Hiring Bankers - Pick the Lowest Number

I have been spending some time lately listening to banker’s pitches.  That’s a good thing.  It means the IPO and M&A markets are healthy and people want to buy the businesses we’ve invested in.

When you enter into a process to take a company public or sell it, the board usually selects a banker (or a goup of bankers in the case of an IPO) to manage the process.  That is called a bake off or a beauty contest.  It’s a surreal experience for everyone involved.

The Board selects a day and typically spends it listening to a bunch of 1 hour pitches from bankers.  The bankers all create pitch books that explain why their bank is the best, why they do more deals like yours than anyone else, and why they will get your company the best price.

Near the end of every pitch book is the "valuation analysis".  This is where the bankers show you how your company will be valued by the buyers or by the public markets.  There is always an elaborate methodology followed by a number.  That number is often a range.

Now here is where I am going to propose something controversial.  I suggest selecting the banker that gives you the lowest number or range, not the highest one. Here are my reasons:

1 – It means they are honest.  An honest investment banker is a special thing.  You should hire one if you find one.

2 – It means they understand your business.  The big numbers that get thrown out are almost always based on some pie in the sky methodology like a discounted cash flow analysis (DCF) that is based on projections ten years out.  Would you buy a business based on that kind of work?  I wouldn’t.  The lower numbers are based on market realities, real comps, and "off the record" conversations with potential buyers and investors.

3 – It means they don’t feel the need to compete on price.  This one is important.  If the banker is really good, they’ll win your business based on who they are, what they know, who they know, and what they’ve done.  Price will be immaterial in that sale process as long as their number is in the realm of reason.

This "pick the lowest number" advice can be applied to other situations as well.  Charlie and I were talking about sale processes yesterday.  In particular, the "game" where everyone throws out a big number just to stay in the process.  Then after all the competition is gone, the buyers get in, do the work, and the actual price of the deal ends up being lower than most of the original indications of interest, including the people who got thrown out for offering too low a range.

This happens all the time.  People throw out big numbers to get selected.  Then they do the real work after they’ve been selected.  Then the re-trade of the price happens.

I say pick the lowest number from someone who really knows what they are doing and go with it. As long as that is a number you’d accept, its the thing to do.  I’ve rarely been disapointed when I’ve done that.