Will Crowdfunding and Marketing Automation Disrupt the Traditional Investment Banking Business Model?
Ask a Bernie Sanders supporter, and his likely answer would be: “No! They’re all useless. I’ll kill them all myself and then burn Wall Street to the ground!”
Back in the real world, though, bankers exist because of fundamental business needs: companies want to raise capital and acquire other companies, and investment bankers have the connections and expertise to execute these transactions.
It’s a high-cost, high-intensity business where bankers have to spend years or decades building relationships with the right potential sellers and buyers first.
But that traditional process may be breaking down.
Just as technology has disrupted markets like transportation (Uber), lodging (Airbnb), and consumer lending (Lending Club), it might soon disrupt investment banking itself.
We spoke with him a few years ago in the article on how to create your own investment banking job, so consider this “Part 2” – and an update on how the game has changed since then:
Introductions and Updates
Q: For those who haven’t read the first article, could you explain your background and what your firms do?
A: Sure. I came from a very random background: I started my own company to do satellite sales, then went to dental school, realized I didn’t want to be a dentist, and then went to business school and got into business brokering and Internet marketing.
Then I started my own company to generate leads – companies looking to buy, sell, and raise capital – and refer them to contacts at boutique investment banks.
It’s similar to what an MD in an industry group does when he/she builds a relationship with a company and then refers the company to a product group when it wants to do a deal, except I’m generating leads with content marketing – articles we publish– instead.
Then, once we win a client, we use technology to automate portions of the deal execution process, including the selection of buyers/investors and even the initial outreach to those buyers/investors.
I’m doing all this through various firms and websites:
- Merit Harbor Group – The traditional firm I’m a part of.
- Investmentbank.com – A site we use for lead generation for traditional M&A and capital markets deals. There’s a ton of content related to those deal types, and it’s intended to educate business owners looking to sell or raise capital.
- Reversemergers.com – Similar, but for reverse mergers (i.e., a private company becomes a public company by merging with a “public shell” rather than going through a traditional IPO).
- Crowdfund.co – This is lead generation for for Reg A+ and 506(c) offerings – we’ll get into the explanations of those later.
Q: Great. So what has changed since the last time we spoke?
What are you seeing in the market now (late 2015)?
A: The market has gotten even frothier, and we’re seeing a lot of interest in reverse mergers, especially for roll-up opportunities (i.e., one company wants to go public and then acquire smaller companies to consolidate and gain scale).
We’ve also seen a ton of growth in crowdfunding and crowdfunding-related methods for raising capital, partially as a result of new U.S. legislation such as 506(c) private placements and Regulation A+ (Reg A+).
Our firm has been using more marketing automation to generate and nurture leads.
For example, if a business owner searches for information on how to exit his/her business and lands on our site, he/she might subscribe to our email list, receive our emails for several months, and eventually call to ask about our services.
Many of those emails are pre-written and then sent out automatically, based on this business owner’s interests and preferences.
Deals from online-generated leads do take more time to close: we might need to go through 4-5 webinar meetings, meet in-person several times, and so on.
But there’s massive potential to reach new businesses and execute previously overlooked deal types.
Aside from new lead-generation methods on our end, a lot of companies interested in raising capital have been going through OfferBoard Securities, which is a site that lets accredited investors invest directly in companies’ private placements.
You’ll see many $20-$50 million revenue companies with 10-20% EBITDA margins raising funding for roll-up strategies there.
Q: I see. Can you briefly explain what 506(c) and Reg A+ offerings are?
A: Reg A+ is part of the JOBS Act, and it lets companies raise up to $50 million from both accredited and non-accredited investors.
To be “accredited” in the U.S. you need a net worth of $1 million excluding your primary residence, or income of at least $200,000 for the past two years with expectations of the same amount this year.
Before the JOBS Act was passed, companies were limited to 35 non-accredited investors, or could market only to accredited investors.
So Reg A+ enables crowdfunding and makes it much easier for individuals to invest small amounts of capital in private companies.
The downside, however, is that there are a lot of requirements to use Reg A+, such as audited financial statements, public SEC reports, ten months of review time, etc., so it tends to be much slower than the “old” method (Regulation D, used for traditional private placements).
The 506(c) rule lets issuers market their offerings broadly, but requires companies to verify that each investor is actually accredited.
With the older rule, 506(b), companies did not have to verify each investor’s status, but they also could not use “general solicitation” to market securities.
So companies tended to approach a small set of investment firms and high-net-worth individuals and selectively market the offering.
The bottom line: both of these regulations allow companies to market their securities to a broader set of investors, but they also introduce restrictions that make the process more time-consuming.
Q: Thanks for clarifying that.
Why would companies want to raise money on a crowdfunding platform rather than through traditional private placements via Regulation D?
Is it just about reaching a broader set of potential investors?
A: These new regulations offer companies some of the advantages of being a public company without the disadvantages.
Investors in these offerings don’t get complete liquidity, as they would with a public company that has significant float, but they can buy and sell shares more easily.
Many companies are also suspicious of working with traditional investment banks, private equity firms, and hedge funds, and would prefer to go directly to investors.
The challenge is that many of these companies are terrible candidates for raising capital, but they still want to do it anyway.
And then as you mentioned, the other advantage of going online to raise capital or to find potential buyers is that the process can be much broader.
In a traditional sell-side M&A deal, a bank might contact a few dozen potential buyers; sometimes that rises to 100+ in a very broad deal.
But companies can contact thousands of potential buyers if they go through us, which increases the chances of a successful deal.
The Lifecycle of a Deal Generated by Internet Marketing
Q: So what size companies are doing this?
Is it still the same range you quoted last time ($10 million to $100 million in revenue)?
