How to Break Into Commercial Real Estate and Build an Empire
This is a guest post from Mike Moran, CFA, a portfolio manager at a long-only asset management firm. He started Life on the Buy Side to teach you what it’s like working in asset management, hedge funds, and more.
When it comes to commercial real estate, you’ve got two choices: do something extremely risky, or do something boring and conservative.
OK, you could also pick something middle of the spectrum – but what fun is that?
If you have your sights set on building a real estate empire, you’re going to have to take the leap and embrace the risk with open arms.
Here’s how to do it:
Risk, Reward, and Reality
With commercial real estate, it’s easiest to think of investment opportunities from least risky to most risky and then analyze the players in each category:
- Least Risky: Core Investing – Acquire and Operate Existing Properties
- More Risky: Value-Added and Opportunistic Strategies – Improve Existing Properties
- Most Risky: Real Estate Development – Build Completely New Properties
Core Investing is all about stability and getting high single-digit returns by operating existing assets. There’s little risk when a building is already operational and generating rental income – think of the GM Building in New York or a class-A regional mall as example investments.
Since these are stable assets that provide a steady income stream to the owners, pension funds are the main investors in core funds – firms that specialize in acquiring and operating existing properties.
You also see Real Estate Investment Trusts (REITs) – both publicly traded REITs and private REITs – in this space, as well as core real estate funds run by real estate investment managers such as AEW and RREEF.
REITs are like private equity firms but for buildings rather than companies – they acquire, operate, (possibly) improve, and then sell properties to earn high returns.
After you leave this Core Investing space, you get into Value-Add and Opportunistic Strategies – this is where the investors try to make substantial improvements and renovations to existing properties rather than just acquiring and operating them.
Returns are typically in the 15 – 20% range, but may go higher depending on how risky the strategy is. Some REITs and core funds managers dabble in this space, but you mostly see private equity shops like Blackstone here – a high single-digit return is horrible for PE, so it makes more sense for them to focus on riskier strategies.
At the riskiest end of the spectrum is real estate development, and the players there are all over the map.
Some REITs have large development pipelines and invest significant resources into constructing new properties – examples are AvalonBay [AVB] (apartments) and Prologis [PLD] (industrial), which often have multi-billion-dollar pipelines.
Private equity can sometimes be active in development, but usually only as the capital partner to developers.
There are also large private companies like Opus that focus on real estate development without the pressures that come from being publicly traded.
Risk = Reward?
Based on the descriptions above, you might think that real estate development offers the highest potential returns and the highest pay since it’s also the riskiest.
But you’d be wrong: It’s a boom-and-bust business, and developers are also the first people to get fired in a downturn.
While Prologis had a $4B development pipeline at the market peak, it dwindled down to less than $500MM after the market collapsed; three of Opus’ five major subsidiaries filed for bankruptcy in the past downturn.
This is not to say that real estate development is “bad” – it’s just that you shouldn’t jump into it expecting to make bank right away.
It’s great if you’re into the brick-and-mortars side of real estate, but if you’re not, think about the other options above.
There are also asset management firms and hedge funds that specialize in real estate securities, and even shops that invest in REITs – if you want to blend real estate and the public markets, both of these can be good options.
How to Break Into Commercial Real Estate
As with everything else in finance, at the entry-level you’re just a high-paid spreadsheet monkey who works on deals all day – whether that’s at the core funds or at private development companies.
A typical “path” for breaking in is to go to a target school and then get into real estate investment banking – that’s what many of the top people at the biggest real estate firms and REITs have done.
Mike Fascitelli, CEO of Vornado [VNO], is an example of a real estate big shot that followed this path. He went to Harvard for his MBA, started at McKinsey, and then went to Goldman as a real estate investment banker. After several years at Goldman, Steve Roth lured Fascitelli away from banking to work at VNO.
But you don’t have to follow that path to break in – and an MBA isn’t even a prerequisite.
The best example is Jonathan Gray, the co-head of Blackstone’s real estate group – Gray started at Blackstone with just an undergraduate degree from Wharton and worked his way up to become co-head of the entire real estate group by age 35. At age 37, he was busy pulling off the $36 billion Equity Office Properties acquisition, the biggest private equity buyout ever (at the time)!
