What Investment Banking Is All About
Deal making is akin to a magic trick. Being an investment banker for better part of my post MBA life, I have participated in and witnessed many such conjurings. M&A transactions are intricate and tedious, sometimes taking well over two years to culminate. It is in the best interest of all the stakeholders to close the deal as quickly as possible. Enter the investment banker. The banker dons the hat of a magician and performs the most complicated of magic tricks possible in the financial and strategic domain. And as with all great magic tricks, there are three major acts — the Pledge, the Turn and the Prestige.
First act is the setup, in which the nature of what might be attempted is hinted at.
As a sell-side banker attempting to find buyers for a company operating in a not-so-attractive sector supported by weak global macro-economic cues, the first act becomes as important as the last one. The banker starts by investing a significant amount of time rationalizing and strategizing about the company’s positioning. This is one of the most crucial aspects of the entire process. The business has to appeal to the investors and be a strategic fit for their operations. A short deck of 5–6 slides called the ‘teaser’ is sent to all potential buyers/investors. This contains a snapshot of the company highlighting its strengths and differentiators but obviously not detailing the whole story. The teaser sets the tone for a long and complicated trick. A quality teaser always leaves the investor wanting more, thus paving the way for the second act.
The second act is the performance where the magician’s lifetime of practice comes to fore.
The interested potential investors thereafter sign an NDA (Non-Disclosure Agreement) and are then sent the ‘collateral’. It usually consists of an Information Memorandum (IM in short), a marketing document with block-by-block details of the business. Alongside, the financial model/business plan gives out the detailed historical and projected future performance of the company. The operative word in both cases is detail as investors scrutinize every scrap of information. A great IM focuses on a few key differentiating themes of the business and if applicable, of the overall sector. It forces investors to assess the business on the parameters and themes illustrated in the IM while limiting their questions on other weaker aspects of the company. The business plan is equally important as it demonstrates the viability, profitability and scalability of the business and at the same time helps the investor evaluate possible synergies. The next phase of deal process hinges on the defensibility of the collateral and herein the skills of the banker, garnered through experience and enhanced by innate talent, are tested. The preparation that went into understanding the business prior to marketing the deal, aids the banker in providing comfort to the investor about the company and the discussion then moves on to the deal price.
The investment banker is the quintessential negotiator. Haggling is in his blood, it gives him a high. He, more often than not, manages to get the best price for the client in a given situation. The deal price/valuation is arrived at after multiple rounds of negotiations, post which the investor gives a non-binding term sheet contingent on legal and financial due diligence. This document contains the terms of the transaction which includes valuation, key rights of the investor, confidentiality clause and time period for exclusivity.
The investor then hires an external agency for due diligence, timeline for which varies from 4–10 weeks depending on the nature of the transaction.
The third act is the product of magic. It is pulling a rabbit out of a hat, which apparently did not exist.
I am sure Murphy had M&A transactions in mind while giving the world his famous epigram -“Anything that can go wrong will go wrong”. This adage is especially true for Due Diligence findings which invariably bring out several potential deal breaking issues. Haggling skills of the banker are again on offer as he works his magic by successfully negotiating all key issues of the diligence with minimum impact on the deal price.
Final phase is the negotiation and signing of the Shareholder’s Agreement and the Share Purchase Agreement (SHA and SPA resp.) which concludes the deal with the investor taking over the reins of the company.
The final act is the greatest of all, with the banker successfully conjuring and closing a deal which was never on the table in the first place.