Sooner or later nearly every growth company needs to raise capital, be it through borrowing, an equity investment or a merger. The days of blindly picking an investment bank and trusting the experts to go out and find capital from private equity firms are over.
Only investment banks that directly align their business model and compensation with the interests of their clients will survive as online investing platforms continue to transform the capital-raising landscape. I say this as a former private equity investor and as CEO of a private equity investing platform, CircleUp.
An advantage of using some online platforms is that companies seeking capital remain in control of who sees their information and can see to it that sensitive information doesn’t end up in the hands of dozens of undesired investors. When an investment bank shares a company's information, potential investors -- typically private equity firms -- might hold onto that information for several years.
When working with an online private investing platform, an entrepreneur can determine which potential investors look at the company's data and first evaluate prospective investors’ backgrounds to decide if they would be a good fit. In contrast to the traditional investment-banking model, the entrepreneur remains squarely in control of the information and the capital-raising process.
This isn’t to say all investment banks are bad. Rather, it’s incumbent on the company to do their due diligence before hiring one. Here are the seven questions you need to ask:
1. What is your success rate?
Ask what percentage of the bank's engagement letters lead to closed deals. While there hasn’t been a formal study conducted, throughout my private equity career I typically saw success rates of 25 percent to 35 percent. So ask yourself going in if you're comfortable with paying a retainer fee when there's less than a 1 in 3 chance of closing a deal.
2. Why do you love my company?
Make the bankers be specific. If the bankers can’t convince you that they are strong believers in your management team and your business, they certainly won't be compelling when they present the company to potential investors.
3. What’s the average time for closing a deal?
Don’t have the bank make speculative guesses about the length of time it might take to close a deal. Have the bank confirm its statement in an email with specifics after it runs an analysis. Once you sign an engagement letter with an investment bank, the meter is running. If the fee structure is weighted toward a retainer rather than a commission, the banker has less of an incentive to close a deal quickly. Often investment bankers will take three or four months before they even begin to talk to investors.
Related: A Beginner's Guide to Private Equity
4. Does the bank have experience with firms of this size?
If the investment bankers tend to work with larger companies, think about what might happen if a larger client needs attention. Suddenly, your company might become a second- or third-tier customer. What if the bank has had no recent clients in your industry?
5. Can you provide five references?
Ask for introductions to five companies that were former clients of the bank in a fundraising effort -- two that were successful in raising capital and three that were not. Ideally, these references will be in your industry and in your company’s size range. Ask that these clients be recent ones and make sure they all worked with your specific banker not just the bank itself.
6. Who are the first five people the bank will approach?
If you run a $15 million food company, and the investment banker wants to approach a Fortune 500 firm, ask for specifics. If the banker mentions contacting Nestlé, say, “That’s great, who exactly would you call at Nestlé and when was the last time you talked with him or her?”
7. What are the firm's average fees?
A very high retainer doesn't provide a banker an incentive to close a deal. Conversely, investment banks that rely heavily on commissions are motivated to close transactions quickly and at the highest valuation possible. And they are inclined to only take on companies in which they believe strongly.