Once your startup has matured and you’re ready to cash out on your hard work, gearing up for your startup to be acquired is a great way to realize your real ROI. Investment Bankers can play a key role in a successful acquisition during this process, and forgoing their vital services can be costly for founders heading into a serious startup acquisition.
For the uninitiated, this article will explore what a startup M&A advisor is, what role they play in the acquisition and merger process, and the costs of not using an investment banking firm during your startup’s acquisition.
What is an Investment Banker?
Firstly, to explore what role an investment banker is and understand their benefits to a startup, we need to know through and through what they are. Essentially, investment bankers are financial advisors, who often are involved in helping businesses raise capital in one form or another.
Outside of acquisitions and mergers, investment bankers help underwrite new debt and play a key role in equity financing. Investment bankers are involved in raising capital from shares and play a huge role in initial public offerings (IPOs). During an IPO, an investment bank acts as an intermediary for your stock and helps take it to market.
Investment banking firms have the contacts and expertise to see private deals and raise significant capital for their clients. As well as to help shop them around, bring credibility, and create materials.
What role do investment bankers play in acquisitions and mergers?
The role of an investment bank in a merger or acquisition (M&A) can fall into two camps:
- Seller Representation: Where an investment bank represents the interests of a target business: a startup willing to sell.
- Buyer Representation: Where an investment bank represents the interests of an acquirer.
Here’s some of the work that investment bankers do to meet these roles.
An investment banker can be tasked with establishing the fair value of the target. Investment banks are highly skilled in analysing the value of a business.
There are few methodologies that an investment banker can use to value a business for acquisition. These include:
- Comparable Company Analysis
- Precedent Transaction Analysis
- Discounted Cash Flow Analysis
- Leveraged Buyout Analysis
The first method, comparable company analysis, is also known as public market valuation. This is a valuation method based on the idea that companies with similar characteristics should have similar valuation multiples.
Using Comparable Company Analysis, investment bankers will value based on the market trading multiples of comparable companies. These companies usually include businesses in the same industry, provide similar products, have similar customer demographics and geography to the target business. Amounts derived from this method will not include a control premium.
A Precedent Transaction Analysis or sometimes referred to as historical transaction or private market valuation. This valuation method works on assessing the value based on the multiples acquirers paid for comparable companies.
An investment banker will perform a historic screen looking for past acquisitions of comparable startups and identify financial multiples in order to value your target business.
A valuation found using the precedent transaction method will inherently include a control premium since the acquirer in the precedent acquisition had to pay for controlling interest in the deal.
The third key valuation method is the discounted cash flow method. This method aims to establish the intrinsic value of a business – or the present value of all expected future cash flows.
Using a DCF model, an investment banker forecasts the startup’s unlevered free cash flow into the future and discounts it back to the present firm’s Weighted Average Cost of Capital (WACC). This method Incorporates both the short-term and long-term expected performance of a startup.
An investment banker would forecast the future performance of the startup and assume a perpetual growth rate. This establishes a terminal value of a business. This forecast is then discounted back to today, giving an enterprise value.
The leveraged buyout analysis is extremely useful for acquirer representation. Using this method, investment bankers build a model of how much debt a buyer can take on. This helps to check the feasibility of acquiring a business with a significant amount of debt. An LBO valuation is useful for estimating a value based on debt repayment and return on equity investment.
Why is a valuation from an investment bank important?
Investment banks are experts in providing accurate valuations for companies. Experienced investment bankers are the most trustworthy source for a founder to indicate what can be realised from a startup acquisition.
These valuations may differ from any internal valuations due to an asymmetry of valuation skills and expertise. It’s important to get an accurate valuation as it could indicate whether a profit can be realised from the sale of a company and whether the market value of your startup represents its true value.
Investment banks representing an acquirer will be advising their clients on possible arbitrage opportunities to help their clients create substantial profit from acquiring undervalued startups. For example, if a company’s market value is significantly lower than the company’s modelled ‘real’ worth, an investment bank would help facilitate a merger or acquisition of this target firm.
When presented with an acquisition proposal, the target firm should seek to gain seller representation to ensure a fair valuation is being made. Investment bankers can advise on the risks of taking an acquisition deal and will help to create a forecasted valuation of your company. This information is key in deciding whether or not to accept an acquisition proposal and is vital in negotiating an acquisition if you choose to pursue it.
Alejandro Cremades is a serial entrepreneur and the author of The Art of Startup Fundraising. With a foreword by ‘Shark Tank‘ star Barbara Corcoran, and published by John Wiley & Sons, the book was named one of the best books for entrepreneurs. The book offers a step-by-step guide to today‘s way of raising money for entrepreneurs.
Most recently, Alejandro built and exited CoFoundersLab which is one of the largest communities of founders online.
Prior to CoFoundersLab, Alejandro worked as a lawyer at King & Spalding where he was involved in one of the biggest investment arbitration cases in history ($113 billion at stake).
Alejandro is an active speaker and has given guest lectures at the Wharton School of Business, Columbia Business School, and at NYU Stern School of Business.
Alejandro has been involved with the JOBS Act since inception and was invited to the White House and the US House of Representatives to provide his stands on the new regulatory changes concerning fundraising online.