Whose Side Is Your Advisor On? By Dr. David Young

 01/Feb/2004 17:13:23


FDs need to be more aware of how corporate finance advice can be skewed by an advisory firm's other interests, says Dr. David Young, veteran of several big investment banks and founder of Shield.

M&A has never been for the faint-hearted. It's a game in which the stakes are high, fortunes and reputations are won and lost, and things can get so adversarial that it feels like war. But there was a time when at least you could tell the difference between your friends and your enemies.

That was before the rise of the "integrated investment banks" - the mammoth financial bazaars that dwarf their clients and specialise in - well, pretty much everything. It's taken Eliot Spitzer to demonstrate that honest objectivity is about the only thing they don't try and sell their clients. Their own interests come first - and FDs relying on their advice to sell a company need to know exactly what those interests are.

So what is a bulge-bracket investment banking team trying to achieve? Firstly, it's under enormous internal pressure to contribute to the bank's standing in the league tables - the fatuous quarterly rankings of the big banks according to volume and value of transactions achieved. To rank high, a bank has to encourage its clients to do deals - with price and terms (along with the objectivity of equity research) often taking a back seat.

Secondly, the team is almost certainly dedicated to a particular industry sector - and its orders are to maximise the bank's earnings from that sector, across all products and services. So if Mr A wants advice on selling his company, that's fine; and if Mr B needs a loan to buy it, that's even better (about three times better, actually, in terms of fees); and if Mr C also wants to buy it - well, three's a crowd. Even if Mr C would have paid more. What's worse, if the bank is financing Mr B, it certainly won't want him to overpay. So it has a conflict of interest in trying to get the best price for Mr A. And whether or not the bank is financing any of the buyers, the industry team won't want to offend its predominantly buy-side clients by pushing hard for the interests of a seller. Much better to secure a quick, comfortable compromise deal, and get on to the next one. Corporate finance conflicts of interest don't end there. The bank will have a "relationship manager" for each significant company, and his career depends on pleasing his clients. When the bank is handling a divestiture, that means passing on helpful information - that other bidders may not be getting. If the helpful information includes the price it will take to win, the seller himself gets sold short.

It's the same story with large accountancy firms. They much prefer to see corporate finance clients making divestitures to companies that are audit clients. Otherwise they lose audit business. But people have woken up to the conflicts of interest that bedevil these large organisations also. Accountancy Magazine recently reported that the non-audit income of the Big Four fell by a quarter last year.

So if you're planning to enter the M&A arena, keep your wits about you. Advisory arms of larger organisations try to manage these conflicts of interest, and sometimes succeed. But they have P&Ls too; don't be fooled by advice that serves theirs better than yours.

Real Finance Magazine, contributed by Dr. David Young, Founder and Chief Executive of Shield, the independent corporate finance boutique specialising in divestitures (www.shield.uk.com)



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