Yes, Wharton is a target school and it also happens to be one of the top undergraduate schools for real estate – but more importantly, it has a great real estate alumni network.
Just like everything else in finance, leveraging your alumni network is essential to breaking in: I wouldn’t be surprised if Gray tapped his network to land his gig at Blackstone right out of school.
Other top undergraduate schools for real estate in the US include UC Berkeley, USC, and Wisconsin – these are well-known institutions, but they’re not the Ivy League and they’re not the ones that immediately come to mind when you think of a “target school.”
Real estate is very much a “who you know” business and having a well-connected alumni base is critical – if you’re at a school without much of a presence in real estate, your next best option is to get an MBA at a school with a strong real estate program.
If you’re already out of school and working, you could get involved in trade groups like ICSC, ULI, or YREP if there’s one in your area.
Whatever you decide to do, networking is even more important in real estate than in other industries so start pounding the pavement as soon as possible.
Got Real Estate Development?
While many top real estate jobs required work experience and/or more than an undergraduate degree, development is one area where undergrads from all different backgrounds can get in right out of school.
So if you’re in this boat and you’re interested in real estate, you’re better off using your career center and alumni network to break in and focusing on development rather than PE, REITs, or anything else.
Q: Do I need investment banking experience to break into development?
A: No, no, and no. In fact, you might have too much experience if you actually do real estate IB and want to break in afterward – an entry-level development role would be a step backward.
Development is significantly different from real estate IB or PE, and they shouldn’t even be in the same category.
Q: Wait, but what should I do with my life if I don’t do investment banking first?! Otherwise everything is meaningless!
A: Pick a major that lends itself to real estate development. Example majors: Real estate, civil engineering, architecture, or construction management.
Since development is much more bricks-and-mortar than other RE-associated industries, knowing these subjects is valuable for breaking in – and you’ll get the alumni network to help you land a development job.
If you don’t know what major and/or school is good for getting into RE development, just ask around and see what types of jobs most graduates get – if “real estate” is a common answer, you’ve found a good match.
Breaking Into REITs
Real Estate Investment Trusts (REITs) are investment vehicles that are exempt from corporate income taxes as long as certain criteria are met; the main one is that REITs must pay out 90% of their taxable income as dividends, which means they have little cash on hand and are constantly issuing debt and equity to fund their operations.
Historically, REITs were passive vehicles that focused on owning properties and escalating rents over time, but today they’re more dynamic, and many REITs buy, sell, develop, and manage properties and 3rd party joint ventures all the time.
A few of the larger REITs in different segments include the Simon Property Group [SPG] (shopping malls), Boston Properties [BXP] (offices), AvalonBay [AVB] (apartments), and Prologis [PLD] (industrial).
Since REITs use so many different investment strategies, there are all sorts of different job opportunities there.
On the operations side are developers, property managers, and acquisition people that deal directly with properties.
On the capital markets side, you’ll find finance people that work on equity and debt deals to fund the REIT’s operations.
If you want to get into the operations side of a REIT, it’s similar to what you need to break into RE development: Get a real estate-related undergraduate degree and network with alumni.
But if you’re interested in capital markets, you need real estate investment banking experience – REITs are one of the main exit opportunities for RE bankers since you advise REITs all the time as a banker.
Bottom-line: if you’re more interested in finance, go the banking route and look for REIT exit opportunities; if you’re more interested in the bricks-and-sticks aspect of real estate, skip banking and go straight into development or acquisitions.
Compensation: What Compensation?
Unfortunately, there are few good data sources on real estate compensation – but pay tends to be commensurate with risk and expected returns, at least in buy-side roles.
The main exception is development – it’s the riskiest investment class and yet the pay is also the worst.
The real money in development accrues to those that put their money at risk in the developments.
To complete construction of a new property, the developer itself only puts down a very small portion of the total equity – maybe 5% or less.
Many times, the developer simply contributes their land basis as the only equity in the project and then uses debt and mezzanine financing to fund the entire construction cost.
Most of the returns will go to the 3rd party investors that come up with the rest of the funds – and to make things even worse, there’s no cash flow from properties that are under development until tenants move in and rental income starts flowing.
Even the fees the developers charge are not great compared to the overhead, so there isn’t much money left to pay salaries to employees.
