Sunday, August 10, 2014

A Cure Worse Than the Disease

Here be dragons. Who do you want in your corner?
Messenger: “I see, lady, the gentleman is not in your books.”
Beatrice: “No; an he were, I would burn my study. But, I pray you, who is his companion? Is there no young squarer now that will make a voyage with him to the devil?”
Messenger: “He is most in the company of the right noble Claudio.”
Beatrice: “O Lord, he will hang upon him like a disease: he is sooner caught than the pestilence, and the taker runs presently mad. God help the noble Claudio! if he have caught the Benedick, it will cost him a thousand pound ere a’ be cured.”

— William Shakespeare, Much Ado About Nothing

I suppose it does little harm to admit, O Dearly Beloved and Long-Suffering Readers, that this site is shot through and through with what my colleagues across the gaping divide in Sales & Trading would call “talking your book.” Notwithstanding the slings and arrows sent this way by those who can see no redeeming social or economic benefit to my profession, I am proud of what I do, and I firmly believe I offer real value to my clients in return for the shiny simoleons which they so graciously bestow on me, however so (and too) infrequently. This should not really be that surprising. I think there must be few human beings who do not find some sustaining or redeeming value in their daily occupation, even if only as a sop to their self esteem or a dodge against despair, and despite all your protestations I continue to aver that investment bankers are human, too.
If you prick us, do we not bleed?

That being said, I think I have been pretty honest in these pages (and in the conduct of my daily duties, too) that M&A advisory services are not for everyone. There are many reasons a client might consider in deciding whether to employ someone like me, and not all of them make sense or can be justified by any honest calculus. While there are plenty of dissembling shysters roaming my industry intent on imposing their services and extravagant fees on anyone they can convince to write a check, I have always been of the opinion that you make a client happy in the long run by only recommending what is truly beneficial for them, rather than yourself. And often, hiring an M&A advisor is not the best course of action. At least not yet.

* * *

So I am pleased to take this opportunity to respond to an article on private equity and venture capital shill site peHUB, written by a corporate attorney, about things to consider when you are selling a private company. As advertised, it is geared towards the owners of private companies, who generally face a simpler and less complicated set of constraints and obligations than the Boards of publicly held ones. Of its type, it is a reasonably comprehensive and useful guide.1

In it, Mr. Stewart offers the following considerations concerning whether you should hire a flesh-eating investment banker like me when you are selling your private company:

*Do You Need an Investment Banker? Investment bankers can add significant value in an M&A process, but they are expensive. Investment banker fees typically range from 1 percent to 2 percent of the deal value, although the fees vary by deal size and profile. Typical benefits of having a banker in an M&A process include having an agent to (1) advise on market trends and valuation, (2) approach potential acquirers with which the target’s executive management would not otherwise have contact, (3) take the difficult, “bad cop” negotiating positions, and (4) co-manage the sale process with the target’s legal counsel.

Now this is fine advice, as far as it goes, but it omits some pretty important content and nuance that I, your reliable guide to all things overpriced and intermediary, will be happy to impart herewith.

Deferring our discussion on whether M&A advisory fees are in fact “expensive” and if so how for later (I promise), I can first address Mr. Stewart’s itemized reasons for hiring a banker by contrasting them with what corporate lawyers typically do in deal contexts. On the first two points the author is correct by implication: rare (and professionally worrisome) is the lawyer who is concerned with markets and valuation, and even rarer (and in likely violation of her professional ethics) is the lawyer who spends time and energy soliciting buyers for her client. These are tasks for which lawyers are unsuited by training, focus, and predilection, and if the client wants someone other than himself to weigh in on such matters and perform such heavy lifting he needs to hire someone for whom they are suited. The third task is more nuanced, as lawyers are perfectly capable of acting (and often quite happy to act) as “bad cop” (read flaming asshole) in matters properly considered legal, but it is true that bankers adopt this role more naturally and properly in matters business.

