So you want to Sell your Company? Use a Banker or Not?

In a company’s evolution, there are times to consider selling your company for personal or other reasons. Or the choice of selling may be forced upon you, the founder/entrepreneur, by your investors, by the market or by the sheer number and quality of soliciting prospective acquirers. At times like these, whether or not to hire an investment banker (or simply “banker”) looms large.

Not all company sales fits a banker’s sweet spot so they may not take your company on as a project.

Types of Bankers

There are really 3 kinds of investment bankers (although there are many flavors).

A. Bulge-Bracket: Very large bankers (whose names were the most prominent on a prospectus and the fonts “bulged” out), who are looking to do deals of $250M to $1B or more. There are about just a dozen of these globally.

B. Middle Market, that are looking to do deal between $15M to $500M. There are hundreds of these.

C. Business Brokers, that are doing deals for $15M or lower.

There are boutiques that specialize in certain sectors and may operate in larger span of deal sizes. There are also regional i-bankers that do a larger variety of deals in a certain geography.

The Million Dollar Proposition

For an entrepreneur/Board considering selling the company, the rule of thumb to keep in mind is that the middle market bankers will cost approximately $1M for smaller deals and more when large exit price inflates the success fee (% of the sale price).

The way the fees are structured is typically in two parts:

1. A retainer that is typically $10K/month for a minimum of 6 months. This can be tweaked up or down or for shorter or longer periods. Some do a straight $50–90K prepayments and get to work.

2. A success fee that typically has breakpoints — lower % as the deal size goes up. For example, it might be 5% up to $15M and 3% beyond that so a deal that closes for $25M will mean the bankers get $750K + $300K, which will be just over $1M. Typically, the retainer fees are credited back from the success fee, but not always.

Since the middle-market is typically looking for $1M fees at a minimum, the bankers are themselves looking at a few hurdles before they take on a project:

a. Likelihood of success: They are looking for healthy companies with good top line and margin, quality management and excellent market position. This might seem like you are being evaluated by investors, but the fact of the matter is a deal that does not close is a negative mark on the banker so they try to minimize failures by refusing to take on difficult deals. Probably the most straightforward rule of thumb is a topline that is robust and growing… so if a revenue multiple in the industry is 5X, to achieve the $15M exit, the company must be doing about $3M in revenue and trending up, otherwise, it will be hard to attract a good banker. Many other parameters besides revenue figure into this, but the revenue is the quickest “sniff test” for the banker and typically the revenue threshold is much higher at $5M or $10M.

b. M&A activity: If mergers and acquisitions (the banker’s trade) is very hot, there is going to be better fish to fry, so your company may not be a good candidate for the banker. But in a lousy M&A market, the supply of bankers overpowers dearth of M&A deals and the bankers start bringing their fees down and taking on borderline projects. Although cyclical the desperation of bankers was evident by very attractive fees for a few years following the 2008 downturn.

c. Training wheels: Sometimes bankers reduce fees if they are looking to gain knowledge and build a network on the client’s dime. In a new area, where the bankers have little exposure of M&A track record, if you agree to be a guinea pig, you might negotiate reduced fees. You may not want to be a guinea pig, however.

Is the Price Tag Worth it?

Whether the banker’s fees are reasonable or not depends on the company management’s experience with M&A and with the expected exit price.

1. No Brainer Scenario. If the expected exit is large, let’s say $50M+ it behooves a company to hire a banker and “run a process.” Running a process is the activity from signing up the banker to getting the M&A transaction done.

2. Inexperienced CEO/Board. If the exit price is going to be reasonable and the CEO has never dealt with an exit (and the Board may not be able to help much), a good banker can be a “Sherpa” helping the company to climb this mountain with confidence. The bankers will do things like:

a. Prep the pitch deck and rehearse/critique the CEO’s pitch

b. Create a list of likely acquirers (both financial and strategic) — this is where the CEO and company adds to the list and if your list is much longer and higher quality than the banker’s it does not bode well to hire that banker)

c. Send out emails/letters to market the company to the list

d. Coordinate and qualify the inbound queries so as to minimize distractions to the CEO and management

e. Create an environment of auction among the various interested parties to maximize the valuation and other terms

f. Get to Letter of Intent (LoI) and negotiate the Term Sheet

g. After LoI is signed and the companies’ lawyers get into legal documentation of the deal, the banker stands by and waits for the close

h. If any hiccups arise, and many will, the banker will try to resolve them (note, the banker gets no success fee, just the retainer, if the deal does not close, so the banker is very motivated to make sure the deal closes)

3. High growth company, high volume inbound queries. If the company is in a very high growth stage, and the inbound queries from potential acquirers are many per quarter or better, it might be more efficient (and potentially higher exit valuation) to let the banker deal with the queries and the management focus on the business.

Banker-to-Corp-Dev Insider: A Creative Option

The cachet of a banking career is not what it used to be. In fact, the cachet of a successful entrepreneur or even being part of an successful operating company role is in the ascendancy. Therefore, it follows that some bankers (typically early in their career) may jump into a company as their Corporate Development employee. This idea was offered by a banker friend of mine who did exactly this after 12 years being a banker in about 3 different firms. He joined a small firm to get it sold within 6–12 months.

Not anyone is allowed to market a company for sale or to raise funds — even private companies — where securities are involved. One must have a FINRA certification, which ensures that the investors are protected. Running afoul of broker-dealer rules like FINRA have draconian consequences — bankers have the requisite certifications. However, an experienced, ex-banker employee of a company can do the same task that the bankers do for a fraction of the cost and can even be compensated a bonus upon completion as any other employee for job well done. It is no different than companies having an in-house General Counsel, rather than going to outside law firms for legal help.