So, do not get into development if money is your main goal – only do it if you’re interested in building and construction side of real estate.
You will not make it big until you have enough money to invest in development projects yourself.
For core funds and REITs, pay is consistent with base salaries for recent graduates elsewhere in finance – the main difference is that you won’t receive Wall Street-like bonuses in these jobs because the fees and returns are lower than in PE, for example.
On the private equity, hedge fund, and asset management side, compensation is similar to what you would earn at non-real estate funds. So real estate PE is similar to normal PE, real estate HFs are similar to normal HFs, and REIT-focused asset management is similar to normal asset management.
And on the investment banking side, you don’t see much of a difference at the junior levels between real estate banking and other groups.
As with other buy-side jobs, the buy-side itself is the end-game. Once you get there, it’s just a matter of working your way up until you become the next Jonathan Gray.
Be careful of getting pigeonholed: If you get into real estate and don’t like it, move on as quickly as possible or it will become more and more difficult to find a non-real-estate job.
In addition to moving up the ladder, investing in real estate yourself is another possibility: A number of friends have amassed nice little portfolios of multi-family assets.
And unlike buying entire companies, the capital requirements for real estate are far lower and you don’t need to raise hundreds of millions of dollars just to buy a house.
Raising a small fund of your own is also possible, but just as with starting a hedge fund you need to raise some seed money to get started – you would go to friends and family first, show solid performance, and then approach a broader set of investors once you can point to results.
Whither Real Estate?
It’s a great field, but keep your expectations in check.
Until you have enough cash to fund massive real estate developments by yourself, you won’t see your name on any buildings.
And if you want to become as famous as a certain real estate developer – and maybe even become President of the United States as well – it might just be easier to get your own reality TV series instead.
Even More on Real Estate
If you want to learn more about the modeling and valuation side of real estate, check out the BIWS Real Estate & REIT Modeling course, which covers both individual properties and REITs via case studies of an apartment complex, an office development and sale, a hotel acquisition and renovation, and Avalon Bay, a leading apartment REIT.
There are also real estate private equity case studies based on stabilized multifamily, value-added office, and pre-sold condo development deals.
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Pitch Anything: “The Game” for Investment Banking?
It’s 11 PM and you’re sitting down at a bar with a friend. You see 2 gorgeous blondes stroll over and sit down across from you (if you’re female, just imagine this from your perspective instead).
You strategize with your friend about what to say and who to approach, you think of the perfect opening line, and then you go up and make your move.
The first girl stops you in your tracks, glares at you, and says, “If you’re going to recite lines from that book, we’ve heard them all before – you can go away now.”
Ouch. What went wrong?
The problem is that it’s 2005 and Neil Strauss has just published The Game, detailing the secret society of pickup artists and the exact tactics they use to get beautiful women night after night.
It became so popular in New York that women learned all about it and instantly knew when a guy was using tactics from the book.
And now a new book by Oren Klaff, a capital markets banker based in LA, might just do the same thing for the world of business and investment banking.
It’s called Pitch Anything, but it could be titled “Persuade Anyone” because that’s what it’s about: how to present an idea so that the other person gets intrigued and ultimately signs on the line which is dotted (yes, Glengarry Glen Ross should be part of your required viewing).
“Wait a minute! I don’t want to work on the sell-side, why would I ever need this? I am a math genius and can sit behind the computer, look at spreadsheets all day, never talk to people, and still make bank!!”
I see where you’re coming from, but even on the buy-side you’ll need to persuade people and pitch your ideas all the time:
- You just got a horrible bonus, only 1% of your P&L. You want to negotiate a better number for next year – how do you approach your fund manager?
- You have a new investment idea and need to present it to the investment committee at your firm. What story will convince them to say “yes”?
- You’ve had enough and are quitting your fund to start a new hedge fund. You need to raise $500 million – how do you sell investors on the idea?
Of course, if you want to keep your bottom-tier bonus, never get any respect from anyone else, and never get the funds to start your own firm, feel free to keep staring at Excel.
When Oren first contacted me and told me about the book, I was skeptical: I get tons of pitches and requests each day and everyone wants me to promote their products and help them out with random favors.
So I let it sit for a while and didn’t get around to reading it until my flight got delayed on a recent trip, I ran out of battery, and I had nothing to do.
