A common question we hear from business owners anticipating selling their company is, “How do I select an investment banker?” As exit planners, part of our role includes helping business owner clients field a team of advisors that can achieve a successful exit. If you intend to sell your company to an outside buyer, an investment banker (or M&A advisor, business broker, etc.) likely plays an important role. Because many business owners have never been through a transaction, knowing what to look for in an investment banker may be new and unfamiliar territory. But selecting the right banker is essential because the wrong choice can cost you thousands to perhaps millions of lost dollars, and/or consume up to a year or more of lost time.
In exit planning and our experience, business owners should apply these five criteria to their search for an investment banking relationship that best fits their situation, needs, and goals:
Select an investment banker that routinely works with companies of similar value to your business. A banker who typically works with companies around $10-20 million in value may not be the best choice if your business is worth $200 million, and the reverse. If your business is significantly larger than the banker’s typical deal size, that professional may lack the experience and resources to represent your company effectively during the sale process. If your business is significantly smaller than the banker’s typical deal size, you may not get the attention and effort required to be successful.
To discern if the size is a good match, ask the investment banker to list the five to ten most recent transactions that he or she directly represented, including company size, industry, and other relevant data. If the banker you are considering is part of a larger team or firm, be sure that the list includes transactions that your investment banker directly worked on, and not a list of deals done by that banker’s colleagues.
In some cases, it makes sense to select an investment banker who has relevant and recent experience in your industry or sector. This applies if your industry is highly specialized, technical, or occupies a precise market niche. If your banker has experience in your industry, he or she may need less ramp-up time, bring a more nuanced and sophisticated understanding of industry factors determining value, know relevant industry trends, and have existing relationships with potential buyers. An investment banker lacking any experience in your industry cannot match these advantages.
Counter-intuitively, it can be disadvantageous to work with an investment banker who specializes in your industry. That investment banker may have ongoing relationships with some of the more prolific buyers in your industry—relationships the banker does not want to strain or damage by pushing hard to get you the highest sale price. Also, being too much of a specialist may insulate the banker, leaving them unaware of potential buyers outside the traditional players.
Either way, ask your potential investment banker about their relevant experience in your industry and with comparable companies—most businesses are more alike than not.
In the past, most investment bankers were paid the same way: they charged a monthly retainer fee (designed to help cover their costs and give evidence that the business owner was serious about selling) and then received a success fee in the form of a commission tied to the sale of the company. The success fee represented the lion’s share of the banker’s income and motivated the banker to make the deal happen. The fee was most commonly expressed as a percentage of the deal value and decreased as the deal size increased. In this manner, the total fee percentage went down as the deal size went up. The most common version of this approach was developed in the 1960s by Wall Street firm Lehman Brothers and is called the Lehman Scale or Lehman Formula.
Modifications and adaptations of the Lehman Scale are still in use today. But, in recent years, a greater variety of compensation methods and models have entered the marketplace. This development creates a challenge for the business owner because you now have to sift through a wider range of models. But, you gain the opportunity to select a compensation philosophy that is consistent with your situation and preferences. For example, some investment bankers completely inverse the declining percentages found in the Lehman Scale, replacing it with a fee schedule where above certain thresholds the applicable percentage actually increases. The logic is that the increasing percentages incent the investment banker to drive the sale price up as high as possible, generating a greater net amount for the seller. Another approach is to charge a flat fee, with little to no variability tied to the sale price. To further complicate matters, monthly retainers can greatly vary in amount from one banker to the next, and some bankers credit the retainer against the success fee, while others do not.
On this issue, meet with multiple bankers to get a feel for which compensation method you prefer. Ask the bankers you interview to explain their method and its justifications. Model the banker’s compensation method in a spreadsheet that calculates the fees at various potential sale prices. Ask your other advisors to evaluate the proposed fees, to be sure they are consistent with market rates.
Selling a company is a team sport. An investment banker plays the lead role in the sale process but needs help and support from the business owners’ other advisors at numerous steps along the way. You should rely on your other advisors to screen and select which investment banker you intend to use, not just to protect your interests but also to make sure that you end up with a team of advisors who work together effectively.
Perhaps the two most important advisors to lean on as you research investment bankers are your exit planner and your deal attorney. Your exit planner should be able to do all the following for you: recommend candidate bankers, research their backgrounds and qualifications, accompany you during interviews, and review their proposals. The exit planner should help you determine which banker is qualified to represent your company and at a fair price.
Your deal attorney plays a critical role in reviewing the services agreement that will govern the contractual and financial relationship between you and the investment banker. Too many business owners sign a services agreement prior to engaging a lawyer with M&A experience—that is a deal attorney. Picking your investment banker before engaging a deal attorney is backward. Select the attorney first, and have him or her review the banker’s agreement before signing it. An attorney experienced in these transactions will know how to limit your risks, protect your interests, hold down fees, and avoid contractual provisions that are not consistent with market norms.
This last criterion may be subjective, but it is no less important. You will be working regularly and closely with your investment banker for many months during the sale process. This person (or team) will be your constant companion, potentially through difficult and emotional matters. Achieving a successful sale will be considerably more difficult and stressful if you are not comfortable with your banker, and all but impossible if you cannot trust this professional.
Spend time carefully choosing your banker. Interview multiple choices—even if you already have a preferred banker in mind, to have different options to compare and contrast. Ask for and follow up on references. If the investment banker is part of a firm or team, verify who on the team you will be working with during the process. Get to know the person or team well, as they will be “in your foxhole.” You must have confidence and comfort in working with them.
Conclusion
Choosing an investment banker takes care and time. Expect the process of selecting your banker to take several months, starting from when you conduct your first interviews up to signing their services agreement (after your deal lawyer has reviewed it.) Then, the real work begins. Making the right choice puts you on the path to a successful sale and exit. Selecting a banker that is not a good fit for your situation can set you back immeasurably.