“Ask the Attorney” – Investment Bankers

by Scott Edward Walker on March 3rd, 2010

Introduction

This post is part of my weekly “Ask the Attorney” series which I am writing for VentureBeat (one of the most popular websites for entrepreneurs).  As the VentureBeat Editor notes on the site: “Ask the Attorney is a new VentureBeat feature allowing start-up owners to get answers to their legal questions.”

I have two goals here: (i) to encourage entrepreneurs to ask law-related questions regardless of how basic they may be; and (ii) to provide helpful responses in plain English (as opposed to legalese).  Please give me your feedback in the comments section.  Many thanks, Scott

Question

We just got an offer to buy our company for a sweet pile of cash, but we don’t know what the next step is.  My father said we should hire an investment banker and let him handle the negotiations.  Do you agree?  Thanks.

Answer

Congratulations!  Without knowing more about the deal and the proposed purchase price, it’s hard to say.  I practiced law for a number of years in New York City, and it was pretty rare not to have an investment banker involved in an M&A transaction.  Here in California, it’s a little different since most of the deals tend to be relatively small.

A strong investment banker can add a lot of value — not only in connection with negotiating the material terms of the transaction, but also in valuing the company and making sure that you’re not selling too low.  A strong banker will also create a competitive environment (or the perception of one) and play bidders off of each other to make sure you get the best possible deal terms.  Indeed, Martin Lipton, a prominent M&A attorney in New York City, captured the value (and qualities) of a strong investment banker in his remarks at the Memorial Service of legendary banker Bruce Wasserstein here.

The problem in the lower middle-market space (e.g., $5-50 million sale price) is that it’s sometimes difficult for entrepreneurs to find a strong investment banker.  A lot of the bankers I have come across here in California are more like business brokers just trying to close two or three deals a year.  I have found that this creates a certain inherent conflict of interest – they don’t get paid if the deal doesn’t close; thus, some of them tend not to push very hard on the key issues.

Moreover, middle-market investment banks often have relationships with certain buyers (e.g., private equity firms) and bring those same buyers lots of different deals.  Accordingly, they don’t necessarily want to rock the boat.

The bottom line is that you should talk to an experienced M&A attorney, and he or she can discuss the foregoing with you.  If you decide that you would like to retain an investment banker, you should ask the attorney for a few recommendations and then meet with them and choose the best fit.  Make sure you ask for references and talk to other clients they have helped sell their businesses.

If you decide that you do not need an investment banker, your attorney can help negotiate the letter of intent (or term sheet).  The letter of intent is very important from your perspective, and you want to make sure that all of the material terms of the deal (e.g., the “cap” on liability, the size of the “basket/deductible,” the survival period of the reps and warranties, etc.) are negotiated at this stage of the transaction.  I discuss this issue in detail in my post “Selling a Company: Ten Tips for Entrepreneurs” (see #5).

Why?  Because this is when you have the strongest leverage – i.e., prior to the execution of the letter of intent. This is when, as noted above, bidders can be played off of each other.  Once the letter of intent is executed, you will not be allowed to shop your company around or talk to any other potential buyers pursuant to the no-shop provision (which is generally in all letters of intent).  Accordingly, if you don’t retain an investment banker, this is when you and your lawyer will need to button-down the key issues.

The buyer, on the other hand, is better served by simply keeping the letter of intent general (other than the no-shop provision) and then negotiating the key issues in the acquisition agreement when the other interested parties (if there are any) have gone away and your leverage is weakest.  I discuss this issue in detail in my post “Buying a Business: Ten Tips for Entrepreneurs” (see #2).

Conclusion

I hope the foregoing is helpful.  If you’re interested, there’s an excellent article in yesterday’s New York Times with respect to the role of investment bankers generally and Warren Buffett’s concern regarding their inherent conflicts of interest (see “Buffett Casts a Wary Eye on Bankers”).

Tags: Ask the Attorney, bidders, entrepreneurs, investment banker, letter of intent, material terms, private equity, term sheet