And then I almost missed my flight because I couldn’t put it down once I started reading.
The Big Idea(s)
There are many big ideas here, but the ones that stood out most:
- The way you pitch something and the way the other person perceives it are completely different.
- Setting the frame makes all the difference when pitching anything or talking to anyone.
- Don’t pitch numbers or logic – tell stories.
A “frame” is just the way a person views the world and what he uses to doubt whatever you’re pitching.
If he digs into your numbers and calculations and keeps questioning those, he’s using the analyst frame; if he spends 30 minutes talking about himself and then looks out the window when you get a turn to speak, he’s using the power frame.
There are others, and there’s an appropriate way to respond to each of them and “break” the person out of whatever he’s using to belittle you.
How to Use the Book
The section on frames and how to respond to frames, by itself, is so insightful that you’ll probably think of dozens of uses just from that (I recommended the book to other friends after finishing that part).
Here are a few situations where you could use the advice in the book:
Handling Co-Worker Harassment
Let’s say you just started working on the trading desk and the other traders are giving you crap for being the new guy. In addition to making you get lunch each day, they’re also making you pick up their dry cleaning and get gifts for their families.
There are 2 bad ways to handle this situation:
- Do nothing and ignore the traders as they make fun of you.
- “Argue” your way out of it by telling them to respect you.
Doing #1 is the equivalent of getting a terminal illness and not going to see the doctor: you can ignore it, but you’re still going to die.
#2 won’t work because of the same reason it didn’t work on the bully in the playground when you were 10: he’ll ignore you and keep pulling your pants down anyway.
In the book, Oren goes through a few examples of how to use a power-busting frame and other tactics to handle a situation like this and re-assert yourself by lightly defying “the authorities.”
It doesn’t require memorizing long scripts or anything like that, but it does require going outside your comfort zone – but if you want to advance in the industry you better get used to that.
Raising Funds… for Your New Hedge Fund, or Even a Student Group
You’ve dreamed of starting your own hedge fund since you were 10 and first saw Wall Street.
And now, after 15 years of working at other peoples’ funds, you’re ready to raise the $500 million of capital you need for your own.
You’re in a meeting with a potential investor and he is using the analyst frame to nit-pick your numbers and press you on whether or not you can really achieve the returns you’ve outlined.
“So I’ve looked at your IRR calculation here based on the funds invested and the potential cash flow coming from these investments and I wanted to know how you derived the margin right here…”
You do not want to get into an argument over the numbers or go into nitty-gritty detail in response to this.
If they want more detail, you can send it to them after the meeting.
In a situation like this you’d apply intrigue or suspense (by telling a story or starting to tell them something surprising and leaving it open-ended) to get the other person to step back from the numbers.
Oren has a few examples of doing this aggressively in the book – you may not want to implement everything he suggests, but using just the basic ideas can take you a long way.
This first section on frames could be applied to almost any social situation; the other parts of the book are more applicable to pitching itself, but remember: much of your life consists of pitching and persuading other people.
So if you’ve spent more time developing your IQ rather than your EQ, this should be required reading.
Though I’m a big fan, the book is not without problems.
First, if you’re a new analyst or associate, you can’t literally apply all the strategies and stories that Oren shares in the book.
If you show up to work on the first day and start “defying” your MD he’ll get pissed and you will develop a bad reputation.
So you have to do it in moderation and not get carried away with following it to a tee.
Another issue is that the deals described in the book, while big (millions / tens of millions and up) to a normal person, are small by the standards of bulge bracket investment banks.
In practice, most pitches from investment bankers for mega-deals are practically identical – hitting emotional triggers all the time might work, but it may also backfire if the audience is sophisticated and wants things presented in a certain way.
Finally, similar to other popular business books (The 4-Hour Workweek), sometimes the author makes everything seem too easy.
It would have been interesting to explore when the strategies here don’t work as well, or whether they apply to much larger deals as well.
Do You Actually Need to Read This Book?
I’ve gotten lots of questions on what the culture of Wall Street is like and whether or not it’s really a frat house.
Experienced traders aside, at most investment banks analysts and associates are more nerdy than fratty.
That’s what happens when you recruit top-performing students at top schools: you get a bunch of math wizards who are great at Excel but not so great at having difficult conversations.
