What’s the Right Way to Manage Risk in Lower Middle Market Investment Banking?

Lower middle market investment bankers might not normally think of themselves as risk managers or investors. And yet, through their work, they do invest an asset that’s precious to them and valuable to others. That asset is time — their own, and that of their firms. Preserving this asset makes risk management one of their core job responsibilities. Unlike peers who advise large companies and have ongoing relationships filled with secondary revenue opportunities, lower middle market IB professionals often have a one-and-done association with clients, and as a result, have much less job security.

To protect their limited time and be fairly compensated, IB professionals often have to accept or decline potential engagements based on the likelihood that those transactions will close. Even if an engagement seems high-risk, though, there are sometimes additional considerations: Saying “no” might mean passing up a golden opportunity or hurting a valuable relationship.

Making the highest impact as an investment banker comes down to managing risk and cultivating strong referral partnerships with peers. Here are some effective strategies for doing that.

4 Tactics for Investment Banking Risk Management

1. Carefully manage your working capital

Investment bankers expect that a certain percentage of deals will fail to close, building that loss into their business models. That said, it’s very important to minimize the impact of a failed deal any way you can. Prioritize deals with the most predictable costs in terms of time and materials, and keep any fixed costs to an absolute minimum. Beyond that, track your time as accurately as possible so that you’re not overcommitting resources to a risky or low-revenue deal.

2. Boost your deal pipeline

To give yourself the flexibility to choose the most profitable deals and manage investment banking risk, continually prioritize new business development. The best way to build up an active deal pipeline is by finding a way to say yes in every possible situation, which helps condition peers and clients to view you as a problem solver, even if a referral partner ends up helping in some situations. In addition, be a willing source of expertise, and never be shy about marketing yourself. Most importantly, always do high-quality work so that the people you interact with are eager to sing your praises.

3. Maximize your potential fees

Within your deal pipeline, focus on the opportunities most likely to generate the highest fees, either from deal size or incentive fees above a transaction’s target enterprise value. Prioritize any clients that might provide secondary revenue opportunities even if their deals don’t close. A private equity fund, for instance, typically has around 15 portfolio investments at any one time. If your investment banking firm establishes a good working relationship with a fund, you can position yourselves to assist with multiple transactions as its portfolio companies are sold and more are purchased.

4. Qualify genuine intent to close

Be ruthless about screening out deals that seem marginal before signing an engagement letter. Sometimes a business’s value, and your firm’s corresponding success fee, are simply too small to justify the hours of work likely to be required. Even a larger company may not be worth the investment banking risk due to seller uncertainty or internal disagreements that make a transaction unlikely to close.

While it’s much more common for firms to charge clients a running fee to cover the base costs of doing preparatory work, one very effective strategy used by some investment banking firms to quickly separate serious clients from tire-kickers is to charge a large retainer upon engagement. The key is for the amount to be sizable enough that by paying it, a client is demonstrating their dedication to finish what they’ve started.

How Oaklyn Consulting Helps Investment Bankers Manage Risk

When a deal isn’t a good fit for your investment banking firm, either because it’s too uncertain or would require working capital that would be better deployed elsewhere, Oaklyn Consulting may be able to assist. We can help you preserve relationships with clients so they continue looking to you for assistance in the future, but without wasting your and your firm’s capital.

Our unique business model, where we never charge success fees and offer investment banking services on an hourly basis, enables us to provide objective consultative advice on deals that might be too complex, uncertain or small to be the most profitable use of time for our peers. We work with clients as long as needed, and can help guide them to the best possible outcome, which may not include a deal at all.

Let us know if we can help you manage risk and preserve your most precious asset by serving as a referral partner for your uneconomic opportunities.