Retaining an Investment Banker, Lesson 6: Is Selling a Company the Same as Selling a House?

By Bill Snow

In the previous parts of this series of articles, I discussed four common misconceptions about mergers and acquisitions (M&A): the importance of knowing a lot of buyers, the value of industry experience, how to enhance valuation, and how to set the ask price. I also discussed the components of valuation. I will now discuss another common M&A misconception: whether an investment banker is merely a listing service.

Misconception: Investment banking is merely a listing service

Far too many business owners and executives mistakenly equate the work of realtors to the work of investment bankers. While at the heart of each process is a sales transaction – a home in one and a business in the other – that’s where the similarities end. Let me explain the differences between a realtor and an M&A investment banker.

• A realtor will review recent transactions of similar properties in your neighborhood and will set the “ask price” for buyers. An investment banker does not set the ask price and does not put an ask price in the marketing materials. Instead, the buyer makes the initial offer.
• A realtor will take a couple of pictures and fill out some quick, basic information about the property (square footage, number of bedrooms and bathrooms, amenities, etc.). An investment banker will create a custom book describing the company in detail (products, customers, management, employees, sales and marketing strategies, financial information, facilities, assets, and much more).
• A realtor will list the property online, in newspapers, and in other periodicals. Anyone can see the property listing and can see the ask price. An investment banker will create a detailed and specific list of buyers that are approved by the seller. The investment banker will contact each potential buyer. The general public does not have access to the materials prepared by the investment banker. In fact, the general public will not even know the company is available for sale.
• A realtor will place a “for sale” sign in front of the property or in a window. An investment banker will not.
• A realtor is reactive, waiting for interested parties to inquire about the listing. An investment banker is proactive and often has to push and cajole interested parties to move to the next step of the process.
• A realtor’s workload is limited to a few walkthroughs with prospective buyers and maybe an open house or two. An investment banker will probably have a team working on the transaction. Jobs include putting together the deal book, researching the industry, creating a buyer’s list, contacting the buyers, setting up meetings, soliciting offers, and negotiating and closing the final agreement.
• A real estate transaction, while suitably complex, is relatively straight forward. Seller shows up with the title. Buyer shows up with the money. The typical M&A transaction is far more complicated than the typical real estate transaction. Components of an M&A transaction can include cash at closing, seller notes, earn outs, and stock. Money is placed into an escrow account. The seller makes a slew of promises to the buyer and backs up those promises with money placed in escrow. Adjustments for working capital are made at the closing and again a month or two after the closing.
• Negotiating in real estate is usually relatively simple and straight forward. A home is listed for $410,000. The buyer bids $395,000. After some back and forth, both parties agree to $400,000. Negotiating in M&A is far more involved and far more complex. In addition to the top line price, both sides will haggle over the form of consideration (how much in cash, notes, stock, and earn out), the value of inventory, the quality of the earnings, the appropriate amount of working capital necessary to run the business, non-compete and employment contracts with key people, and on and on.
• And here’s the real rub: realtors take a 6% commission. Even after being split two ways for the buyer’s agent and the seller’s agent, realtors probably wind up with a higher rate than investment bankers. In percentage terms, an investment banking fee is usually lower than a realty fee.

Correction: Hire investment bankers for their negotiating skills

The most important value an investment banker brings to the table is not in the preparation of materials. It is not from putting together a buyer’s list. It is not from contacting those buyers. Those are all very important jobs that require skill and ability, but the biggest value an investment banker brings to the process is the ability to close a transaction that makes sense for the seller.

The hardest work, the trickiest work, is dealing with all the issues that might pop up as a closing approaches. Transactions do not close themselves. Someone needs to stay on top of it. Someone needs to push the other constituents to get the transaction done. Someone needs to know how to strike the right balance of forcefulness, persuasion, creativity, persistence, and accommodation.

Ironically, time and value often have an inverse relationship in M&A. Closing a transaction is not necessarily the most time consuming part of the process. Putting materials together, researching and refining a buyers list, contacting all the buyers, soliciting offers, and setting up meetings all take large amounts of time. Weeks and months. The amount of time negotiations take, especially a last minute negotiation that resurrects a transaction and maintains value for the seller, might be measured in mere hours. Perhaps only in minutes.

In the movie “Walk The Line,” Johnny Cash proposes to June Carter numerous times. She repeatedly rebuffs him and cites myriad reasons why a marriage would not make sense. Cash, utterly indifferent to any of her concerns, simply says, “That stuff will just work itself out.”

Carter responds, “No, it does not work itself out. People work it out for you and you think it works itself out.”

The same principle applies in M&A. The details don’t just work themselves out. Someone has to take care of all those details. If an owner is not represented by a strong negotiator, guess what? Those details might work themselves out, but if so, they will be in the favor of the other side.

An initial offer with a seemingly good valuation might be slowly and methodically whittled down if an unprepared executive or a weak investment banker is heading the process. This is the so-called death by a thousand cuts. Worse, absent a strong negotiator, an owner responding to a buyer trying to lower the valuation might end up with a busted transaction. A skilled negotiator has far greater odds of countering the new bid, keeping the buyer at the bargaining table, and maintaining the agreed upon value for the seller.

How can an investment banker’s negotiating skills be determined? Here is a good starting point: The business owner should ask for a fee proposal…and then cut the investment banker’s fees to the bone. If the investment banker accepts the low ball offer, the business owner should not hire them. Anyone offering their services at a cut rate price is probably offering a cut rate service. The way an investment banker negotiates with the business owner, is exactly how they will negotiate for the business owner.

Conclusion

I have discussed numerous misconceptions about M&A investment banking in this article. The nearby table sums up those misconceptions:

Seemingly Important	Actually Important
Knowing a lot of buyers	How the buyers list is created
Having industry experience	Ability to “clear the market”
Possessing special words to get a higher price	Techniques to enhance value
Determining the right “ask price”	Handling the “ask price” question
Finding a low cost provider	Negotiating prowess

Another factor should be weighed when picking an investment banker: chemistry. The business owner and the investment banker will be working closely for many months, perhaps close to a year, so if the business owner does not like the investment banker, the business owner should move on and look for a different investment banker. Lastly, references should always be checked. The final article in this series will provide some useful tips.

 

This is Lesson 6 of a seven article series about hiring an investment banker. In Lesson 7 we will discuss checking references. The previous article, Lesson 5, discussed how the “ask price” is determined.

Link to Lesson 5: The Ask Price

Link to Lesson 7: How to Check an Investment Banker’s References

For more information, please contact the author.