If you already have a lot of real-world experience dealing with skeptical people, persuading others, and pitching your ideas, maybe you’re an exception to this rule.
But if not, I can’t recommend Pitch Anything highly enough – and at the very least, you’ll be entertained by all the stories within.
The Next Neil Strauss?
So will Pitch Anything become The Game of the investment banking world?
While guys who want to get more girls read everything they can get their hands on, bankers have no time to read or do anything besides pitch, deal, and occasionally snort cocaine.
So unlike that situation with the 2 blondes back in 2005, you won’t suddenly have a market where everyone knows your tricks.
And that’s great news for you, because you can pick up Pitch Anything and start applying the tactics right now – when no one else knows how to respond to your newfound superpowers.
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Bottles and Bottles? How You Really Win Clients and Land Mega-Deals as an Investment Banker
Why does the mainstream media hate Wall Street so much?
You can think of dozens of reasons, but one of the biggest is that they don’t understand what bankers really do to earn their fees.
They see news of million-dollar bonuses and assume that financiers earn those bonuses by sitting around and playing Monopoly.
But you don’t earn massive fees by playing board games all day – it’s a process that takes years, which is one reason why bankers make the money they do.
And the infamous “pitch” has very little to do with it.
It’s All About the Pitch, Right?
The most common, wrong suggestion I’ve seen before is that “Bankers win clients by pitching them.”
But that’s like saying that you got into Harvard or Oxford by submitting a really good application – technically true, but not the full story.
Yes, the application is critical and if your essays suck, you’re screwed – but you got into a top school because you spent years developing the skills and experiences to do so, and you then presented them in the best possible light.
It’s the same with winning clients as a banker: your pitch needs to be on-point for you to win the deal, but the process of putting yourself in the position to pitch for the deal starts long before that.
What Really Happens
As you move up from Associate to VP and beyond, gradually you’re tasked with more and more sourcing work: finding potential clients, getting to know them, and then pitching for a deal when the time is right.
Managing Directors spend almost no time on deal execution – unless it’s a massive transaction that requires their involvement – and instead spend most of their time on finding new clients and serving existing ones.
If you already work with a company on all their M&A deals and your bank has been advising them for the past 20 years, you’ll probably continue to do so in the future.
Like legacy admissions in university or Roger Sterling and Lucky Strike, it’s a good bet that you’ll receive the benefit of all that history unless you make a colossal screw-up.
So it’s more interesting to look at how you find new clients – companies your bank has never worked with before.
This entire process is more applicable to smaller firms than to bulge bracket banks, because there the “legacy” factor is high and you mostly work with huge companies that everyone already knows about.
But even at huge firms, you still need to find new clients because existing companies get acquired, merge, and go out of business all the time.
In sales, a “lead” is just a potential customer – someone who might sign up for the products or services you’re offering.
It’s the same idea in banking, but since your leads are fewer in number and are worth much more, some strategies don’t work so well.
What Doesn’t Work
Strategies like online marketing (paying for ads on websites, Google, Facebook, etc.), TV/radio/direct mail advertising, and posting flyers would never work.
It may sound silly to even point this out, but I’ve actually seen some banks use Google AdWords to market themselves to clients and I have no idea why they bother.
All these methods are too impersonal – it’s like walking into Armani and having a robot display a list of recommended clothes for you rather than having a real live person greet you, chat for a while, find out what you’re looking for, and then suggest something good.
When the number of clients is low and the per-client value is high, you need to get very personal to make deals happen.
PE / VC / HF Referrals
One way to do this is to go through your friends on the buy-side, see what portfolio companies they have, what sectors they’re interested in, and who else they’ve been speaking with lately.
Let’s say you’re an MD who has worked with a private equity firm for 10+ years. At your next catch-up meeting with them, you might casually ask how their portfolio companies are doing (translation: are any of these companies ready to sell, refinance debt, or go public?).
If the PE Partner likes you and wants to give you business, he might refer you to the CEO or CFO and say, “Hey portfolio company, this banker’s good – you should get to know him.”
Or if a deal is imminent, he might tell you directly: “They’re going public next year, and the pitch is coming up next month – we’ll be sure to include you.”
In tech and healthcare groups, venture capitalists are arguably more important and bankers get referrals to startups via VCs.