The fourth task is generally a bone of contention for lawyers and bankers on a deal, as each usually considers the other an interfering nuisance who focuses on the wrong things at the wrong times. Nevertheless, it is true that a properly run deal process usually starts with the banker running things until definitive negotiations begin between the seller and the potential buyer, at which point the seller’s attorney takes over to control the legal minutiae of drafting purchase agreements and other such trivia. While I am convinced many if not most deal attorneys would be delighted if they never had to deal with another investment banker again, bankers are more than pleased to have lawyers around to handle the boring scut work of transaction documentation and risk mitigation. After all, somebody has to stay behind to argue over semicolons while the banker takes her client off for a nice, celebratory bottle of Échezeaux.

* * *

But Mr. Stewart misses three very important reasons why it usually makes sense for a private company, in particular, to hire an investment banker to sell itself. The first is the fact—evident if an attentive reader were to consider the range and complexity of the tasks Mr. Stewart himself recommends the seller perform—that selling a company is long, complex, and difficult work. A typical sale process, depending on its structure and the number of potential buyers it involves approaching, can last anywhere from four to six months or longer, and that is if all goes well. During that time, company management and owners (usually the same people) must continue to run the firm with the same level of intensity and focus they do normally, otherwise things being things and people being people results will start to wobble or decline, and the intrinsic value and earning power of the business will erode. Yet pre-deal preparation, internal due diligence, and identification and potential communication with selected potential buyers all take a substantial amount of time, and once the deal is launched keeping it humming along and tending to its myriad details and interruptions requires constant daily attention. Virtually no private company of normal size has the extra personnel or dedicated, trained professionals to handle this properly, and, frankly, few private company CEOs or CFOs have the skill or training either, even if they did have the time. (And they don’t. Or shouldn’t.) A skilled sell-side advisor will manage this entire process, and she will arrange things so company management spends as little time as necessary providing the input, attention, and personal presence they must so they can continue to focus on their day jobs. Lawyers just don’t do this sort of thing.

Second, a good2 M&A advisor will bring market intelligence to bear on a sell-side assignment which nobody else—not even a dedicated internal M&A functionary at a large private company—can come close to providing. This is detailed, intimate knowledge of a firm’s potential buyers, based on comprehensive discussions and extensive deal experience and interaction with all of them. As I’ve written before,

You might think that a participant in a particular industry should know the strategic intentions and capabilities of its direct competitors well, but normally you would be wrong. Competitors do not talk to each other directly about strategy because—wait for it—they are competitors. On the other hand, it is the job and practice of any good investment banker not only to develop an informed opinion about how each significant competitor in a space thinks about strategy but also to have done so by talking directly with them, frequently if possible. This is simply not practical for most corporations. Investment bankers are normally far better informed about the strategic landscape of an industry than any one of its participants.

And this knowledge is not limited to other companies, either. A good advisor will also know the likely, potential, and just-barely-possible buyers of her client among the financial sponsor (private equity) community, too. Not only will such a banker know these parties and their own acquisition appetites and capabilities well, she will know which ones of them are complete and utter assholes, which ones tend to fire the management teams they acquire with companies within the first year of purchase, which ones like to bait and switch sale processes by bidding high then whittling down their offer during exclusive negotiations, and which ones are irredeemable bottom feeders.3 This is invaluable information which even the best informed private company in the most incestuous industry has very little of, if any.

Knowing the likely buyers in the private equity world and being able to bring them to the table is critical in virtually every industry sale process nowadays. Not only are sponsors often the best capitalized and most aggressive buyers, they are almost always faster and more professional than the strategic buyers in an industry, because unlike the latter the former do deals for a living. Incorporating this type of determined, fast-moving buyer into a sale process is very helpful even if the seller and his banker think the most likely buyer is a competitor in the same business, because it helps the banker keep time pressure and process discipline on the strategic buyer which might otherwise dissipate. They also usually offer a very different purchase alternative to a private company seller: sell us your business, then come work with us as a (junior) partner to build it bigger so we can sell it to the next guy, and you will get a second bite at the apple. This, in contrast, to the typical offer from a strategic competitor: sell us your business, then either join us as a salaried employee or go away. Many private company owners prefer selling to private equity firms for this very reason nowadays, but they are babes in the woods when it comes to knowing those buyers. A skilled investment banker can offer crucial guidance in this area.

