What exactly is investment banking for startups?

Let me start off by explaining why I felt the need to write this rant. I want to share with you one of the biggest challenges of my professional life – answering the innocent question: “What do you do?”. Yes. Whenever I meet someone new, the first thing they ask is, “so, what exactly do you do?”. When I answer, “I do investment banking for startups,” I usually draw blank stares and confused nods. Investment banking is usually associated with power-suited professionals closing multi-million-dollar deals on Wall Street, not with techie Israelis you meet at a conference or meetup. I, therefore, have to explain the long answer, which is to break-down the process and method of investment banking and how it perfectly relates to startups.

Understanding investment banking in 5-seconds

In short, investment banking is the process of connecting companies with capital. Sounds simple, right? It’s not. Investment banking firms offer a wide variety of services that, in the end, culminate in exchanging money from an investor for securities in a company, these services may be provided to both the company and the investor in a deal to ensure its success.

The first thing you need to understand is what an investment banking firm does (did you notice how I did not say ‘investment bank’? There’s a reason for that, performing the investment banking process does not mean you are a bank, and I do not want to have the two confused). An investment banking firm seeks to help companies find capital and/or help investors find opportunities for investment. However, as opposed to brokers (or “finders” as they are commonly called), investment banking requires the company and the investment banking firm to be (for lack of a better word) invested in an in-depth process and long-term relationship that will eventually culminate in a capital injection to the company.

An investment banking firm will not simply bring any company that approaches them for capital raising assistance to the firm’s network of investors. That would be futile and irresponsible. As part of its responsibility, the investment banking firm will perform a measure of due diligence on the company, its business, its market, and its future prospects. A company that fits all the necessary requirements will then undergo a process of financial advisory, which is business-speak for selecting the right way to raise capital, e.g., type of security (equity, bonds, IPO) and its pricing, and only then will the investment banking firm locate the right investors for the company and present to them the investment opportunity. Startups, of course, need these services most of all. However, most startups fall under the illusion that investment banking is for mature companies seeking late-stage financing, M&As, LBOs, or IPOs. They are wrong.

Why investment banking is a good fit for startups

Many early-stage startups prefer the spray-and-pray approach to capital raising. A startup founder will send its investor deck, one-pager, or business plan to everyone (relevant or not) and will employ brokers to shop it around to their networks in the hope of closing the round. This is a wasteful and time-consuming process that mostly results in disappointment or a bad investor-startup-fit. A smart startup will enlist all its resources, and most of its management team, to pre-qualify and approach investors, to internalize investor feedback and to follow-up on any investor lead that is truly relevant. Regretfully, the process that smart startups employ is very time and capital intensive.

There is really no reason that the same methodologies that are used in the investment banking process for large companies seeking capital cannot be applied to a startup in their quest for funding, employing investment banking methodologies to assist startups in improving the fundraising process, maximizing its effectiveness, and lowering the time investment necessary by the startup’s management.

So, back to the question – what is investment banking for startups?

Let me break down the investment banking process. Essentially, there are three major stages to the investment banking process: becoming investable, investor lead-generation, and closing the round.  Here’s what happens at every stage:

Becoming investable – perhaps the most important, yet most overlooked aspect, of the investment banking process, is ensuring that the startup is a viable investment opportunity. This means evaluating the current status of the startup, identifying areas for improvement, and focusing on those areas that do not cost additional money. Typical areas include strategy, business model, plan, story, materials, pitch, team, partnerships, traction, investor strategy (including deciding on the type of investment, sum, and valuation), and more. The process of becoming investable can take anywhere from a few weeks to a few months. During this process, investment bankers work with the startup’s legal and finance team to ensure full compliance and preparedness for all eventualities.

Investor lead generation – most startups assume, incorrectly, that we will simply send their materials out to our network of investors. If that was the case, we would be no better than regular brokers. Each startup must be matched with the investor that suits its specific industry, stage, offering, and strategy. Doing this might include introducing the startup to investors the investor bankers know personally and work with, but most often means identifying the relevant potential investors, pre-qualifying them, and introducing them to the startup CEO for direct contact. Some CEOs like to have their investment bankers in the meetings or roadshow; some prefer to do it alone.

Closing the round – once investors start showing interest, the investment bankers will be involved in all investment negotiations and investor due diligence to ensure that the deal closes in the best results attainable for the startup. Hands-on involvement by investment bankers will include providing all necessary information to the investor in a professional manner, advising on terms such as valuation, investment amount, warrants and options, board composition, as well as other business terms.

Often after the investment, the investment bankers will continue taking an active part in the company, such as sitting on the board of directors or continuing in an advisory fashion to begin preparing for the next round of funding, which will inevitably arrive (inevitable means within 12-24 months).

How long is this process? The investment banking process is lengthy and may take anywhere from three to six months and more.

Who is this process for? Usually, I find that such a process fits a startup raising $1 million to $10 million, which means a large seed round (in Israeli terms) to an early B-round. The sweet spot is usually Round A, which on the one hand, is difficult to execute while trying to build a business from scratch and on the other hand, is large enough to warrant such an extensive move.

When should you start? Truthfully, you should start your next round as soon as you complete your current round. Yes, you heard (or read) me correctly. If you just finished raising your seed or Round A, take a couple of weeks to celebrate and then start working on your next round before its too late. My partner, Aaron Rothenberg, wrote a blog entry about just this, and you can read it here.

How much does it cost? I will not go into exact numbers here but take into account that as a rule of thumb, each funding round will cost you approximately 10% of the sought-after capital for the various services, expenses, and fees you will require. This means that if you are raising $1M, you should be prepared to depart with $100,000 for that raise. Some of this money is paid in advance and some after the money is in your account. I hope to write another blog entry about the real cost of fundraising in the near future. Well, if you got to this section, then congratulations! Next time we meet, and I tell you I do investment banking for startups, I hope you will know what that means. And if you still don’t, feel free to send me an email, WhatsApp, or any other form of communications, and I will gladly explain more.

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