In the previous parts of this article series, I discussed four common misconceptions about M&A investment bankers: The importance of knowing a lot of buyers, the value of industry experience, the use of "magic words" and how to set the ask price. To conclude, I will discuss whether an investment banker selling a company is the same as a realtor selling a house.
Misconception: Investment Bankers and Realtors Do the Same Thing
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 transitions 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 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 more).
- A realtor will list the property online and in newspapers and 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 individually contact each potential buyer. The general public does not have access to this company information. In fact, the general public will not even know the company is available for sale.
- 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 walk-throughs 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 buyers list, contacting the buyers, setting up meetings, soliciting offers, and negotiating and closing the final deal.
- A real estate deal, 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, earnouts and stock. Money is placed in an escrow account. The seller makes a slew of promises to the buyer and backs up those promises with the money in escrow. Adjustments for working capital are made at the closing and 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 earnout), 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.
Reality: Investment Bankers Are Hired for Their Negotiating Skills to Close a Complex Deal
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 buyers 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 deal 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. Deals don’t close themselves. Someone needs to stay on top of it. Someone needs to push the other constituents to get the deal 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 deal 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 deal 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 deal. 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.
So, how can you determine the investment banker’s negotiating skills? Here’s a good starting point: Ask for a fee proposal and cut their fees to the bone. If they accept your low ball offer…don’t hire them. Anyone offering their services at a cut rate price is probably offering a cut rate service and, more importantly, the way your investment banker negotiates with you is exactly how they will negotiate for you.
Fifth and Final Tip
Instead of asking, “You’re the same thing as a realtor, right?” the owner or executive should determine the investment banker’s negotiating prowess.
Summing It All Up
I’ve discussed numerous misconceptions about M&A investment banking in this article. This table sums up the five points I’ve made:
Additionally, another factor should be weighed when picking an investment banker: Chemistry. In other words, do you like these people? If the answer is, “No,” proceed no further. If the answer is, “I’m not sure,” proceed no further. But if the answer is, “Yes,” then remember to consult and review the misconceptions I’ve detailed in this five-part series.
Remember, you will be working closely with your investment banker for months, perhaps close to a year. You need to like the people with whom you are working. If you don’t like them or if you are unsure, move on and find another. It’s as simple as that. And make sure you check references (tips on that coming up soon)!