Why do entrepreneurs need Investment Banks?

It was in the summer of 2000 when I first heard it. The pink paper was punctuated with this “word”… this “person”… this “entity”… The suit, the tie, the thin-rimmed glasses, the leather suitcase, the laptop and the pink newspaper tucked in neatly under the arms are the typical characteristic of this animal who works for an “investment bank”. Thankfully not all of them match the above features.In the world that we live today, our universe is filled with opportunities that have arisen owing to technological advancement, increasing income levels and an ever bourgeoning population. We have moved from hunting with spears and making babies to reaching mars and well … still making babies … probably in a more advanced fashion. While I do not deny that the platforms have been in existence for ideas to flourish, there has always been a need to provide an idea with a fertile land to germinate, grow and provide fruits of its growth. The business ideas have required capital assistance at some stage and without investment banks; the ideas would have died a natural death.

I say this with great aplomb that corporate/ entrepreneurs (whether start ups or established businesses) need investment banks (and not because I work for one of them). Why? Amongst a variety of reasons that I am about to enumerate below, the most important function that they do is that of channelizing capital. Let’s see why there is so much hype surrounding their existence:

a) Confidante to the entrepreneur/corporate: Outside of business opportunities, when it comes to raising capital it’s a tricky game. It’s important for the entrepreneur to have some idea of who they want as a partner in their growth plans. It’s like finding a bride or a groom. Without your best friend’s advice, you are most likely to end up with a bad marriage. Investment Banks are your “best friend” when it comes to raising capital and their insight can be really helpful in finding the right investor for you. More importantly the whole purpose of capital raise is growth. Investment banks take complete ownership of the process allowing the entrepreneur to concentrate on the business.

b) Preparation of key document: Have you ever wondered if Ramesh Sippy had not directed “Sholay” would Salim-Javed be still the best story writers till date? You may have a brilliant idea and great growth story but without the right presentation it can all fall apart. It’s an expectation from most private equity players and venture capitalist that they have complete clarity on the business. You need to create just the right kind of excitement about the industry, the business, the promoters, the products, the potential and its eventual success that lines up investors outside your doorstep. Whether it’s a 2-page teaser or a 100 page investment memorandum, Investment banks have the pulse of the investors and are in the best position to present the case. The documentation is like a bait and it better be lip-smacking else Chetan Bhagat’s novels are a better bet any day.

c) The numbers: “So, what’s the bottom line?” A commonly used phrase that has sadly lost its inference at various places except the financial markets. How do the revenues look 5 years from now? What is the EBIDTA margin? When do you turn profitable? What is the ROE? What is the IRR of the investment? May not sound familiar now, but once the interested investor/VC has taken the bait you will find yourself on the “hot seat”. Like KBC, if you have all the right answers you will walk away with money. But for that to happen, the business has to be modeled right. Investment Banks give shape to the business idea into numbers. They are the builders and the entrepreneur is like an architect. With key assumptions in place, investment banks have the ability to build a financial model that best encapsulates the business opportunity and the expectation from the investors.

d) The legal side: Having had the experience of running multiple transactions, investment banks have an insight on the distribution of rights and obligations between the corporate and investors. While it’s prudent to involve a reputed lawyer while preparing the legal documents, it is always in the best interest of the corporate to include the investment bank in the process as well. Lawyers are a smart lot but at times protecting their clients’ interest supersedes the need to arrive at a consensus. Being on the negotiating table means that you give some and you take some. Investment banks help an entrepreneur take hard decisions by making them understand the practical implications of key terms of the agreement.

e) Targeted approach towards investors: It took the US nearly 10 years in locating Osama after they had carpet bombed the entire Afghanistan. Clearly highlighting the importance of a focused approach. Capital raising is no different. While most private equity players are sector agnostic, they are extremely sensitive about the stage of their investment. Investment banks are in constant touch with most of the investors and match their requirements with that of entrepreneur’s need.

The above article may look academic but it’s extremely practical. These are just some of services that are provided by investment banks. One may say that they are a necessary evil in the financial markets but without them … well … there is no excitement...

A small anecdote to share … My mother still unclear about what I do for a living has finally resigned to a more simpler explanation …” he works for an investment bank ... you know just like the house broker …” ... I grin in a corner wondering, “I wish it was that simple”.