I had the pleasure of seeing my second investment as a VC come to fruition when 3M acquired Brontes for $95M (huge congrats to the entrepreneurs, who were two HBS students I met on campus in early 2003 and an MIT professor). The process reminded me of the role and importance of bankers and brokers, a topic that many entrepreneurs often ask me about.
It’s actually very amusing to solicit VC views on bankers and brokers. "Hate ’em coming in, tolerate ’em coming out" is the refrain you’ll often hear. In other words, VCs don’t like dealing with bankers and brokers when representing companies who are raising money, but like working with them when they are selling their companies. Why the dichotomy?
Simply put, VCs believe that if a company needs a banker or broker to represent them to raise VC financing, then they’re probaby not worth pursuing. VCs are required to be snobs by nature. They have to select one business in a thousand to invest in. That means they are looking for 999 ways to say no (see related post, Dr. Seuss and The Land of No). If an entrepreneur needs a broker to find VC money, then VCs automatically think "mediocre". After all, the super-successful, serial entrepreneurs know all the VCs in town and would be aghast at the thought of hiring a broker. Sounds unfair, but it’s the way it is.
It’s even more unfair when you put the shoe on the other foot. Once a VC is an investor in a company, when it comes time to harvest the company for exit, they are often quick to hire investment bankers. If this appears somewhat hypocritical, you’re right. For the same truth should hold on "the way in" – talented CEOs know to build relationships with the possible acquirers in advance of approaching them or, better yet, prompt them to proactively approach you as a result of a business partnership. The reason many boards and VCs turn to bankers is that they know how to run a professional process that will yield the best outcome for the shareholders (i.e., maximize the share price in the sale). Practically speaking, the bankers run these processes all the time. Entrepreneurs only sell their companies, if they’re lucky, every five years. There is also some benefit to creating separation between the CEO of the target and CEO of the acquirer – allowing for good cop/bad cop positioning, back-channel communications, and other negotiation techniques that can yield better outcomes.
All that said, I think the jury is often out on whether entrepreneurs should hire bankers on the way out – it depends very much on the particular situation and the individual entrepreneur. And unless they want to be perceived as a "knave", like the old nursery rhyme, entrepreneurs should be very wary of hiring them on the way in.
Jeff Bussgang of IDG Ventures comments on the relationship between bankers, brokers andthe VC communityin this fresh take onwhere and how real value is created. As with most businesses, the dealmkaing community is relationship-base…
Excellent post, I’d add two follow-ups based on my own experience.
I’ve met a handful of very talented and experienced entrepreneurs who simply aren’t excited about the early stage fundraising process. Sometimes these are folks with a more technical bent but othertimes its simply an entrepreneur who wants to focus his/her time & energy in building the business rather than pitching VCs. In these cases, I certainly think (as a VC) it’s worth working thru a broker/banker if that’s the only way to pursue an opportunity. But I’d say that these sorts of entrepreneurs are fewer and somewhat far between. Also, I think bankers/brokers are more common in later stage venture rounds for a variety of reasons.
On the exit side I’d add that in addition to providing a layer of separation and running a systematic process to maximize sale price, hiring a banker can be a useful signalling function. I think many potential acquirers recognize that a banker’s presence means the company and board are actively engaged in a sale process as opposed to merely testing the water. This signalling isn’t always appropriate (don’t want to exude distress in a fire sale), but when used judiciously I’ve seen it yield some excellent results.
Some Interesting Stuff . . .
I’ve been totally swamped for the last two weeks and blogging – both reading and writing – took a back…
You’ve forgotten to mention one critical difference between a fundraising and a trade sale. In the latter, everyone ought to try to maximise price. In the former, the company should seek the “best-fit” investor. The two are almost never the same. Intermediaries are great at price maximisation, but entrepreneur’s can’t motivate them to find the best investor. Left to their own devices, most advisers will seek out the investor that pays the most, which is certain not to be the most knowledgeable or valuable one. When investors see advisers in a fundraising, they know they’re going to end up in a competitive auction. So they lose interest because they don’t want to back entrepreneurs who are maximising price this early in the game!