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Raising private equity? Seven questions to ask your investment banker—before you hire them.
Ryan CaldbeckOctober.10.20146 min read

Raising Private Equity? Seven Questions To Ask Your Investment Banker Before You Hire Them

What entrepreneur wouldn’t jump at the opportunity to have an investment bank introduce their company to a hundred plus potential investors or acquirers?

Me. And here’s why.

Last February a Consumer Company Was Searching For Investors…

The company had $15 million in revenue and hired a boutique investment bank that specializes in the consumer and retail.

At the time they hired the bank, they were getting inbound interest from potential investors, as well as acquirers, at reasonable valuations. But the CEO hired the investment bank, assured that a more “comprehensive and robust” process could return higher valuations. So the company hired the bank and started paying a $20,000 / month retainer. The agreement also required a sizeable success fee in the event a deal ever got done.

Herein lies the disconnect: the Company wants to close an attractive deal as soon as possible—the process is time consuming and hugely distracting. On the other hand, the investment bank is getting paid $20,000 a month, deal or no deal. It’s difficult to believe the bank’s sense of urgency in structuring a deal will mirror the companies.

Here’s what happened next.

The investment bank sent out details of the company to 50 large strategics (public consumer companies) — basically every Fortune 500 company they could think of — and 75 private equity firms. I can safely say 90% of those investors and strategics would never invest in a company that size. TPG, a massive private equity firm with $66 billion under management, was sent materials on the $15 million consumer company. At least 20 of the private equity funds had $1 billion + under management. Those firms typically can’t touch a $15 million brand because the investment size will be too small.

By August, each of the prospective investors had passed on the deal. The company was stuck trying to lower its valuation and find immediate capital. But it was too late: the investment bank had poisoned the well.

Now that company can’t go back to those prospective buyers. To make matters worse they had strung out one a major lender because they believed they would be acquired, or at least secure a large investment. The company was performing well, growing at >100% year-over-year in 2014, but having planned for a capital infusion that never came its finances were in disarray.

Last I heard, the company was being shopped to a private equity firm that specializes in distressed companies and turnarounds.

Why Do Situations Like This Occur?

Oftentimes it’s because there is a fundamental misalignment between the incentives of the company and its banker.

Recently, I heard an investment banker proudly recount, “We close probably 25% of the companies we try to raise for.”As a former private equity investor, and CEO of an investment platform that focuses on deals in this size range, I had to scratch my head at this statement. Even in Major League Baseball a .250 average puts you in the bottom third of batters.

On the contrary, CircleUp has successfully closed approximately 65% of the companies that have attempted to raise capital on our platform. Furthermore, when using an online platform companies remain squarely in control of who sees their information—owners can see to it that sensitive information doesn’t end up in the hands of dozens of unlikely investors. (One thing many companies don’t realize is that when an investment bank shares your information, all those potential investors will hold that information for several years.)

Getting It Right: Seven Questions You Need to Ask Your Investment Banker

Don’t get me wrong. There are certainly great investment bankers — bankers like Janica Lane, at Piper Jaffray, David Jacquin, at North Point Advisors, and Houlihan Lokey’s Jay Novak. They are, however, Kingmakers, and by definition represent not the majority but the minority. As a result, before you choose how you will raise capital and with whom, it’s critical to do your due diligence.

When I talk to companies seeking investors, I give them seven questions to ask every potential investment bank.

  1. What is your success rate? While industry-wide statistics are hard to come by, it’s not uncommon to hear success rates of 25-35%. So before you decide on an adviser ask yourself: Are you comfortable paying a hefty retainer for a one in three chance of closing a deal?
  2. Why do you love my company? Make the bankers get specific. If they can’t convince you that they are strong believers in you, your management team and your business, they certainly aren’t going to be compelling when they present to potential buyers or investors.
  3. What’s the average time to close a deal? Don’t have them guess and don’t let them beat around the bush. Have them confirm their representation in an email with specifics after they run the analysis. Time is money—your money. Once you sign an engagement letter with an investment bank, the meter is running. If the fee structure is weighted toward a retainer rather than a commission, the banker has less of an incentive to close a deal quickly. Often, investment bankers will take three or four months before they even BEGIN to talk to investors.
  4. What experience do you have with companies in our size range and in our industry? Size matters. So does industry. If you work with investment bankers who tend to work with larger companies, what do you think will happen if a larger client needs their attention or a larger prospect comes their way? Suddenly, you are a second or third tier customer. What if they have no recent clients in your industry? You can bet they don’t have the ears of the most relevant investors or buyers.
  5. Can you give me five references? You should ask for introductions to five companies: two that were successful in their raise and three that were not. Ideally, these references will be in your industry and in your company’s size range. Have them be recent and make sure they all worked with your specific banker, not just the bank itself.
  6. Who are the first five people you want to call about my company? Who are five people you won’t call? If you’re a $15-million food company, your investment banker should not be wasting your time and money calling Fortune 500 strategics or billion-dollar private equity firms. If they say “Nestle” say “that’s great—who at Nestle, and when was the last time you talked with him or her?”
  7. What are your average fees in the past year and what has the split been between a retainer and commission? This tells you a lot. A very high retainer doesn’t incentivize your banker to close a deal. Conversely, investment banks that rely heavily on commissions are motivated to close transactions quickly and at the highest valuation possible, and they are inclined to only take on companies in which they believe strongly.

Sooner or later nearly every growth company needs to raise capital, be it through borrowing, an equity investment, or M&A. We’re past the days of blindly picking an investment bank and entrusting “the experts” to go out and find capital. Only investment banks that directly align their business model and compensation with the interests of their clients will survive as online investing platforms continue to transform the capital raising landscape.