June 12, 2007
Believe it or not, there was a time when no one knew what a venture capitalist was. Today, if you're a venture capitalist, you know you've arrived because, not only do most people know what you do, but you also have your own cliché nickname: "vulture capitalist." Even the term "angel investor" has started to drift into mainstream vocabulary without being mistaken for some religious term.
However, when it comes to investment bankers, I find that many entrepreneurs don't have a clue as to who they are, what they do, and how they differ from a VC or an angel. This is a curious problem since the concept of an investment banker has existed far longer than either of the other two terms. So, why am I so hung up on the confusion surrounding this term? Because I'm an investment banker, and I believe that many entrepreneurs fail to consider what the people in my profession can do to help them raise money.
Let's start with the basics. What is an investment banker? The best overall definition I found was at Wikipedia.com. "Investment banks help companies and governments and their agencies to raise money by issuing and selling securities in the primary market. They assist public and private corporations in raising funds in the capital markets (both equity and debt), as well as in providing strategic advisory services for mergers, acquisitions and other types of financial transactions."
So, the simple answer is, investment banks help companies raise money by:
- Lending their expertise to a company to help it determine the best strategy and the best place to raise either debt or equity capital. Most companies don't have a clue as to how to do this, and a good investment banker can save them an enormous amount of time and money.
- Preparing all the necessary documents to accurately present the value proposition for funding and to protect both the company and the investor from any misunderstandings. This is more than just a business plan. Good investment banks prepare something called a private placement memorandum--or PPM--which is a legal document designed to protect both sides from making a bad investment.
- Ensuring that all government regulations have been followed in the raising of any capital. Typically, entrepreneurs raise capital in ways that violate SEC and NASD rules they didn't even know existed. Such ignorance could come back to bite them.
Investment bankers, unlike VCs, don't generally have funds they can tap into and immediately write a check. Instead, they have a network of investors (often both institutional and private, accredited angel investors) that trust the investment banker to bring them quality deals. Now, here's where a lot of confusion and, frankly, bad reputations are made. Generally, most investment bankers won't accept a client without a paid, up-front retainer.
This tends to rub entrepreneurs the wrong way because they typically would prefer to "pay for performance" and not get stuck paying a retainer that produces nothing. So, how can entrepreneurs make sure they're getting someone who can truly help them?
Here are a couple of pointers for choosing an investment banker:
- Make sure both the brokerage and their principals have been licensed by NASD. You can verify this by looking them up at www.nasd.com. Being licensed means they're subject to regular NASD audits to ensure that everything they do complies with all government rules and regulations.
- Ask for examples of previous successes. This is important to establish a track record of actually raising money. However, no amount of past success will ever be able to predict any degree of future success in a specific company. The variables are always complicated and in flux.
- Before agreeing to pay a retainer, ask for a basic plan as to how, where and in what form they think your funding will come. If they can't give you an idea up front, they probably won't have a better one later.
- Although retainers will vary widely, a general rule of thumb is to allot $15,000 to $25,000 for raises under $5 million and $50,000 to $100,000 for raises in the $10 million to $50 million range.
- Finally, ask them what your retainer will be used for and how it will be paid. The best answer goes something like this: Your retainer will be paid over a period of two to three months, usually in three payments. The first two-thirds of the time will be used to conduct due diligence on you, your idea, your technology and, in general, your total value proposition. If they're not 100 percent convinced that your idea is fundable, they should stop all work and tell you why. Unfortunately, you'll be out, at most, two-thirds of your retainer, but you'll be spared the pain--and expense--of trying to sell a lost cause to unsympathetic investors. The last third of the time will be spent preparing your PPM and all associated marketing documents to help raise the capital they ultimately feel is appropriate.
Hiring a good investment banker can be one of the smartest decisions an entrepreneur can make. The banker will teach them things they couldn't learn from anyone else and, most importantly, will help them reach their funding targets faster than most any other route (assuming, of course, their idea is fundable). Even if an idea isn't viable, an investment banker is probably the most cost-effective way to find out your concept lacks investor appeal than any other alternative.
Jim Casparie is the "Raising Money" coach at Entrepreneur.com and the founder and CEO of The Venture Alliance, a national firm based in Irvine, California, that's dedicated to getting companies funded.