The Value Of Forming A Relationship With A Banker Long Before You Hire Them To Sell Your Company Or Raise Growth Capital
Navidar | April 7, 2022
We have talked in past blogs about the importance of developing a relationship with an investment banker well before a contemplated sale of your company or capital raise (4 Things Startup Founders Should Think About Now, Even If You Are Not Thinking About Selling Your Business). In this post, we want to expand this discussion based on questions that we have received from a number of our readers. To be clear, when we say, “develop a relationship”, we are simply talking about having an ongoing dialogue (where no fees are charged and no money changes hands) with one or more trusted and helpful investment bankers (who have signed NDAs) in which the CEO and the banker discuss the company’s vision, goals, challenges, and desired areas of improvement, among other topics.
Is It Really Worth The Time And Effort To Invest In And Develop This Relationship?
Some CEOs and founders may think that they have many better ways to spend their time than to talk with investment bankers and that every second should be spent building and improving their company. We understand the sentiment. Perhaps some CEOs and founders have Board members who have told them that they should not bother to meet with any bankers until very shortly before the company is ready to hire them for a deal. These Board members may even say that when the company is ready to do a deal, they can quickly and easily assemble any number of investment bankers who will come and meet with the company and present their credentials, views on valuation, positioning, and how they would market the transaction to buyers (for a sale of the company) or investors (for a capital raise). After hearing these banker presentations, the company and its Board can then select their investment banker, without ever really having had to spend time developing a relationship before the contemplated sale or capital raising transaction.
What Is Wrong With This All-Too-Common Approach?
If something about this approach to choosing a banker to lead one of the most important strategic decisions in the life of your company leaves you feeling a bit uncomfortable, we understand completely. As you might expect, Navidar does not think that this approach to banker selection is a particularly good one. We believe that this all-too-common approach is based in part on the mistaken view that the relationship between a company and an investment banker is purely transactional—that is, the banker is a service provider and your company is simply purchasing a service—and therefore there is little to be gained by forming a strong early relationship with a banker well in advance of a transaction.
If you spend very little or no time with a banker before they are asked to present their credentials and thoughts on how they would sell your company to you and your Board, can you realistically expect to receive insightful advice or have a meaningful discussion about potential challenges to your deal? We think it is unrealistic to expect much from your banker when little has been invested in the relationship before selecting your banker.
Another common-sense question is whether you would feel comfortable buying a very expensive and important item, say a new house, after having done little or no research on that item. We suspect that most people would do extensive research before making this type of purchase decision and we recommend doing the same thing when it comes to selecting your investment banker.
It is critical to remember that you and your team will be working closely with your banker over a period of months to accomplish a very important strategic goal—be it a sale transaction to monetize years of hard work or a financing deal to propel the next stage of growth. A failed sale process or an unsuccessful financing can jeopardize a company’s future and undermine years of effort and sacrifice, so making sure that you spend a relatively small amount of time forming a good relationship and seeing what the banker can do to help you before your transaction can yield many significant dividends which we discuss below.
What Are The Benefits Of Forming An Early Relationship With The Right Banker?
We want to state quite plainly our view that there are several very clear, tangible, and important benefits to be enjoyed from forming a relationship with a banker well before you are contemplating hiring a banker to advise you on a transaction. Our bottom line is this: the relatively small amount of time and energy you invest in your banking relationship will yield disproportionately high benefits.
We discuss a number of these potential benefits below.
- A Banking Relationship Can Help Avoid Significant Mistakes Long Before A Deal
Many mistakes can be made in the course of an M&A transaction, but there are perhaps just as many mistakes that companies can make long before they even undertake a transaction. By having an ongoing dialogue with your banker, you can avoid a number of fairly common—as well as some uncommon—mistakes that young companies often make. By avoiding these mistakes which can delay the launch of a deal or, worse, undermine the ability to successfully complete a deal, you would be tilting the odds of success in your favor, which is always a good thing to do. For example, Navidar has helped clients avoid mistakes in many different areas, including accounting, sales tax, revenue recognition, presentation of financial results, and many more areas.
