9 ways to improve the cash flow cycle at an investment bank

  • Posted October 30, 2023 by

One of the challenges of managing a mid-market M&A firm is coping with the sporadic, binary nature of the payoff for your efforts.

In an industry where the compensation for a deal is often a large lump sum or nothing at all, it’s critical to manage both the company’s internal cash flow and the operational workflow of the firm’s team. 

A typical investment banker’s focus swings like a pendulum between deal origination and deal execution, sometimes at the expense of the internal organization. A banker in a deal flow lull focuses heavily on marketing to land a new client. Because M&A transactions are time-consuming and require tremendous focus, the banker must now allocate the vast majority of time to deal execution.  

With this single-minded, concentrated effort, the banker begins to neglect three things: sleep, internal organization, and marketing – in that order. 

When deals close (or die), the banker realizes the deal pipeline is once again anemic and the pendulum swings back to deal origination. Bankers are either doing deals or marketing, but rarely simultaneously. This results in a vicious workflow cycle and unpredictable cash flow that can be difficult to manage and may exert an emotional toll. 

Middle market bankers might think this cycle is confined only to smaller shops. Surely bulge bracket firms find a balance between origination and execution, right? 

They don’t. 

At the largest banks, deal teams function fairly autonomously and behave like smaller, non-competitive, industry-specific practice groups. Although the larger entity has a smoother revenue cycle because its various industry groups are often not in sync, each industry group experiences the same swings between origination and execution as seen at the smaller banks. 

Here are several ways investment bankers can smooth lumpy revenue endemic to the industry. 

Introduce a retainer fee 

Surprisingly, many investment banks accept new clients without an upfront retainer. In the process of selling the business, the banker provides ample strategic advice on positioning and strategy. A consultant would charge for this. A banker should too. 

Most sell-side clients will accept an upfront fee if you agree to credit the retainer to the final transaction fee. If the potential client fully intends to sell the company, the retainer is not viewed as an extra fee, but as an advance of the success fee to cover the expensive process. 

This is also a valuable mechanism to qualify potential clients. If the seller views the upfront fee as an additional expense, they may be signaling a lack of conviction to exit. Losing a potential client for this reason might save you a lot of time. 

Add consulting revenue and drive new leads 

Consulting isn’t as lucrative as transaction work. However, consulting provides a steady income and it’s a great way to position the firm as the preferred transaction advisor when the client is ready. 

Be wary of long-term consulting assignments that steer you away from your ability to allocate resources for transactions. But with a structured approach, the clients you target for consulting can eventually lead to deal flow. 

Only engage great businesses 

You can spend a tremendous amount of time trying to sell a mediocre business. It consumes resources and could adversely affect your firm’s reputation. You’ll feel like it was a herculean effort to find a buyer, and the company owner will be disappointed by low valuations. 

Declining revenue, customer concentration, poor financial records, spotty management, or legal liability are all factors to avoid. 

Focus on larger deals 

This shift won't necessarily smooth the cash flow spikes, but it will bring larger success fees for approximately the same amount of effort. Most middle market investment bankers agree that larger deals are easier than smaller deals. This is partly because the client is often more sophisticated and requires less handholding through the transaction process. The financials are cleaner. The organization may be more professionally run. And the M&A process itself is nearly identical. 

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Hire a business development executive 

For many transaction-based executives, adding business development expertise may feel like another operating expense. But a good business development executive can do wonders for a bank’s deal flow activity. They continue to bring in leads at a steady pace while the banker actively works on live deals. This can help smooth the cycle. 

Start a valuation services division  

Valuation service firms are not glamorous businesses. They can be lower margin and, frankly, a grind. But a valuation division can deliver reliable additional cash flow, provide valuations for M&A pitches, and become a source for future deal flow. Just be mindful of the cultural and branding challenges between valuation firms and investment banks. 

Outsource lower cost analyst work  

Outsourced analyst services can help alleviate some of the workload of deal origination and execution while not committing to a long-term increase in fixed costs for the firm. It’s worth investigating, and quick to test. 

Take advantage of the lunch hour 

A proven way to meet more business owners, improve your network and consistently prime your deal flow pipeline is to take business owners to lunch. You need to eat anyway, and most people do not turn down a free lunch.