside of valuation there's these other factors like cash at close, different transaction responsibilities around things like post transaction roles. All things that should definitely be focused on and not left out of the engagement.
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Mike Lyon
And I think one thing that comes up a lot on some of these middle market deals is the retainer. A lot of banks want to have a retainer, some don't. I think the thing you want to focus on there is you want to make sure the bank isn't what I would call a retainer shop. That means they don't close that many deals, but they did a lot of retainers. You can typically tell because that retainer is structured as like just to pay out every month with no end in sight. One of the things you can ask for, pretty much every bank has to have audited financials as part of finra incipit. Ask for the breakdown of their fees based on success fee and retainer. What you want to see is the vast majority, like 90% plus all of their revenue should come for success fees and the retainer should be a really small portion. If the retainer is a big proportion, I'd be really concerned about that because that implies they don't really close a lot of deals. They sign up a lot of deals, but they don't really close a lot of deals with buyers. So something to look at. Miles, lastly here talked about when is the right time to engage with the bank. I know on about probably 2/3 of our transactions it comes late, right? They have a couple of Lois, they want to do A transaction soon. What's ideal in terms of getting a bank up to speed to run the process the best way possible.
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Miles Lacy
There's sort of two different camps as you alluded to. There are those that have some type of inbound interest, be that from a term sheet or maybe it's even a little bit earlier stage than that where it's initial conversations with the buyer or investor. And then there are other folks who they've largely eschewed those types of conversations, kept their head down, and are now at the point where they've decided it makes sense to explore a transaction. And so there's nothing quite as pressing from a time perspective in those scenarios. Generally anywhere up to six months in advance of wanting to run a process makes a lot of sense. So the typical prep phase, if there is no LOI in hand is called like a month, maybe a little bit longer. And just with the added benefit of time, there are some little things you can do around positioning the business, warming up conversations, particularly with large strategic buyers, that make a lot of sense and ultimately make the process much more smooth once launched. For those that have inbound interest, it never is too late to engage a bank either. So a lot of our clients, as you mentioned, they have those term sheets in hand and even then we're able to go out, secure a better valuation and frankly even oftentimes just a more preferential deal altogether with a different party. So even for folks that have an LOI in hand, it's not too late. So it's a bit of a wide spectrum in terms of when to engage the right bank, but it's generally never too late.
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Mike Lyon
Great advice, Miles. In today's episode we explored when founders should hire an investment bank and what they should and shouldn't do when evaluating banks, negotiating fees and determining the best time to hire. Miles, thanks for joining us.
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Miles Lacy
Absolutely, thanks for having me.
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Podcast Host
Disappoint Advisors is a founder focused investment bank that advises software and Internet founders through M and A and capital raised transactions. We are a fully unconflicted investment bank who only works for founders on the sell side, so you know that we're always representing your best interests. Securities offered through VistaPoint Advisors member FINRA Sipic. This has been provided for informational purposes only. It is not intended to address all circumstances that might arise. Testimonials from past clients may not be representative of the experience of other clients and there is no guarantee of future performance or success. Clients are not compensated for their comments. If you have any questions about the process of selling your business or raising capital. Reach out to a member of our team or check out the four Founders section of our site by visiting four Founders Guide.