One simple but powerful example of how a banker can help you avoid a major pitfall is through a review of your financial statements and key performance indicators (KPIs). Navidar was once hired to help sell a company after the company had contacted buyers without any banker involved, had received an offer, and signed an LOI. Sadly, the company had calculated a number of critical common SaaS KPIs incorrectly or not at all and this caused the buyer to simply withdraw its offer and withdraw from the process entirely because having certain KPIs correctly calculated and tracked was critical in its evaluation of companies it intended to purchase. All of the wasted time, effort, and expenses could have been easily avoided had the company shared its KPIs with a banker before they embarked on a sale transaction.
Many CEOs have told us that they found it very useful to have a non-Board member to share thoughts with and bounce ideas off of on a confidential basis over time. An engaged and experienced banker can provide very valuable business, market, and strategic advice well in advance of any potential transaction. There frankly is no good reason not to take advantage of this resource.
- A Banking Relationship Can Meaningfully Improve Your Company’s Positioning
Having an ongoing dialogue over time with a skilled banker can not only help avoid pre-deal mistakes and better prepare for a successful transaction, but it can also deepen the banker’s understanding of your business, what makes your company special, and how you are differentiated in the marketplace. This knowledge—which takes time to acquire—is critical to ensuring a successful transaction because it enables your banker to tell your story more effectively and with greater nuance and differentiation. When your banker really knows the company history, its evolution, mission, and the specific challenges the company has overcome, they will be better able to tell your story in the way that attracts the most interest in a sale transaction or a capital raising process.
For example, we told a midwestern CEO whom we had known for quite a while before he ultimately decided to sell the company that his company would be more attractive to a broader range of strategic buyers if the company could broaden its current client base in a specific manner and change its pricing. The CEO agreed and obtained several new clients in the months preceding hiring Navidar to conduct the sale process for his company. During the time before hiring Navidar, the CEO implemented our advice and moved away from cost-plus margin pricing to value-based pricing which resulted in contract gross margins on the new deals increasing to approximately 70% compared to the old approach which yielded gross margins in the 30% range. Interestingly, the strategic buyer that ultimately purchased his company did so precisely because of these new clients that he had added based on our input. As the CEO later said, Navidar “added more operational value” before the transaction than any other firm of any type that he had ever worked with and felt strongly that this advice helped make the deal a major success for all shareholders.
- A Banking Relationship Can Get The Deal To Market More Quickly
A good banker can help you lay the groundwork to accelerate and smooth out the deal process long before the deal is actually launched. For example, Navidar has shared with CEOs, with whom we are in an ongoing dialogue, which specific KPIs and business metrics are most important to potential strategic buyers and financial investors. Armed with this knowledge, the company can track these metrics over time to not only measure their business performance but also build up a track record of data which will be important to buyers and investors. One of the most common issues we confront is companies reporting results on a cash basis rather than on a GAAP basis or reporting their GAAP financials with incorrect revenue recognition. It is frequently the case that revenue growth looks slower, and the company looks smaller, after a conversion to GAAP reporting. The second most common issue is that the financials are not presented in a manner that allows the buyer to properly assess the health of the business. Often, for example, cost of sales is typically understated which leaves founders with an inflated sense of product profitability in the business.
In addition, Navidar has also helped CEOs understand well in advance what the M&A or capital raising deal process will look like, what steps it will involve, and how best to manage the company’s resources to lay the groundwork for a successful deal—all well before the formal deal preparation process begins. This knowledge and advanced understanding enhance the company’s preparation before the deal, accelerate the deal process, and avoid surprises once the deal is underway. In one such example, the CEO shared some standard employment agreement templates which we noted were inadequate to protect the company from employee claims of IP inventions and protect company IP. By modifying these agreements to include appropriate language and requesting that employees sign the forms well in advance of the process, this avoided an unnecessary ‘fire drill” during the process and prevented unnecessary representations being made in the purchase agreement.
Moreover, an ongoing dialogue can help the banker to provide valuable insight on timing (When is the best time to launch the deal?) and market sentiment (Is the market currently frothy, average, or cautious?), which are critical inputs into running a successful process.