A: For sell-side M&A deals, yes, the size range is about the same.
On the fundraising side, the company has to be generating at least some revenue to list itself on OfferBoard – in that sense it’s much different from AngelList.
But investors there don’t care that much about the amount of revenue.
Instead, they focus heavily on other attributes, such as whether or not the company has great management, protectable IP, or some other type of “moat.”
These days, we push many companies interested in traditional private placements toward 506(c) offerings on these sites instead.
Q: Can you walk through an example of how a deal might be sourced under the new methods your firm is using?
A: Sure. One recent example is a lead generated from one of our sites, reversemergers.com.
The lead consisted of two companies that approached us and wanted to become a public entity via a reverse merger, and then pursue 5-10 other roll-up acquisitions.
They saw some of the content there, signed up for our newsletter, and then contacted us about initiating the reverse merger.
The companies had around $50 million in revenue and $10 million in EBITDA, and the entire industry was consolidating, so they felt it was the right timing for this move.
It took a lot of time to win these companies as clients: about 3 months of negotiations from start to finish, including trips to their headquarters and discussions around transaction financing and post-deal ownership.
We’re just now marketing this transaction, but once these two companies merge to become a public company, we’ll use our extensive database to contact companies that might be interested in selling.
We’re automating much of the initial outreach, and we’re selecting parties to contact based on statistics and data rather than gut feeling.
Q: OK, so a few questions on that example… first off, it sounds like you still need a lot of human interaction to win clients.
How much does marketing automation actually help you?
A: To be honest, that’s still an open question because we don’t have enough data yet.
We often get calls or emails directly from our site, and often they come from companies that are very eager to do a deal and don’t need much convincing.
The process of sending out emails, newsletters, etc. is longer-term and we may not see results for months or years.
The human touch will always be required at some level: no one is going to sign up for a reverse merger or an M&A deal without meeting you first.
Q: So it sounds like technology helps with lead generation, but not necessarily with lead nurturing.
When large companies want to sell, they generally like to keep things quiet and focus on the best prospects.
So why would a company want 5,000 potential buyers to know it’s selling?
A: Well, let me clarify two points first:
- It’s not a 100% automated process. We might start with 5,000 – 6,000 potential buyers, but we’ll narrow that down to 400 – 500 before bringing the list to our client, and if we have relationships at some of those firms, we might reach out the old-fashioned way.
- We only send a teaser and NDA in this initial outreach, and we hide our client’s name. So it’s unlikely that anyone could guess the specific company, unless the potential buyer happens to be in the exact same market.
Companies agree to this process because they want to maximize value: the more buyers submitting bids, the better.
By contacting so many potential buyers, we can assess interest early and get as many Indications of Interest (IOIs) as possible.
If we contact 400 – 500 buyers, we might get 30 – 50 IOIs after requesting initial bids.
And then that will be narrowed to 10 – 25 LOIs after another round of bidding, and then that number will be reduced even further as the process progresses.
But there’s always some human element, even if it’s supplemented with technology.
For example, we might look at which firms have opened our outreach emails and then get on the phone with the ones that appear most interested.
The Future of Investment Banking: Programming?
Q: So you’re not really “automating” the entire process so much as using technology to enhance and supplement parts of it.
Do you think bulge-bracket banks will be affected by these changes?
Or will boutique banks that focus on private placements feel most of the negative impact?
A: I haven’t seen private placement-focused boutiques suffer much yet, but that might happen in the future.
My impression is that most companies seeking traditional private placements are bigger than the ones we work with.
I don’t think these changes will impact the large banks much because automation doesn’t work as well for $1 billion+ deals where the buyer pool is limited.
And if these changes do impact the large banks, they’ll acquire a bunch of smaller companies to get these capabilities themselves.
Very few investment banks or business-brokerage firms are using these strategies, and even fewer are using them well.
Q: What types of career opportunities are these trends creating for university and MBA students?
In the future, will you need programming and marketing skills if you want to work in finance?
A: I would say, “Any chance you have to expand your awareness is good.”
I’ve seen people teach themselves Python via Coursera, and then use it to automate their trading or risk-management jobs; sometimes they end up doing nothing at work all day, but the company doesn’t know this fact and keeps paying them.
I do think Big Data will become an important part of M&A deals.
Even today, selecting potential buyers and sellers often comes down to “gut feelings” or bankers’ knowledge of the market.
But no one knows everything.
If you have good data on which opportunities would interest which firms (e.g., if you send out 100 emails for companies of Type X, what percentage of firms in Category Y will open your emails and respond?), you could come up with buyer and seller recommendations based on statistics.
Q: I could also see this process being becoming a part of interviews in the future.
Banks might extend case studies into “full” case studies where you have to recommend how you might generate leads, win clients, and find buyers/sellers.
A: Yeah, that’s possible. But again, it would likely be more common at smaller firms.
Q: Where do you see these trends going over the next ten years?
A: I think you’ll see more of a hybrid between fin-tech and traditional investment banking.
There are still a lot of lower-middle-market deals that remain untouched and that have highly inefficient M&A / capital-raising processes, if processes exist at all.
There’s a big opportunity to create a more efficient market for these smaller companies and give them access to automated methods of raising capital and buying/selling assets.
There’s also a big opportunity for companies that are “too small to be big, but too big to be small” – companies with $1 – 5 million in revenue in revenue that are effectively just one person’s full-time job.
Private-equity firms aren’t interested in these businesses, and the companies are too small and owner-dependent to go public, so crowdfunding and technology-enabled M&A could enable more creative exits there.
The cost of capital, the time required to do a deal, and even the time it takes to source a deal will decrease as technology lets us gather information and select potential buyers more quickly.
Q: Great. Thanks for sharing your insights!
A: My pleasure.
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