Starting a business is in itself quite a feat, let alone managing to get the ship sailing in a profitable direction. In this era of technology and scientific advancements, ideas are rifer than ever; every year, we hear about thousands of startups with crazy business ideas that seem like they could revolutionize the world around them.
A year or two later, they fail, with many reasons piling up behind the shouldering mess left by the once hopeful start-up team. Why does it happen, what are the most crucial steps towards getting your start-up to succeed and how can investment bankers come in for the rescue or the fundraiser?
The first thing you need to know regarding this whole investment banking stuff is that they are not just limited to raising capital for businesses. As easy this may sound, this process isn’t just attending fundraisers and swooning old men and women with money to part ways with their estates and whatnot. And neither do investment willy-nilly accept any start-up that comes their way, asking for them to round up a couple of rich people to fund their business ideas. No, it’s not like that, and if anyone says otherwise, oversimplification is the obvious answer.
But wait a minute, weren’t investment bankers reserved for big corporations and banks themselves. Didn’t they bring us the 2008-09 financial crisis? Why are we discussing them if they have been revealed to the point that socialism is now looking like a good thing in the US? With the advent of crowdfunding websites and platforms that specialize in funding great ideas, that too on the internet, why are we still stuck with investment bankers, with their lofty salaries, hefty bonuses and consultation fees that run in the millions?
Well, as it turns out, the old ways are still the best ways, and you can use all the GoFundMe you want to, but the simple truth is, that investment bankers are still better at funding your start-ups and can ensure that the idea does not just go belly up due to a lack of funding. That does not happen, provided you meet all their criteria and can come up with their hefty fees.
This whole point aside, let’s get into what investment bankers are, and for a start-up, how helpful an investment bank really is?
What Is an Investment Bank?
An investment bank, as the name implies, is a bank that specializes in securing investment from willing investors for the project or start-up it deems nascent enough to receive this seeding. You might ask that regular banks also issue loans for businesses, what is it about investment banks that makes them so special?
For one, banks lend out money to anybody on a fixed interest rate and are limited by law to how much they can lend out, which in the case of some start-ups requiring heavy investment, is not feasible at all. Which is where investment banks come in. You see, there is no cap on how much an individual can invest in a start-up, and since this is part of some offering (like an IPO or a share sell-out), the start-up does not need to worry about returning it back with additional interest tacked on it.
Furthermore, as stated beforehand, investment bankers aren’t just supposed to get you the investment. Instead they’re expected to thoroughly vet each and every startup that requests an investment injection, and are supposed to do their homework over which startup gets the most of the money. Then, they are also responsible for mapping out the financial future of the startup since the team itself will be too busy running the establishment.
While the general consensus is that investment bankers are overpaid, the entirety of it is not true, since a lot of responsibility of securing the investment and ensuring it gets to the deserving startup takes some work on their part.
Investment Banking For Startups: How It Works
You might be wondering why investment bankers are so interested in startups and vice versa. One can easily go for a conventional bank loan and be spared from all the investment pitches and paying large sums to the investment bankers who handle your portfolio. All you’ll have to worry about is paying back the loan with some interest on it, but still better than paying the 10 percent of the total amount raised to a banker, right?
Well, it’s more than that. For one, you need to understand that conventional banks are very selective when it comes to lending money out to startups. Not as selective as an investment banker may be, but a conventional banker for a startup just isn’t very feasible. Consider this for an example: conventional banks can only go up to a certain limit to provide a startup with investment, and that is because they are restricted by the law to provide a certain amount of money. In other words, there is a cap on how much a commercial bank can lend.
On the other hand, investment bankers are extremely selective on what startup they add to their portfolio. They require some pretty detailed paperwork, projections and statistics to make sure the case they present to the potential investor is strong enough that the financing party sees no reason to say no. However, all of this headache does pay off, because unlike commercial banks, a private investor is not regulated by the law and is not capped at a certain amount.
There have been instances of raising millions from a single investor, which is only possible if the startup is pretty lucrative and has a solid establishment team behind it. And on the part of the banker, they also need to make a good, strong case for the startup, since they are the only one who can convince the investor to put faith in the start-up and invest in it.
Are Investment Bankers Really Good For Startups?
Yes, far better than conventional loans from a bank. As explained beforehand, commercial banks can only lend so much. And once they do, you need to know that they usually have an interest rate that will keep the repayments inflated for a considerable time. All that and the risk of the startup failing is still looming in the distance, which, if happens, can mean the end for your finances.
On the other hand, investment bankers do not usually take up a startup unless it has the potential to attract capital towards itself, which would mean that the idea behind the startup is lucrative enough for the bankers to sniff around and look for investors willing to foray into this opportunity.
More so than that, once you have been vetted and accepted as a portfolio startup in an investment bank, you now have the opportunity to raise more than you need, for a rainy day. For instance, it can be arranged that a million or two extra in seed money is stored in the investment bank itself as a rainy day money, which isn’t a problem for both the investor and the investment bank since they already have a substantial amount of return tied to it.
So, to summaries, yes, investment bankers are far more better for startups, as they can guarantee (to some extent) the success of your nascent company and can secure vital funding from their own contacts, usually in the form of a stock buyout or an initial public offering (IPO), the details of which and the particulars are also worked on by the investment bankers.
Cons Of Getting an Investment Banker on Board For Your Startup
All is not rosy and gold. Investment bankers do come with their own set of cons, and for a good reason, for some nascent startups, it is generally not feasible to get investment bankers on their side. Why? Let’s get to know the reasons why,
First up is the cost: as explained earlier, investment bankers do not come cheap, and there is a reason why they are reputed to be overpaid, since their work doesn’t always fall in proportion to what they end up making just from one startup. There are usually two to three types of costs associated with getting an investment banker on board. These are discussed below, and are pretty much the same everywhere in the world, wherever investment banking for startups is common.
1. Upfront/ monthly retainer fee: Is a sort of salary or monthly remuneration that the startup pays the investment bank before any sort of funds are secured. Think of it as a member on the startup’s initial payroll.
2. Percentage cut: This is their share from the total amount of money raised, and according to several industry members, can go for anywhere from five per cent to 10 percent of the total amount raised.
3. Closing fee: Closing fees are the fees they charge once the entirety of the sum has been transferred. As the name implies, it can be considered a ‘thank-you’ money for the investment bankers for finding the startup, the capital and the investment.
All of these fees and cuts can eat up the earmarked budget a startup might’ve had for a time when it is already cash-strapped. Therefore, many startups are actually discouraged from getting an investment banker onboard, especially the ones that are resource-extensive and require a certain amount to be on-hand at all times.
Secondly, there’s the paperwork and the due diligence that has to be done by the startup in order to get itself into the briefcase of some investment banker. Whereas conventional banks will only require a surface-level detail of the startup, investment bankers are expected to make strong cases for the startups they tout, which is why they require things like monthly projections, expected sales numbers and growth over the years to prepare, do their homework and build a case for raising capital for the startup.
Since the startup itself is in a tumult and cannot be really bothered with all of this, plus factoring in the fact that many of the startups are not that much experienced in this whole deal, this can get very overwhelming very soon and may discourage the startup from getting one at all.
The Bottom Line
Investment bankers for startups are the smart and safe choice, considering that the business is just in its nascent stage and requires the most input of effort and resources at this point in its life. While input is not their headache, resources in the form of capital are, and investment banks are still one of the more efficient ways of raising capital short of leaving the startup and going after investors yourselves with little files that contain all the projections and whatnot. Investment banks do come with some cons, but these can be ignored in the favour of the massive amounts of capital they can raise.