Lastly, having an informed understanding of a company’s strategic goals enables a banker to suggest other professionals who can help the company prepare today for the future time when it decides to sell the business or raise capital. When bankers have an ongoing dialogue with the CEO, they can use this knowledge to tap their network of lawyers, auditors, and other professionals to meet the company’s unique needs.
- A Solid, Trusting Relationship Can Make A Deal Run More Smoothly, Especially At Critical Moments
A trusting working relationship developed over time during the months preceding a deal is virtually always better than forming a relationship with your banker after you have already selected his firm to lead your deal. Wouldn’t it make sense to see how a banker thinks and how he or she analyzes information before you hire them? Don’t you want to have confidence in your banker based on and developed through multiple conversations over time? It is a fact that not all M&A or capital raising deals go smoothly and a good relationship can really make it easier for the company and its shareholders to achieve their strategic goals.
We recall a very talented CEO with whom we had been talking to for over a year before he and his Board decided to sell the company. During that time, the CEO came to trust our openness and insight. He eventually hired us to lead the sale of his company. At a critical moment during the sale process, the CEO told us that he wanted to force several potential international acquirers to “chirp or get off the branch” and submit bids to buy his company—even though Navidar did not think that these international buyers were ready to do so. We were able to draw on the reserve of trust that we had built up and clearly explain why doing this would be a serious mistake. Had we not developed a trusting relationship long before this critical point in the deal, it is not at all clear that the CEO would have been as inclined to take this advice. As it turned out, giving these international buyers more time and information was the key to a successful transaction as the company was ultimately bought by one of these international buyers.
Is It Possible To Get These Valuable Benefits Without Investing Some Time and Energy In The Relationship Before A Deal Is At Hand? Can I Have My Cake And Eat It, Too?
It is natural to wonder whether it is possible to get the benefits discussed above without having to invest some time in developing the relationship before the deal. The unfortunate answer is that a number of these benefits are far more difficult to obtain without having had an ongoing dialogue over time with your banker.
For example, if a CEO has not spoken with a banker over time and gotten his insights, you may make one or more of the mistakes mentioned above that can delay the launch of the deal or undermine the chances for a successful deal. In addition, you may choose an inopportune time to launch your deal, may not have the historical metrics needed to create a track record of success for buyers, or may not have thought sufficiently about how to overcome the potential weak points in your company’s story (and all companies have potential challenges to overcome in their story) that may turn off potential buyers or investors. Finally, and very importantly, by not investing time in the banker relationship, you will not have a good sense of what they would be like to work with, how they add value, how they solve problems, or how well they understand your business before you hire them. For a relatively small investment of time, a CEO can obtain significant benefits that far outweigh the time and energy invested in forming the relationship.
How To Go About Initiating And Developing A Banker Relationship
In terms of the “how” question, forming a relationship with an investment banker is a straightforward process. There are multiple ways to begin the dialogue. A CEO can use their network of other CEOs and colleagues to get a few introductions to bankers that they recommend. Accountants and lawyers may know bankers who could be a good fit for your company. If you reach out to a banker based on a recommendation, the banker should respond quickly, and this response time will give you a good idea of how important you are to that banker. Finally, if a banker reaches out to you, returning their outreach is likely a good idea as it just might be the start of a great working relationship.
As to the “when’ question of how far in advance of a potential sale of the company or capital raising transaction to begin the relationship, there is no perfect amount of time, but we would suggest that 12-18 months is an appropriate time to begin initial discussions and start forming relationships with bankers.
The time you spend with your banker in the months before you hire a banking partner to formally launch your deal will be among the best investments you and your team can make in improving the chances of a successful deal outcome. The effort will not be overly demanding, taxing, or divert you from your job of building your company, but it will position you well for success when the time ultimately comes to begin the very important strategic undertaking of selling your company or raising growth capital.
If you are interested in speaking to us about ways to start preparing your company now for a future M&A, or if you are currently seeking advice on a potential transaction, please contact Stephen Day at [email protected] or (512)765-6973.