• Dec. 9, 2016, 5:37 am

How crowdfunding will forever change the face of mergers, acquisitions and investment banking

With the final rules and implementation of Title III upon us, the constant industry hyperbole is not likely to cease anytime soon.

Between the lines of rhetoric lies a verifiable fact: the financial services industry is to be forever altered by both changes in the law and shifts in technology.

While, on the whole, this is a very good thing for investors, issuers and promoters alike, it will require existing industry leaders to forge ahead with enough foresight to adapt. Human functions will no doubt remain an absolute necessity, but forced adaptation in the face of industry-wide change is likely to alter the functions and processes of many traditional, mid-market investment banks.

Creative destruction

Schumpeter’s 1942 Creative Destruction hypothesis and “essential fact about capitalism” is coming to play in financial services yet again with the broad-based influx of new crowdfunding rules brought about by the JOBS Act and the fintech that follows in its wake. These rules are likely to disrupt how companies procure seek, growth and acquisition capital and how both acquisition and organic growth is financed in the coming years. While advances in financial services are likely to turn, in my mind, crowdfunding holds more promise for companies in the lower mid-market, or those operating with less than $100M in annual sales.

These businesses often operate profitably and work well with local banks and bankers, but opportunity gaps in what traditional banking can provide will likely be filled by some of the creativity we’ve been discussing. Capital events in the lifecycle of a business do not happen frequently. Typically, mergers, acquisitions, divestments, sales and capital raising are infrequent, one-off events for most smaller companies. The ability to perform them more quickly, more frequently and at a lower cost completely changes the game for smaller companies where capital constraints abound.

Adapt or die

For those prepared to ride the wave of change within the industry there remains a great deal of opportunity. For those unwilling to adapt, there is greater risk of inevitable decline and failure, especially in the future. For those already in the industry, employee beware, new tools are likely to alter the processes, cost and inevitably the fees investment banks and others are able to charge to procure capital. Here are some likely future examples of how companies that fail to adapt may fail to succeed in this “new world order.”

  • A company seeking seed funding of $1M files a simple private placement with the necessary disclosures, executive summary, business plan, team and financials to a crowdfunding portal. They’ll only engage with a real, live investment banker if they fail to fully subscribe their offering to their desired audience.
  • A profitable growing company seeks a late-stage investment and offers-up $5M of securities in a 506(c) offering, using general solicitation to target accredited investors. Only a portion of the raise utilized real investment bankers, while the rest was subscribed and syndicated through multiple investment portals.
  • A company owner—as part of a predetermined business exit plan—seeks to take some chips off the table before eventually retiring (and does not wish to do traditional sell-side M&A or an ESOP) uses the Title III exemption to sell $1M of securities annually for a several year period. As a result, his/her business is owned by a mix of local and national groups and s/he maintains a minority equity stake.

These rough examples only scratch the surface of creative and new deal structures and processes which the new laws will allow. As the technology makes the strides necessary to catch up with the hype, there is a likelihood that crowdfunding will begin to greatly impact the world of middle-market investment banking similar to how other financial technologies have obliterated traditional processes.

Bridging the gap between promise and technology

The technology has yet to catch up to the theory, legality and promise of a future run by machines, machine learning and robots, but fintech continues to eek closer to its promise. The “post and pray” mentality of both M&A and crowdfunding will likely fail to move the needle, regardless of the quality of the technology. It is important to note that deals are sold, not bought and an investment banker—acting as the seller—still needs to play the role of promoter. Remember, regardless of the size, scope or sizzle of any deal, there still needs to be flesh and blood in a deal. Checks are not typically inked without direct human involvement. For the investment bankers, this should at least provide some promise of job security.

The decline of traditional processes and procedures in investment banking is not likely to happen overnight. That does not mean investment banks should fail to prepare for and work with the veritable flood of financial technology. As inking deals becomes easier for issuers without the use of a banker, investment bankers will be forced to work hand-in-hand, allowing the deal to dictate how the tech is used in working a transaction and not the other way around.

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2 Comments

  1. John
    November 5, 2015 at 8:55 am Reply

    although his article brings up interesting point – it fails to take into consideration the types of owners exiting mid market businesses and and their psychology and thus undermines the true role a sell side m&a banker plays in the process.

    Usually this is a retirement event and the owners aren’t going to sell their baby if twenty years to the general public etc.. They are highly emotional and often times leave millions on the table for true fit, to make sure their employees are looked after and their company is in the hands of a strategic partner wanting to grow the business further.

    Furthermore: earn outs and buy outs etc are not the sexiest of options and all cash is always preferred.

    Lots of holes here but nice attempt in shaking things up. If this is even a reality (specifically in M&A), then it’s about 50 years away. Raising debt etc is another story – crowd funding might fit more in this arm of investment banking. Fortunately M&A is safe and sound for the time being.

    Ps I’m an associate for a mid market investment bank.

    • John White
      John White
      November 8, 2015 at 11:49 pm Reply

      Thanks for the comment and thank you for reading.

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