How to Use Investment Bankers
April 3 2007 by Robert Lawrence Kuhn
Notwithstanding all talk about their gargantuan bonuses, investment bankers evince no chagrin about the fees they charge. They unabashedly retort that they are paid only a small fraction of the value they add to transactions. It is this “value-added,” they claim, that justifies their hefty emoluments, that when they raise billions of dollars in public offerings or get a few dollars more per share in a corporate merger, shareholders reap enormous benefits. Investment bankers state that their fees are only a small fraction of this incremental benefit.
Does the economy need investment bankers? Do companies? Are financial intermediaries promoting their own profession over professional service? What service can they provide, and how can senior executives use investment bankers to their firm’s advantage?
Though public policy debate will continue, the task for CEOs and CFOs is to determine if, when and how to use their investment bankers. Investment bankers perform a real service for companies, but knowing how to use these services will make the process more efficient in cost and more effective in results. I’ve been in this business for about thirty years, and I’ve seen them all in action. Consider these tips for tangling with investment bankers.
Specify Your Goals
Know in advance precisely what your company wants to achieve in the anticipated transaction. In a public offering, consider the range of pricing; in M&A, prepare a list of objectives. Generalized goals make weak foundations. Proper financial goals should have the following characteristics: clear not vague (everyone should understand them); specific not general (precise and accurate in numerical terms); focused not diffuse (wish-lists are fine; just remember what you really need); contained not boundless (don’t swing for the fences unless you’ve already assured your minimum goals); difficult not easy (if you don’t stretch you’ll never get the best results); consistent not inconsistent (financial goals must mesh with all other corporate goals); measurable not immeasurable (you must know when it works); and achievable not unachievable (living in blue-sky dream worlds frustrates closure).
Become Familiar with Comparable Transactions
Know what other companies have done in similar circumstances. Learn what happened in the past-but never be satisfied with history. Keep current: the market changes constantly, new deals are going effective daily and you need to be aware of what’s happening. Ask questions, suggest alternatives, interact with your bankers. Above all, don’t be intimated. The best antidote for the poison of embarrassment is continuous updating of knowledge. (Note: Selecting comparable transactions is usually as much art as science, since true comparability is uncommon. Investment bankers are often quick to list comparables; their assumptions should be challenged.)
Interview Several Investment Banking Firms
The courting process is important. This is your time to expand horizons. You will never be treated as well as when you haven’t made your choice. Your prospective bankers will never be more solicitous or more patient. (And if they’re not solicitous and patient now when they want your business, how much less will they be when they have already gotten it!) During the interviews, ask about transactions on which they have been the lead-the “book runner” on public offerings-not just a co-manager. Note the level of bankers with whom you are meeting; the usual procedure is for senior bankers to make the pitch-but then, for smaller transactions, junior bankers will be doing the work. Ask about the team that will be actually executing the transaction, particularly about the involvement of the senior bankers.
Worry First About the Deal, Then About the Fees
CEOs are often so concerned, even nervous, about investment banking fees that they may pay less attention to the transaction. This is a mistake. When speaking with several investment banks, compare fees, sure, but look carefully at the services. Sometime a disparity in fees is due to a disparity in service; sometimes different firms have radically different perceptions of the transaction or the kind of work required. One of the most astute entrepreneur-financiers told me that he doesn’t mind paying high investment banking fees since by doing so he knows he will always get the best service (e.g., if an attractive acquisition emerges, investment bankers will likely show it first to those who pay full fees). Furthermore, when this entrepreneur was making a key divestiture, he hired two investment banks, paying a combined fee that was 50% higher than normal, just to ensure that the best price was obtained.
Select the Firm That Meets Your Needs
Name and reputation are important, but not all important. How valuable you are as a client to a given firm, among high quality firms, is sometimes the most vital factor in the selection decision. You want a banking house to be well experienced in the specific kind of transaction you seek (you don’t want them to learn to shave on your face). A top-bracketed firm with little commitment to your specific needs may be the worst of all-the illusion of expertise mixed with the frustration of neglect. In reality, in doing your deal, the key success factor is often the individual bankers working on it.
Maintain Relationships with More Than One Firm
No matter how well you are working with one investment bank, always keep one or two others in your back pocket. Stay in touch with the competition. Don’t feel guilty about it. Don’t even hide it! Companies maintain relationships with more than one commercial bank; the same principle should be applied to investment banks. You never know when your investment bank will undergo a radical change-corporate restructure (eliminating your personal bankers), corporate reallocation of resources (going out of your business), or plain disappearing altogether. Furthermore, by talking to your banker’s competitors, you can keep an eye on the pricing markets and prevent your banker from taking you for granted.
Minimize Downside Risk; Then Try to Get Lucky
The deal business is intoxicating, and CEOs can be tempted, hearing all sorts of stories from their investment bankers, to reach for more than they are likely to achieve. Ego is usually a liability in transactions. This is especially dangerous in transactions that are essential for the overall welfare of the company. First, be sure that you get what you really need. Ensure the bare minimum; secure that bottom line-this takes all danger out of the situation. Then, and only then, go for it.
Motivate by Ego As Well As Greed
Investment bankers are motivated by money, sure, but even more important is often their reputations and relative positions. Rankings among investment banks are critical, and whether the adjudications are quantitative (the so-called “League Tables” that list the leaders in public offerings and M&A) or qualitative (their reputations), investment bankers will work even harder when their egos are on the line. Astute CEOs can increase the intensity of investment bankers’ efforts by appealing to their egos.
Don’t Be a Pioneer (Unless You Want to Be a Pioneer)
Investment bankers like to do deals that their peers will talk about. This means doing something bigger or better or unusual. The danger for a client company is that an investment bank may want to do a deal that is more in the interest of themselves than their clients’. Convincing a client to pay a very high price for an acquisition has happened repeatedly. Creating a structure that is original, such as for tax purposes, may not be in best interests of the client.
Work Closely with Your Investment Bankers
It is a mistake to assume that your bankers are always working for you, that they are living and breathing your deal. They are working with many clients on many deals (not infrequently focused more about getting the next client than satisfying the current one). Your deal is the most important to you, but it may not be to them. Keep on their tails.
Maintain Control of the Process
Senior management must participate actively with their investment bankers. CEOs should never allow the apparent complexity of a financial structure to pressure them into abdication, to disenfranchise them from able involvement. If you are a CEO, it’s your company, not the investment bankers’. You know it better than anyone else. So although you may not be a finance expert, you are probably better able to integrate the financial structure with the business structure than those hotshot bankers. The subtleties of the business are often harder to appreciate than the complexities of the finance.
Used properly, investment bankers can add substantially to the worth and wealth of a company. But investment bankers, for all of their value-added contributions, tend to put the deal ahead of the company, and they can often intimidate senior management into acquiescing to their recommendations. Knowing how to use investment bankers keeps the CEO in charge of the transaction.
Dr. Robert Lawrence Kuhn is Senior Advisor, Citigroup Investment Banking, and the author or editor of numerous books in business, finance and science, including The Library of Investment Banking and, most recently, China’s Banking and Financial Markets: The Internal Report of the Chinese Government (John Wiley) and Closer To Truth: Science, Meaning and the Future (Praeger). Previously, Dr. Kuhn was president and co-owner of The Geneva Companies, the largest M&A firm representing privately owned, middle market companies (in 2001 he sold Geneva to Citigroup). Dr. Kuhn has a doctorate in anatomy / brain research from UCLA and a master’s in management from MIT.