Investment Banking “Much More an Art than a Science.”
Douglas E. Mitchell
Philip M. De Carlo | - Eagle Partners, LLC.
Posted Wednesday, February 8, 2012

What does your company Eagle Partners do, and with what industries are you involved?

Eagle Partners is a boutique investment-banking firm that deals with corporate finance and strategic advisory work. Specifically, our firm conducts M & A related advisory and capital raising services targeted at the lower end of the middle market. This includes companies between about $10 million up to $100 million in sales. Our typical assignments are representation of sellers of privately held companies. These are usually entrepreneur-founders, who may be seeking retirement and liquidity value in their businesses. Sometimes this includes younger owners who want to pursue other interests. The strategic advisory work also includes buyouts of minority shareholders or partners who want an exit and liquidity. The other side of the business is capital-raising, which involves raising funding for companies for growth, diversification, acquisitions, etc. 

In terms of our industry work, the partners at Eagle have over 100 years of collective experience, involving a broad base of companies in manufacturing, consumer products, technology, entertainment, health care, agriculture, and business services. We have extensive experience with international and publicly traded buyers across many types of transactions. 

How did you end up in this particular market?

I had this business for many years at Bank of America. I started my career at B of A out of Business School. I went through a number of divisional assignments, including corporate lending in the Fortune 250 world, and then transitioned to the middle market in high tech. I was at the technology-lending group out of Palo Alto for several years. That brought me into the middle market, and then I was asked to start up a middle market investment-banking group at B of A. I had that business for 12 years. We really focused that business at B of A on the commercial banking or middle market franchise, which was actually the largest of its kind in the banking industry. We had quite a portfolio of privately owned, middle market companies to focus on. When B of A was bought out in 2000, I joined Eagle Partners with some associates from my group. At that point, B of A was really starting to transition its investment banking business to the higher end of the corporate market, in an attempt to become a “bulge bracket” firm. This strategy focused on businesses more in the Fortune 500 sector, and accordingly, we felt our model was probably going to get less attention.  As part of my transition out of B of A, we arrived at an agreement with the Bank to refer us their smaller deals, and that started us on kind of a referral track, not just with B of A, but with other major banks as well.  

Generally, when a company comes to you and says we want to merge with somebody or we want to buy out the minority shareholders stake in the company, what do you do from day one until the end?

The best way to characterize it is that we really assume the role of a financial engineer. We sit down with an entrepreneur-owner, and we diagnose his or her needs. Sometimes that meeting is fairly straightforward, as would be the case of perhaps an older owner seeking retirement, and just wants to sell the company. But frequently, entrepreneurs can have a very complex set of motivating factors, including lifestyle, family considerations, financial considerations, and so on. Our first task is to get to know the owner, or owners, to understand the driving factors, and then take on a financial consulting or engineering role to analyze options and present an array of financial options.

There can be as many as five different transaction types that can accommodate a certain need. There are all kinds of buyout options, including ESOPs, other types of management buyouts, a sale to a “financial buyer” (a private equity group), or a strategic sale, which is what most people generally think of related to M&A. They think about two companies in the same industry merging, which would be considered a strategic sale. There are different kinds of strategic sales-vertical mergers, horizontal acquisitions, and all of that. Thus, our initial role is to diagnose the financial solution that best fits the needs of the client and the conditions of the marketplace.

We then go about performing the tasks necessary to accomplish the objective. In a sale scenario, there are various stages. The process starts with due diligence, which is the stage where we dig into the numbers, the data, the operations, etc. We follow this by writing what is called an information memorandum (IM). The IM does not have the legal requirements imposed on the various documents used for IPOs, for example, but it is the same concept. Then we analyze the market and develop a marketing strategy for the sale. This includes a list of potential suitors, which could be a very broad or a very targeted list. We have had assignments where we have gone to one buyer and others where we have gone to hundreds of buyers globally, and everything in between. We solicit interest, negotiate terms, value the company, go through that whole exercise, and then assist in the ultimate closing of the deal. That is generally the M & A side of it.

The capital raising side involves similar steps, but instead of going to buyers, you are going to either equity investors or lenders and running a comparable process. What is important for the advisory role in either case is running what can be described as an “auction process” in order to give the client the optimum set of conditions and valuation. You want to go to multiple parties to drive the best possible outcome for the client. For example, the valuation differentials, when we take a company to market and introduce them to a variety of potential buyers, can be substantial. In fact, the minimum valuation variation between different buyers is typically on the order of 30 to 50 percent, and we have had a good number of cases where the final negotiated valuations from different buyers were, believe it or not, in excess of 100 percent apart.