Third and last, surprisingly enough—given the regular beatings good sell-side advisors give potential buyers in M&A deals—most serious buyers prefer private companies to have professional sell-side help engaged. This is for all the reasons cited above: they know most private companies do not have the time, M&A experience and discipline, or negotiating skill to run a tight, efficient transaction process. Buyers want to know the person sitting across the table from them is not procrastinating, flip-flopping on deal provisions or objectives midstream, or negotiating in a disingenuous or irrational manner. Being a buyer of companies is expensive and time-consuming, too, and buyers who are serious don’t like to suspect their time is being wasted. Having a professional investment banker across the table gives them some confidence, because everybody knows no investment banker would allow herself to be hired by a client who wasn’t serious themselves.

And this, at the last, is probably the most compelling reason a private company should hire a financial advisor to sell itself: because that banker will make sure to keep her client disciplined and focused on accomplishing the sale. Privately held companies—for all sorts of good, bad, and indifferent reasons—can often be pretty squirrelly, and nothing will kill a deal faster than a squirrelly seller. After keeping buyers in line, a good sell-side advisor’s principal role is to keep her own client’s eyes on the prize.

* * *

Which brings us to the matter of expense. It is true that, for most deals, the check a seller writes to his investment banker is usually the biggest one crossing the closing table other than the purchase price itself. Even so, one or two percent of the transaction value is arguably a pretty small price4 to pay for someone who has broadened the potential universe of buyers, guided and directed the sale to achieve the highest price and best non-price terms available given the seller’s other objectives, and performed all the tiresome, dirty work of managing a complex sales process for upwards of six months or more. Even more compelling, except for the occasional nominal retainer, the success fee a banker earns upon her client’s sale is just that: a success fee. If the sale fails, or her client withdraws his company from the process for whatever reason, she does not earn anything. Her risks and incentives are completely aligned with those of her client, assuming of course her client really wants to sell.

And that is the real answer: if you’re not really sure you want to sell your company, don’t hire an investment banker. It is our job and embedded in the way you pay us to do everything in our power to close your transaction, including beating you up if you’re backsliding, procrastinating, or otherwise doing anything unreasonable and likely to derail a potential sale. Other bad reasons—like you’d like to play investment banker yourself, no matter how much it costs you in distraction from your core business, diminished transaction value, and fruitless legal and accounting expense—are also good arguments for not hiring a banker, but presumably you are too intelligent to need me to tell you that.

Of course, any good corporate law firm would be more than happy to accommodate you in such circumstances. After all, they charge by the hour.

Related reading:
Matt Stewart, Things to consider when selling a private company (peHUB, July 28, 2014)
Eight Reasons Not to Hire an M&A Advisor. And One Reason to Do So (May 14, 2011)
A Good Start (January 19, 2011)

1 If I’m being honest, as I claim, I think the author is a little lackadaisical about describing the necessary structure and elements of the sale process for a private company. While he gets the major elements right, he is a little slapdash in describing how they all fit together. It has been my experience that a robust and disciplined process is absolutely necessary to keep deals moving at an appropriate pace, to encourage potential buyers to play nicely, and to keep the seller focused on what needs to be done. Without a firm hand on the tiller (and an eagle eye on the clock), there is a tendency for all deals to fritter away into time- and money-wasting nonsense. Given the fact that, of all the players involved in these little dramas, lawyers are usually the only ones paid by the hour, I will leave it to the cynics in the audience to conclude whether this omission was intentional.
2 The perceptive among you will note that my use of “good” here is definitely normative, if not prescriptive. The type of knowledge which informs nuanced, deep understanding of the strategic landscape of an industry is normally only collected by investment bankers focused on and active in that industry. This means if you value and want such knowledge you should search for an advisor from among those who actually have it, rather than the generalist sell-side firms who market themselves as one size fits all. They are prolific sausage factories, it is true, but all the sausages tend to come out the other end looking the same. Just sayin’.
3 Yes, we know who you are. All of you. You, too.
4 Unless you are paying 2% for a billion dollar deal or greater, in which case your banker is a shyster and you are a fool. Or neither one of you cares how much of your public shareholders’ money you waste.

© 2014 The Epicurean Dealmaker. All rights reserved.