When bankers meet, it is clear that they realize the value-add they bring to the client companies is not always superlative. For this reason, many bankers tell each other “that’s not something you want to share with the company/the entrepreneur.” However, the information arbitrage that bankers operated on is eroding rapidly. Some go far as to suggest that with AI/robots, the banker’s days are numbered.

My friend, who is now a Corp Dev guy inside a primarily technology services company doing $3M in sales is running a process just like he did in his banking role. He has 3 private equity firms and 2 strategic partners interested. He is running an auction just like he did before, except now it is as an employee in a firm he joined just 6 months ago. He thinks in another 4 months the sale will be consummated — the “fee” to the company is well south of $1M, but more importantly, no banker would likely take on the sale of this particular company for a smaller-than-usual fee, in a very new area of technology services.

When Not to Hire a Banker

There are many situations when hiring a banker does not make sense.

1. A buyer(s) appeared organically. If you found a buyer or they found you organically in the market (e.g. a trade show, as partners on a project, referral from a friend, investors, etc.) and you feel the deal terms (in particular valuation) can be maximized, a banker may not be necessary. (Some bankers will take a significant cut in fees just to work with a prospect you already found.)

2. Need to keep it quiet. Sometimes you need to sell quietly and quickly so as not a arouse a sleeping giant/competitor, etc. because the market will eventually know you are selling the company even though the banker will make the prospects sign an NDA to share any financials, etc.

3. Company’s Network. If the company’s management/Board’s network is large enough (and much better than the bankers’ that you have interviewed), it may not make any sense to re-educate the banker in your space.

4. Fees. If you cannot afford (due to cashflow needs), you may be able to be creative (see above Corp Dev hire) and roll-your-own.

Due Diligence to Hire a Banker

If you decided to get a banker, the following due diligence questions will help. It is important to speak to a few bankers — note that when they have their pitch decks out, they are in sales mode, so everything is very rosy, particularly if yours is a very desirable company.

1. Domain Knowledge and Network: What are some of transactions concluded in your space and your size of companies? If there are no transactions in the last 2 years, the bankers’ domain knowledge and/or network is non-existent or weak. Once you engage the banker, they are the first folks the potential acquirer will likely speak with — if they have no domain expertise, the top of the funnel will not fill fast. If the banker consummated transactions, ask to speak with the CEO of those companies and ask what was good, not-so-good about going with that banker. Would they use that banker again? Would they use any banker again to do another transaction?

2. Deal Team: Many bankers pitch with their seasoned folks, yet the deal team working on your deal may get little or no attention from the seasoned folks because they are busy with much larger deals or pitching to win new deals. A mixture of senior bankers and more junior associates is typical, but experience (or lack thereof) can have very material impact in your “process.” In ours, the senior banker provided a good amount of coverage, but the folks doing the work and working the numbers were two associates — one of them was the banker’s nephew (who was not disclosed to me). At the last minute, our law firm noticed that the escrow was double-counted which meant that the proceeds were going to be 10% less than it should have been — this is a very big, material error due to the inexperience of a junior associate. Suffice it to say, we will never use that banker again.

3. Speed to Consummation: Again all bankers will give you a timeline that maps, getting the ducks in a row, marketing, pitching, getting to LoI, negotiating, documentation and closing — the full process end-to-end to be 4 to 6 months. However, unless a potential acquirer is already ready and waiting in the wings, it is always going to take longer — more like 6–12 months, typically longer. And you need to be prepared for that in terms of cashflow, running the business, etc.

4. The fees: How will be fees be structured? How much in retainer/prepayments? How much in success fee and breakpoints when lower % of success fee comes in. Any special expenses you will be charged for? (Typically travel, stationery, etc. that the banker incurs is on them, not the company).

5. The Tail Period: The engagement letter you sign will typically have an exclusive term — say 12 months — when only the banker gets to market your company. After that the term, there is typically a tail period — and 12 months is typical, but could be a few months more or less. If the company gets sold during the tail period (small investments or minority stake sales are excepted), the banker gets their fees as if they were actively working the deal. Obviously, it is important to keep this tail period as short as possible — in case you have to terminate the engagement term early due to non-performance or mismatch between your banker and the company. Usually the tail period is alive even if the engagement is terminated early — so be sure who you sign the engagement letter with!

6. Documents & Material: Ask to see what they produced after reviewing the company’s initial pitch deck — do the bankers have storytelling skills in-house? Ask to see the prospect list, the email/letter that goes out to the list of prior transactions. Glitches in previous transactions and how they got resolved for the company by the banker.

7. Logistics: Who arranges the roadshow and arranges the travel logistics? Who sets up the meetings and who follows up? Who sets up the data room? (Typically it’s the banker, but in our case, their methods were so archaic that we just used our DropBox account with passworded PDF files). There are whole companies that manage data rooms now, like SecureDocs.

8. Chemistry: And make sure you can work with the banker and like him/her and their style. You will be spending a lot of time with them on roadshow, etc. and may even spend more time with them on the phone/travel than you might with your spouse/partner during the intensive part of the process. So make sure you know how they work and you are comfortable with their style.

Sale of your company is an important event. Whether or not you use a banker has huge implications — you need to go in with your eyes wide open. It is absolutely possible to do transactions without a banker — make sure you have an experienced Board and a good corporate lawyer that has done a lot of M&A transactions so they are current on what is typical to ask for. Note that a simple mid-market sell-side deal for legal work (whether you use a banker or not) might run you about $100K (complicated deals will be more), adding a bit more legal fees for your lawyer’s M&A advice might be a lot less than the $1M ticket price for hiring a banker.