We had a client some years ago, with a California company in a very stable industry with a very stable cash flow. The low bids to acquire the firm were in the $30-35 million range, and the winning bidder offered in excess of $70 million. This really illustrates how radical the variation can be in valuing the company. It is much more an art than a science. There are a variety of formulas and other quantitative techniques utilized in the business, but ultimately, valuation is more of an art form than anything else. This is the most tangible or “bottom line” outcome that we can talk about with clients.

Do you have in-house counsel at your company or anybody that you have who handles that or do you usually send that out to an attorney outside of your office?

This topic is very important, and let me get into it in the following manner: First, to answer your question directly, we do not retain counsel; our clients retain counsel to represent them in completing the transaction. That said, we believe it is important to discuss with our clients all of the facets of the engagement, including the documentation and legal negotiations. We talk to them at length about the need for specialized counsel when we get to that stage. We strongly advocate that they have legal representation that is experienced in the type of transaction being negotiated. We have learned some difficult lessons over the years, where a client with the best intentions will turn to his or her long time, trusted corporate attorney who may or may not have substantial background in M&A. Now, this is less of a risk with the larger firms, where there are usually specialized resources to assist in the transaction. But often in the lower end of the middle market, a client’s long time corporate attorney might be a one-person shop, and we have found that if that attorney is not well versed in the issues specific to M &A, then it can be a major problem. 

Accordingly, we discuss the client’s need for legal representation at length in advance of the process. We ask who will represent the client, and what their qualifications are in this type of transaction. If there is a need, we can recommend various attorneys who we have worked with over the years that are well suited to fit the requirement. This is an important issue, and while we are careful not to give legal advice on specific items, we remain involved throughout the documentation process monitoring the situation, ensuring as best we can that the deal is negotiated in a reasonable manner.

How does Eagle Partners protect itself legally from suits when a transaction falls through?

Well, first we carefully analyze each opportunity. Generally, liability to our firm can come from two different directions: either the client can make a claim against us for lack of performance in some manner, or a buyer/lender can make a claim based on lack of disclosure of or misleading representations of material information. On the first topic, we are very candid and direct with our potential clients about the evaluation of the transaction--we do not “over-promise”. We provide a very objective appraisal of the strengths and challenges of completing the deal--including potential valuation returns. We do not sit there in front of the client and say, “We think you can get $25 million for this company,” when we know the market is at $12 to $14.They get the straight story from us, and on occasion, this can cost us--no one wants to be told their baby is not the most beautiful child on the street. But we have been receiving opportunities for new transactions from our referral partners for many years based on the belief that we will provide their clients with an honest evaluation of the transaction opportunity. And at the same time, it is a good business practice to protect ourselves from any liability.  

The second risk is usually more significant--we are the mercy of our clients in terms of the quality of the information we receive to bring to the market. We protect our interests in this regard through provisions in our engagement agreement (EA) with the client. The EA has various disclaimers and a rigorous indemnification clause. If you were to ask me what the most typical legal issue is in negotiating our EAs, it is the indemnification provision. It is written as a “one-sided” provision, providing broad indemnification from the client to Eagle Partners.  Often, our client’s attorney will attempt to create an “equal” indemnification, flowing back to the company from Eagle. In effect, they take all of the indemnification terms and aim them back at us, where we are cross-indemnifying the company.

Well, our position is that, if you understand M&A, you will know why the indemnification has to be strongly in favor of the financial advisor. This is necessary because, if Eagle is guilty of misrepresenting something in the market, then we are liable, and our document contains that standard language. But absent any misrepresentation or gross negligence on our part, all of the data and information we are conveying to the marketplace comes from our client. And while we conduct extensive due diligence on the information, we are not auditors. We have significant limitations in our ability to confirm financial information and other representations from our clients. In this regard, we rely to a great extent on the information provided by the company that is passed into the market. As a result, we require stronger indemnification language to protect our firm.

The last argument related to the “risk-reward” aspect of the transaction: our compensation is typically in the range of 1-3 percent of the value of the transaction. Thus, the “upside” of the transaction obviously favors the client.

This conservative approach, and the care with which we evaluate our transaction opportunities, is hopefully why we have not had an actual or even threatened suit in over thirty years of practice.

About the Interviewee:

Philip M. De Carlo joined Eagle Partners in April 2000 to provide capital raising and advisory services to middle market firms. Prior to joining Eagle Partners, Mr. De Carlo was Executive V.P. for middle market investment banking for Bank of America.

Mr. De Carlo received a Master of Science in Industrial Administration from Carnegie-Mellon University and a Bachelor of Science in Business Administration-Finance, from California State University, Northridge. 

Telephone Interview with Phil M. De Carlo, Partner, Eagle Partners LLC (Oct. 22, 2011).