There is a rather silly notion that–more often than not–stems from ignorance related to private, corporate investments.
That is, nearly all investment funds (private equity, venture capital, family office) and investment bankers fall within the same bucket. News flash: Investment bankers are not venture capitalists OR private equity investors.
Very few middle-market investment banks invest using their own funds. Very few have their own investment vehicles and, when they do, they typically are less inclined toward early-stage venture capital deals. Most private equity funds are interested in risk-sheltered, boring deals in steady-state sectors. Valuations, business models and investor types are all differentiating factors between investment bankers and venture capitalists. Here we will discuss some of these in more detail.
There is a difference between a venture capital valuation and a valuation for M&A. One often bases assumption on forward-looking potential, while the other uses historical performance. VCs use pre and post-money as the basis for the “valuation” while the other looks at some multiple of the historical cash-flows, typically based on industry comparables. Both play the diversification game very differently and therefore treat business valuations very differently as well.
Venture capitalists want the lowest valuation with the lowest amount of capital infused for the associated risk–except in cases when they need to place funds and they have the opportunity to feed a unicorn.
Investment bankers are apt to push for the greatest amount of capital input and the highest valuations possible. Their commissions move in-step with both of those metrics. In fact, when investment bankers do work with venture capitalists on behalf of a client, they are typically at odds with them. There are some venture capital firms that refuse to pay the fees of intermediaries. It’s a picky mentality, that is not exclusively the curse of venture capitalists, but had among private equity firms as well.
In the valuation differences discussion above, we are speaking as though the investment bank itself directly invests in deals. While many investment banks have their own investing funds, most in the middle-market investment banking firms do not directly invest. They are typically the connecting link between buyers/investors and the issuers/sellers. They advise clients on the nuances of capital transactions (e.g. buy-side M&A, sell-side M&A and debt/equity capital infusions). They are not fiduciaries of investor funds. They do not have a investment “thesis” or “mandate.” Most are brokers and intermediaries, advising clients on their own transaction(s) with capital sources, they are not investors themselves.
Bulge-bracket banks differ here, but the general advise or invest rule holds true for most in the mid-market.
Fewer investment bankers work with startups than do venture capitalists. Most bankers like to see substantial revenues (again, the bigger, the better). Why? This is how investment bankers ensure they are able to truly take both front-end and back-end fees for the work they do. That’s not to say investment bankers are more picky than venture capitalists. Both rightly apply stringent filters on potential deals. They simply have different filters to keep out the riff-raff. In fact, one of Berkshire Hathaway’s investor filtration strategies is to never split the company stock. In Warren Buffett’s vernacular, “it keeps out the riff-raff.”
As you might imagine, we receive an inordinate number of capital raise requests. So many, in fact, that I have automation email chains set up using appropriate tags as the trigger in our marketing automation and CRM system. The tag I regularly use is #RaiseCapital. This elicits the following email:
Hi [first name],
Thank you for reaching out regarding your desire to raise capital for your business. To better understand if there is an internal fit, can you tell me a bit more about the opportunity?
If any of the additional information or answers on the above questions involve details of a proprietary nature, feel free to execute our mutual NDA: [link to the NDA]
When it comes to assisting companies in raising debt and equity, we want to make sure there is a good fit and a high internal confidence that we can add significant value in a transaction.
Both investment bankers and venture capitalists will put off phone calls, NDAs and “presentations” from companies until they know whether or not there is real meat on the bone or potential proof in the pudding. Such filters should be expected. If a company is unwilling to jump through the hoops, then they become one of the many self-filtered deals.
Investment bankers are advisors, intermediaries and brokers. They are rarely active direct investors, venture capitalists, private equity investors. If an investment bank invests directly, they typical do so through investment vehicles run by separate teams than those who manage the processes of their capital transactions.
The perfect example of “what not to do” comes from a request we had this week. The message included name, email, phone and location with the following text: “Need a loan.”
In the regulated financial services world, investment bankers are required to following “Know Your Customer” or KYC rules, so as not to provide investing advice to products unsuited for various investor types. While I would not assume the same scrutiny would be applied to company issuers looking to transact in some way, it would be very helpful if issuers applied some form of “Know Your Investor” principals to their outreach.
The more you know, the less you will look foolish and the more likely you will be to get a deal done with the right investor group. In fact, that’s the reason most companies hire an investment banker in the first place.