What the Growing Number of Boutique Investment Banks Means for Deal Sourcing

While the M&A landscape has recently been shaped by a myriad of macroeconomic, industry-specific, and legal changes, one of the most influential shifts has been the rising number of boutique investment banks.

“Over the past 5-10 years, there has been a proliferation of business brokers and boutique investment bankers,” explained Member Steve Connor of Hamilton Robinson Capital Partners. “Many bankers — after leaving Wall Street firms — have set up smaller shops throughout the country.” As these investment bankers develop a presence in new cities and new markets, “they [integrate] into the local community and get to know the business owners.”

The expansion of boutique investment banks is changing how many banks identify relevant buyers and, therefore, how many private equity firms and financial sponsors are sourcing relevant opportunities.

Targeted Auctions & Sourcing

Instead of running broad auctions, boutique banks will likely run more targeted auctions with smaller buyer lists — employing tools like Axial to help. As Member Brian Trauth of The Capital Corporation previously explained, “15-20 years ago, whoever had the biggest network was the best bank. Today, it is more about your tools than your existing network — you can find relationships you never had before.” Boutiques that are not targeted with their lists and relationships may struggle to identify the best investor for their client.

As boutiques — and the smaller processes they run — boom, private equity firms and other investors will need to find better ways to access the two-man shops.

Traditionally, effective sourcing was a balance between channels for either quality and quantity.  As Member Lee Miklovic of Opus Capital Partners explained, “The best approach to deal sourcing is a multi-faceted strategy of sourcing from bankers/brokers, service providers, and other referral sources.”

Member Rob Lemos of RailFence Capital, echoing a similar idea, added “The balance between sourcing channels depends on broader market activity. At the end of last year, for example, I was focused on developing relationships with brokers and bankers because many business owners were exiting through them for capital gains. In the summer, when typical deal flow is slower, I spend more time performing direct outreach.”

However, the balance between different channels has shifted with the relative growth of boutique and mid-market investment banks. Lemos has noticed the shift during his own sourcing efforts. “While I have had some opportunities come through accounts or lawyers, most often, the service provider refers their clients to an intermediary, to whom I later get introduced,” he explained.

With smaller auctions, it is still critical to differentiate your firm from the others. As Lemos explained, “This differentiation can be accomplished through successful branding and emphasis on operational partnerships rather than financial engineering. Since you are participating in a large scale job interview, you have to prove why you are better than the other candidates — and price is often only one factor in the equation.”

Benefits of Targeted Auctions

As Steve Connor explained, “Very small auctions can be a great situation. Instead of going to hundreds of PE firms, the banker may go to just five or six. The more intimate auction allows you to get the…benefits of an intermediary without extra competition.”

A greater number of smaller, targeted auctions could mean good news for financial sponsors. In addition to offering recurring deal flow from all across the country, intermediaries simplify the conversation between business owners and PE firms.

“Without the advisory services of a banker or broker, a private equity investor works harder and requires more time to evaluate deal opportunities,” Miklovic explained. “Bankers and brokers add significant value in properly summarizing and rationalizing a company’s business and growth prospects, collecting the relevant diligence materials, and being an unemotional conduit between the buyer and the business owner.”

In addition to simplifying the process, Connor noted that bankers tend to increase the likelihood of a sale. “The seller is typically more motivated to sell in an intermediated deal,” he explained. “While proprietary deals are extremely valuable, it may be 2-3 years before the owner decides to sell.”

As the middle market and lower-middle market continue to fragment, gaining exposure and presence to these smaller auctions is critical to sourcing the best opportunities. Whether it is making more phone calls, attending more conferences, or joining Axial, identifying the smaller banks and brokers is proving critical to current and future opportunities.