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Hiring Bankers - Pick the Lowest Number
I have been spending some time lately listening to banker's pitches. That's a good thing. It means the IPO and M&A markets are healthy and people want to buy the businesses we've invested in.
When you enter into a process to take a company public or sell it, the board usually selects a banker (or a goup of bankers in the case of an IPO) to manage the process. That is called a bake off or a beauty contest. It's a surreal experience for everyone involved.
The Board selects a day and typically spends it listening to a bunch of 1 hour pitches from bankers. The bankers all create pitch books that explain why their bank is the best, why they do more deals like yours than anyone else, and why they will get your company the best price.
Near the end of every pitch book is the "valuation analysis". This is where the bankers show you how your company will be valued by the buyers or by the public markets. There is always an elaborate methodology followed by a number. That number is often a range.
Now here is where I am going to propose something controversial. I suggest selecting the banker that gives you the lowest number or range, not the highest one. Here are my reasons:
1 - It means they are honest. An honest investment banker is a special thing. You should hire one if you find one.
2 - It means they understand your business. The big numbers that get thrown out are almost always based on some pie in the sky methodology like a discounted cash flow analysis (DCF) that is based on projections ten years out. Would you buy a business based on that kind of work? I wouldn't. The lower numbers are based on market realities, real comps, and "off the record" conversations with potential buyers and investors.
3 - It means they don't feel the need to compete on price. This one is important. If the banker is really good, they'll win your business based on who they are, what they know, who they know, and what they've done. Price will be immaterial in that sale process as long as their number is in the realm of reason.
This "pick the lowest number" advice can be applied to other situations as well. Charlie and I were talking about sale processes yesterday. In particular, the "game" where everyone throws out a big number just to stay in the process. Then after all the competition is gone, the buyers get in, do the work, and the actual price of the deal ends up being lower than most of the original indications of interest, including the people who got thrown out for offering too low a range.
This happens all the time. People throw out big numbers to get selected. Then they do the real work after they've been selected. Then the re-trade of the price happens.
I say pick the lowest number from someone who really knows what they are doing and go with it. As long as that is a number you'd accept, its the thing to do. I've rarely been disapointed when I've done that.
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Listed below are links to weblogs that reference Hiring Bankers - Pick the Lowest Number:
» How to pick an investment banker from Strategic Board Blog
Good investment banking advice on - A VC: Hiring Bankers - Pick the Lowest Number. [Read More]
Tracked on May 5, 2005 9:27:03 AM
» Hiring Bankers from Chris Selland's Weblog
Loved this post from Fred Wilson - so right on so many counts. Applies to M [Read More]
Tracked on May 5, 2005 10:10:52 PM
» Hiring Bankers from Chris Selland's Weblog
Loved this post from Fred Wilson - so right on so many counts. Applies to M [Read More]
Tracked on May 5, 2005 10:11:47 PM
Posted May 5, 2005 in Venture Capital and TechnologyComments
I'd say the same advice when selling real estate. I recently sold a flat here in London and saw a few estate agents, there was a massive range in the valuation and I initially (naively) went for the one who gave me the highest. They then started giving me offers at 35% below the listed price with a straight face and no excuses. I went with another agent and got the price they had initially valued the property at. I reckon there's even fewer honest estate agents (realtors) out there than ibankers!
Posted by: scott | May 5, 2005 8:07:17 AM
Ah, if only the world worked that way.
Back when I was an analyst, it was part of my job to lend credence to the valuations the bankers produced for our pitches. I think our valuations were more credible than most (especially since we'd worked on most of the important deals in our space), but there was always pressure to raise the proposed valuation.
At the end of the day, bankers are basically salespeople, and the good ones understand the fundamental law of sales: everyone wants to be loved. And in the world of finance, love = money.
(I'll save my rant for later: the one about how almost any quality inventment bank is perfectly capable of executing an IPO, and the whole beauty contest idea is fundamentally flawed so why don't more companies focus on process and fees the way Google did and so on and so forth.)
Posted by: Shivering Timbers | May 5, 2005 10:09:04 AM
"some pie in the sky methodology like a discounted cash flow analysis (DCF)"
..sorry, just thought the point needed to be reilliterated for our professor’s sake. (Hi Claudia!)
Posted by: Danny | May 5, 2005 11:24:22 AM
How about the price closest to your estimate of the true value and not the highest or the lowest? That's what I try to do with only modest success. It's hard to talk other out of hitting the high bid.
Posted by: Jay | May 5, 2005 11:55:41 AM
as long as they aren't off by orders of magnitude (and they never are), i ignore the numbers thrown around by the bankers -- they're irrelevant.
what's relevant is the number and types of deals they've done recently, how close they are to this deal (market focus, size, etc), and therefore how fresh their contacts are with potential likely buyers.
i don't pick someone who pitches a higher or lower number -- i pick people who bring to the table the assets that will help the company sell itself faster and for the highest price. and that's fresh, relevant contacts with buyers.
Posted by: just.a.guy | May 5, 2005 3:46:09 PM
I am surprised that you made no mention of web-based IPO services (i.e. W. R. Hambrecht). Dutch auctioning is the way to go IMO. Low costs and efficient pricing :)
Posted by: James Bachman | May 6, 2005 9:39:31 PM
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