Just like with your own networking efforts, cold-calling is less effective than meeting in-person first or getting referrals – but sometimes it works.
You’re far more likely to see cold-calling at smaller banks where you have to fight for every deal – and if you’re a summer analyst there you might get tasked with poring through lists of companies and finding contact information.
Cold-calling is also more common at small and middle-market private equity firms, some of which are notorious for making their newly hired associates cold-call companies all day long.
Bankers also spend a lot of time on the conference circuit, meeting with executives at events (CES, Davos, etc.).
These are like information sessions: if you can stand out from everyone else and then follow-up appropriately, your chances of success go way up.
The real action at conferences happens offstage, so bankers skip keynotes and panels and schedule as many 1-on-1 meetings as possible during the day.
Wouldn’t it be nice if banks just called you when they wanted to hire someone?
When companies want to sell or raise capital, they sometimes contact banks directly – this scenario is much more likely when a lesser-known company wants to work with a bulge bracket bank and has no other way to get on their radar.
Sometimes investors also contact bankers directly and provide the introduction, especially if they’re pressuring the company to sell so they can realize their returns.
Wining & Dining: Building the Relationship
Once you’ve contacted or been contacted by the executives at this potential client, you need to build the relationship.
If it’s an inbound contact and they urgently need to sell or raise capital, you won’t do this and you may be asked to pitch for the business right away.
But if the deal is further off in the future, you need to take time to build trust and convince the CEO that you’re not just another Gordon Gekko or Patrick Bateman character waiting in the shadows to decapitate him and steal all his money.
You do that by:
- Coming up with acquisition ideas and meeting with the executives to discuss what areas they might want to expand into.
- Giving market updates to the executives and telling them what’s going on in the M&A or capital markets.
- Meeting casually for lunch or dinner to catch up on what the company has been doing and their future plans.
- Being “on call” to answer whatever questions they have, whenever they have them.
The tricky part is that you don’t get paid for any of this – and the entire process could take years before you see any revenue.
Sure, making $10 million on a single deal sounds great – but if it takes 10 years of relationship building to get there, the NPV is much lower than $10 million.
This is the slowest and most extended part of the “client-winning” process, and if you’re not interested in relationships, this is where you’ll fail.
But if you like meeting and greeting and can’t stand Excel, then you might make a great MD – even if you’re a lousy analyst.
How does a company decide when it should sell, buy another company, go public, or raise capital?
Sometimes it’s forced to sell by investors who want to realize their returns (Amazon / Zappos) – going back to our theme of NPV, the longer an investment stays unrealized, the harder it is to get solid returns.
Other times the executives reach the decision themselves – the CFO looks at their cash flow projections and realizes their burn rate is too high, so they decide to raise debt or equity.
And still other times, bankers “plant” the idea in the CEO’s mind.
While you don’t have to plant this idea in a dream within a dream within a dream within a dream, you do have to be subtle about it – going out and blatantly pitching an LBO won’t work even if you really want a PE firm to buy the company you’re speaking with.
Instead, bankers are more likely to make casual references to private equity firms and leveraged buyouts elsewhere in the market when they meet with the company to discuss other topics.
Over time, if the CEO and Board buy into the idea or show interest, the bankers keep selling them on it and gradually start to reveal more and more information.
The best bankers – the true rain-makers – are the ones who are best at “selling” the company on a transaction, even if the management team had no interest initially.
Regardless of whether the idea was planted or original, once the company decides it’s ready to sell or raise capital, it then pits bankers against each other in a bake-off.
Sometimes if a company has a special relationship with just 1 banker and has never spoken to others, it will skip the pitch and give the business to that banker.
But that’s more common at private and smaller companies where there’s not as much oversight from the Board of Directors – at anything bigger the Board usually requires the management team to solicit competitive offers.
At this point they would contact all the bankers they’ve gotten to know over the years and tell them what they’re planning, send over relevant financial information, and invite them to pitch for the deal.
The number of banks invited depends on the deal type – IPOs have many banks, whereas in M&A deals there’s just 1 or 2 advising the buyer and seller – and whether or not the company wants to stick with the bankers it knows best or go for a broader set.
Who Wins the Deal?
