WALKING ON WATER — AN ENTREPRENEURS GUIDE- Part 6 (Investment Bankers)
This Article is part of a series of eleven articles from my book. You will find the links to the next feature article at the bottom of this page.
SKIP TO A PARTICULAR ARTICLE IN THIS SERIES
Part 1- Introduction
Part 2- The Beginning of a Business
Part 3- Planning and Goal Setting
Part 4- Act As If
Part 5- Financing your Business
Part 6- Investment Bankers
Part 7- Your Management Team
Part 8- Lawyers, Accountants, and Auditors
Part 9- Doing Your Homework
Part 10- Strategy & Growing Your Business
Part 11- Exit Strategies & Keeping Your Sanity
Chapter 5 — INVESTMENT BANKERS
An investment bank, also known as a securities dealer or broker, is a firm that assists businesses in raising debt and equity capital. Investment bankers are the used car sales people of Wall Street. They will promise you the world, charge you hidden fees, and then not deliver — or so people say. I have had quite a different experience. Most of my i-bankers have become great friends. Once again, it comes down to the importance of building relationships. My lawyer made a couple of calls to get me in touch with a boutique investment firm that had specialized expertise in raising money in the oil, gas, and mining sector and was looking to diversify into renewable energy. The reason I say boutique is because they were small enough to care, connected enough to raise money, and confident enough to put their own money at risk. They managed to help me raise in excess of $10 million over three years, and I made some friends along the way who helped me during those crunch times I mentioned previously. This of course is in stark contrast to software based businesses that have the benefit of pitching wild ideas to venture capital investors in Menlo Park. But I am not a coder and never will be, so raising money for a “normal” business requires a different approach than what you have read about.
Investment Bankers versus Crowdfunding Platforms
If you have a physical product you can pre-sell, then a crowdfunding platform like kickstarter and indiegogo make sense. It’s a way of funding the production and inventory. And figuring out whether there is actual demand for your idea. If its another form of business I would be weary of funding platforms. They really are just in it for the fees and you are just a number. You quickly realize, if you don’t have a network they really won’t work for you. Similar to your banking relationship, you want real people to know you, to understand your business and above all to put you through the wringer, to ask the tough due diligence questions and to poke holes at your idea. You’ll never get that from a website. Even if most will pass on your idea, you will learn something from every interaction. Every no, should be evaluated for valuable data.
How to Choose an Investment Banker
There are three things to consider when looking to engage an i-banker to help you raise capital:
1. What are the commissions and fees they charge?
2. What is their hurdle rate?
3. What is their relevant expertise and track record of closing deals in your industry or related industries?
Most i-bankers work on what is called a “best efforts” basis. Unlike an underwritten public offering where they take on risk, best efforts means that they will do their best to help you raise the money, but there are no guarantees. Most of the time they will also help you create proper financial models and presentations, and they will put a value on your company and the share price. You may not like that price, but it’s probably what the current market is giving; furthermore, they know what their client base is looking for. Essentially, they will make the calls and set up the meetings for you. Since you have already created your Staging Kit, their reps will use this document to pitch on the phones and email on your behalf. Then it’s up to you to impress at the meetings.
TIP: A good i-bank can set up ten to twelve meetings per day — that’s almost one meeting per hour. Subtract fifteen minutes of travel time to get to your next meeting, and this leaves you with only forty-five minutes max at each meeting. After a short introductory handshake, you have about twenty minutes to get through your power point presentation, ten minutes for questions and answers, five minutes to talk about terms, and you’re off to the next guy. Now do you see why you can’t have more than twelve slides?
Commissions and Fees
For their services, i-bankers charge various fees. The four most common fees are as follows:
1. A commission, which is a cash percentage (usually anywhere from 8–12 percent) of the total amount raised.
2. Warrants, which give the i-banker the right to buy stock in your company at a pre-determined price, usually higher than the market value of the deal. Sometimes investors might ask for warrants as well, to sweeten the deal.
3. Working fees, which are fees i-bankers charge during the capital-raising effort or just prior to it. As far as I am concerned, this is a bullshit fee and you should do everything possible to avoid it. Increase the commission if you have to. But avoid upfront fees.
4. Expenses. Very often there are expenses associated with raising money — trip expenses, photocopies, and the list goes on. You should always require these to be pre-approved by you, and expenses should always come out of the proceeds of the capital raised, never out of your pocket. Beware of so called “working fees” that are billed upfront. These people are crooks and will never raise you money. Ever.
Hurdle Rates
When choosing an i-bank, you need to be aware of hurdle rates, both for the i-banker and their existing list of investor clients. What does that mean? A hurdle rate is a minimum threshold amount the i-bank can raise without losing money. Small deals are just as expensive as big deals. It takes as much effort to raise $1 million as it does to raise $100 million. So if you need $5 million, don’t waste your time with i-bankers that have a $50 million hurdle rate. In fact, investment bankers will respect you for understanding this, so don’t be afraid to ask. Even if they can’t help you, you can always ask them for a referral to a smaller boutique firm with the promise of getting them in on your larger raise down the road.
The same goes for investors. When Warren Buffet announced to the world that he was looking to go green, I blatantly and without introduction sent him a letter asking him to invest $100 million in my wind farm. Much to my surprise, I got a phone call from him a week later. He said that he really liked the deal, but his hurdle rate was somewhere around $500 million for comparable deals. There was no way he could make an investment because he needed to focus his time on placing billions of dollars. Once again, it takes him the same amount of time for a small deal as it would for a large deal, but the large deal will have greater overall return on investment. Warren ended up making a $500 million investment in another wind project in the midwest. So always ask your i-banker about their hurdle rates.
Private investors excepted, many funds have limitations on the market cap or revenues of the investee company, whether it’s public or private or the time to make an exit strategy. For example, you are meeting with Fund X. They need you to have sales of $10 million and go public in less than nine months. But you are raising your first million, and you have about $500,000 in sales so far and don’t expect to go public for another two to three years. What chance do you have of getting their money? It’s better to save that meeting for a year down the road when you have grander ambitions.
Expertise and Track Record
The final key element to choosing an ibanker is to understand their track record and expertise in the field. You have to think a bit outside of the box here. I’ll give you an example. I chose an oil and gas boutique firm to raise money for my wind power business. Sounds somewhat odd, doesn’t it? But to an investor in Texas, it’s the same concept whether it’s an oil well or a wind turbine producing a royalty on his land and the associated tax benefits. So the i-bank’s expertise, track record, and contacts in oil and gas, and my ability to dumb down the idea of a wind farm (KISS principle) made for a perfect combination. Try to think of a cross-industry combination in terms of your business. People love pigeonholing a business. If you can expand your horizon to find similar business processes, even in a completely unrelated business, you stand a better chance of raising money. On the other hand, be careful when choosing a firm that has all your competitors as their clients. Working with such a firm is never a good idea, because they already have a relationship with your competitors, and the last thing you want is for you to get less attention from your i-bankers than your competition gets.
TIP: There is a difference between an i-bank’s “order book” and funds in the bank account. If an i-banker says to you, “Our order book is at $2.3 million,” that doesn’t mean they have closed the investor; it’s just a so-called soft-circle sale. The order book is full of non-firm commitments. So once you’ve hooked an investor, be ruthless about getting him to sign the documents and send his money. Work with the representative that took you to the meeting to get the guy to close. The longer it takes, the higher the risk that he won’t convert from the order book to a closed deal.
