Tips for Working with a Merchant Bank?

OP Here: Thanks, this is really helpful. I'll add:

They get zero if we don't have capital after 90 days.
They want an equity piece, plus whoever is committing funds will also want a piece (if it is equity, not debt)
They have a track record of success
They are committing to doing hands-on work to get us to the point of closing as it will make their equity stake worth something
We have full control to turn down deals that are less than advantageous to us, without a penalty
Fees on capital management seem to be lower than market average

We do need the help. We can get more aggressive with fundraising but it will take a lot of time and resources that we don't have.

This is original commenter:

What % of equity / warrants are they looking for?

Ballpark how much are you trying to raise?

Do you have a good transactional corporate attorney?

It sounds like you have a done a good job finding them based on what you outlined.

Two other points from OC:

call 2 of their references (CEOs that have raised with them)
be aware that their is a small negative signalling impact for future capital raises with having a merchant bank/broker in your cap table

They are looking for 10% equity. I'm new to this, but my research shows that they generally get 8-12%. My personal POV given where we are is that 10% is fair.

Trying to raise $1M. They get 10% whether it's $500K (min) or higher in this first pass. No commitment for future equity in this agreement. Yes I have tried other sources. This is the fastest path to reaching the right investors.

This is much smaller than they normally deal with, but they like the concept and know people who are looking to put dollars towards this kind of transaction. They have a track record.

Corporate attorney is quite literally one of the best in our non-California town.

I am concerned about the cap table comment. But I don't know how big of a deal that is. It seems like having people who raise capital in the space on the team would do more to help than to hurt. Is that the right way to look at it?

OC here:

From their side, 10% makes sense - they make $50k-$100k on the raise (which is about the min threshold for them to take on a project.) and it is not in cash.

That said I your equity is valuable. Presumably it can grow in value at 30%-50% a year. Overtime their stake is very expensive (10% is half an option pool of value-added hires).

Maybe do a combo of cash and equity for their fees (cash portion portion is funded at closing from $'s raised)? Look at the Lehman formula which most merchant banks follow for small M&A:

http://en.wikipedia.org/wiki/Lehman_Formula

Re: cap table - it creates complications down the road (e.g. pro-rata rights exercise, etc.), signals you couldn't raise capital by yourself and the merchant bank is perceived as less value added than an angel or VC (e.g. helping with hires, Board-level strategy guidance, etc.). Based on all you described I wouldn't be too concerned with this - just wanted you to be aware.

Good luck with it.

Thanks, I appreciate the suggestion. We have something like this in the works, but it's a short-term tactical answer, not the longer-term play we're looking for. We need help for that.

10% for $500K. Not $100K. But it's expensive either way.

Perhaps I'm misunderstanding, but the merchant bank isn't giving you the money directly - they are acting as a broker with actual investors.

If you're getting a loan, then you're paying 10% for a $500K loan.

If you're getting investment, then you're giving up 10% on top of whatever equity the actual investors get.

In neither case are you paying "just" 10% for $500K.

That is correct. I'm learning here, this is all new to me and I hope helpful to anyone else who might get involved with these kinds of folks. There is a lot of money in private equity and other channels that is sometimes hard to tap for small companies that have high growth potential, are tech-enabled, but aren't pure tech.

Agree that's it's not cheap, this is a 10% equity burden, which is expensive, even with their domain expertise. The alternative is that we might not make it, at current course and speed. So this is a gamble.

If this is the only way to make money, then you take your lumps and go with it.

However, the question I would ask is this: is your startup really so hard to invest in?

The merchant bank won't make recommendations to its high net worth clients unless it really thinks it is a good bet: getting its clients to lose money in ventures is a great way to ruin the merchant bank's own reputation and possibly lose the client.

Equally, the merchant bank could be just making an 'intro' and not putting its own reputation on the line. If so, you're just getting some names and phone numbers which there are tons of better ways to go about getting (and paying less).

So, what I'd do is really push hard to see what precisely is the merchant bank going to do. Are they going to act like a real lead investor - which is to put their own reputation on the line for you? If so, 10% still seems high but is defensible (a chairman of the board/lead investor is something like 5% normally).

If they're just going to pass your name around with spoken or unspoken "this is high risk and invest at your own peril", then 10% is WAY too much.

Sounds like you know this space. They plan to make the introductions and putting themselves out there, bringing deals to the table, acting like a lead investor and being hands-on.

This business should not be that hard to invest in, but it is a specialty that is requiring inordinate time to find organizations that understand the fundamentals of what we do, understand the risks/opportunities, trust our experience and results, and be a geographic match. This would be a slam-dunk in the Bay Area or NY.

Acting like a lead investor means putting reputation at risk.

Brings leads to the table is a sales and/or marketing job.

Being a lead investor almost always means putting money where mouth is. There are exceptions, but those are generally things like "Bill Gates thinks XXX is the next big thing" - which doesn't apply here.

At a minimum, put a vesting on any equity you grant - either time based or better yet, performance based.

As for investable - there are a lot of criteria there which have nothing to do with the merchant bank.

Some examples: Are the potential investors experienced/interested in your market area? If not, waste of time.

Are the investors serial and/or professional angel, or are wealthy people? This makes a difference too as dumb money can be very painful especially if you cannot guarantee to meet the expectations you set.

Do you have a credible 5 year budget? Credible estimates of ramp costs? Ability to ramp? growth path that will support investor interest?

The LOI does not include their own investment, although they have told me they do plan to invest as well as raise capital.

Plan is to take a rifle-shot approach with wealthy individuals that have experience in this space, with whom they have relationships. I know of a few of them, and they have the right background and mindset. Agree that dumb money will get us many headaches.

We have a realistic budget and growth projections. We know what we need to do to ramp, and have a line of sight to getting there.

Love the vesting of equity idea. Fantastic.