This must come down to whether or not you’ve dotted all the i’s and crossed all the t’s in your pitch book, right? And whether or not you remembered to change the font size on every single page, right?
Nope – most of the time the pitch book itself is irrelevant to winning the deal, even if you pulled 4 all-nighters to create it.
What matters is how much the company likes the senior bankers, what the senior bankers say, and how they say it – and what they say compared to the other bankers pitching for the deal.
Let’s say you go in and claim that the company is worth $500 million and that you can complete the sale process in 6 months. Then another banker goes in and says the company is worth $400 million and that the sale process will take 12 months.
You might assume that you’ll win since your claims are more aggressive and will result in a better price for investors – and sometimes that’s true.
But the CEO and other Board members/executives could also look at your pitch and think that your numbers are unrealistic and that you’re not being honest – especially if everyone else there is predicting lower valuations.
So you need to use a careful blend of salesmanship and pragmatism to win deals.
After the Pitch
There may be a clear “winner,” but more often than not, the company will follow up with multiple banks to see what the fee structures are like and what their recommendations are in more detail.
For smaller companies and deals, the fees make a bigger difference and sometimes a bank will win the deal by promising lower fees or a structure that rewards them for better results (e.g. 0.75% under $500 million and 1.5% for the amount above $500 million).
Most of the time, though, it comes down to all of the above factors and the company considers everything when making a decision.
This is not a rational or logical process – just like selecting which applicants will receive interviews, it’s random and fraught with emotion.
If you think executives are rational just because hundreds of millions or billions of dollars are involved, nothing could be further from the truth – sometimes the more money that’s involved, the less rational the deal (AOL / Time Warner).
Putting everything together, here’s an example of how you, after you become a Managing Director, might meet a CEO, develop the relationship, and then pitch for the deal:
5 years ago you were having a catch-up meeting with a local VC and he mentioned that a tech startup in their portfolio was hot and would change the world of online media.
He gave you an introduction, so you met with the CEO, learned about his vision for the business, and got an idea of the company’s financial performance.
A year later, you caught up with the CEO once again and gave him an update on the capital markets and what IPOs were pricing at. The company was not yet cash flow-positive, but they had killer revenue growth.
The next year (3 years ago), the IPO markets were closed but the CEO wanted to use his stock to acquire smaller competitors – so you ran a buy-side M&A process for him over the course of 6 months. It never went anywhere since they couldn’t find anything good and got distracted by other issues.
Then, 2 years ago, the company finally turned cash flow-positive and started thinking about an IPO, which they told you about during your quarterly meeting with them.
You made your analyst monkey stay awake for 60 hours straight to prepare a 200-page pitch book laying out all the nuances, but then the CEO decided to hold off until the market got better.
Finally, a few weeks ago the CEO contacted you again just before another meeting and said that they are now serious about selling and want to hear your thoughts – so he invited you in to pitch for the deal.
Not only did this process take 5 years, but there’s no guarantee that this planned sell-side M&A deal will even happen – or that the mandate will go to your bank.
Maybe no one will be interested; maybe the CEO will change his mind yet again; or maybe investors will pressure them to go public instead.
And you ran a failed buy-side M&A process for them a few years ago.
This is why investment banking is such a tough business: you could do everything right for 5 years and still lose the deal because your fees are 0.1% too expensive, or because the CEO gets emotional and happens to like an unknown banker more.
Wait, This Sounds Boring!
One time I was explaining this process to a friend who was still in university and he said, “Wow that sounds boring – I’d rather do modeling and analytical work.”
If your IQ is higher than your EQ, it may not sound too appealing to develop relationships like this and constantly pitch for new business.
But as Jonathan Knee points out in The Accidental Investment Banker (highly recommended), all deals start to look the same after a while.
You learn a lot at first and valuing and modeling companies seems exciting when you’re new, but they become routine and boring once you’ve done them 500 times.
We’re more interested in stories and inter-personal drama than we are in staring at Excel all day – so even if the process above doesn’t sound interesting right now, you may change your mind in a few years.
You might assume that you should move to the buy-side if you’re not interested in any of this, but that’s only partially true – in PE and VC you still do a lot of relationship-building, meeting with new companies, and so on.
So if it’s really not your cup of tea, think about hedge funds or trading – where you can make bank without talking to people or leaving your 8 computer screens.
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