Jay Jung first realized that investment banking was ripe for disruption several years ago. Jung, then employed at Goldman Sachs, had just completed advising on a “straight down the fairway” acquisition of a mid-sized software company. The advisory fees totaled $46 million. Yet, just two years earlier, he had worked on Verizon’s acquisition of web portal Yahoo!, a deal that had taken months, and involved many buyers and complex issues. The fee in that case had come to just $15 million, split among three top-tier banks.
Jung was baffled, but he also saw an opportunity for disruption. Boutique advisory Embarc Advisors was born soon after.
“Not all M&A deals are created equal,” Jung observes. “Some deals are more difficult than others, and some are more certain than others. Although, most investment banks will charge a straight percentage of the deal regardless.” He devised a different framework for Embarc. First of all, the two primary metrics would be company quality and business complexity. Second, fees would be based on work performed, not deal value. Finally, Jung decided to focus on the middle-market.
The “bread and butter” of Embarc’s business are relatively straightforward tech and industrial plays. “We end up doing a lot of work with companies of great quality that are plain and simple,” Jung says. Clients have included regular-way business services, IT Managed Service Providers, Business Services, Software-as-a-Service (SaaS), and e-Commerce / Consumer-Retail companies. It’s a diverse list, but what they share is a need for narrative. “There’s a lot of preparation involved because you need to tell a story that differentiates the company from the fray,” Jung says. “But with our deals, there is also a very high conviction that a deal will get done as long as the seller is motivated.”
Large investment banks and advisories do plenty of legwork too, of course. Embarc’s major differentiation is its fee structure. A typical lower middle-market investment bank will charge 3-6% to advise on a deal, even if the company is scaled and its business easily grasped by potential buyers. Jung’s question to potential clients is, why give up hundreds of thousands — or even millions — for advice on such a transaction?
Pre-Internet, the answer was simple: the bank knew how to identify buyers. “Think about selling an apartment before Zillow,” Jung says. “Brokers were the intermediary; they knew who was selling, so they could leverage their network to match up sellers with buyers and charge a outsized fee for their service. The old world of investment banking was the same. Investment bankers had relationships with corporate and private equity buyers of businesses, so when shareholders or owners wanted to sell a business, they would have to hire an investment banker. That investment banker would then liaise with other investment bankers to identify would-be acquirers. Colloquially, it was the old boys’ network.”
Now, Jung says, anyone can find potential acquirers on the Internet. It may not be as easy as going on Zillow and posting a property, but the access to information is starting to get democratized. Through various industry databases, an experienced deal professional can identify a broad pool of potential buyers without relying on an exclusive rolodex. As the digital platform democratizes access, the value creation point moves to other parts of the deal process. According to Jung, “The key is positioning the company to achieve the optimal mix of value, certainty of close and speed to close.”
Embarc’s proposition is simple: find well-run businesses in well-known industries, where there is a high probability of sale and little incentive for a seller to pay an outsized fee contingent on “success.” The 3-6% fee ends up transferring about 5% of the seller’s equity to an intermediary. Oftentimes, this intermediary is one who arrived at the last inning of what has, for many business owners and shareholders, been a very long journey. “If you knew you were going to sell in six months, or even 12 months, after building the business for 10+ years, would you give someone 5% equity?” Jung asks rhetorically.
Embarc, he says, is turning the investment banking model on its head. The firm’s fee is not contingent on a sale, but it is typically far less than a deal-based fee. He and his principals bill hourly so that the amount his clients pay is proportionate to the amount of work done. It’s a win for Embarc, too, Jung points out, because his team is able to make much more efficient use of their time. They do not, for example, go on “fishing expeditions” for clients who may or may not really want to sell. Embarc only works with solid businesses that have a clear intent to sell, as well as a good track record and performance.
Embarc also advises on negotiated deals where the buyer and seller are already identified. In those cases, Jung and his team will perform deal analysis, due diligence, and handle negotiations — mainly overcoming deal obstacles and finding ways to clear negotiation points. And because there is usually a high probability that the deal will get done in these situations, both buyers and sellers are better off paying a modest fee, even with the small risk that they may be out of pocket should the deal fall through. Indeed, the smaller fee itself may be an incentive to get to closing. Jung estimates that even if only one out of four deals go through, buyers would still be better off.
Perhaps the most disruptive aspect of Embarc’s model, however, is its elimination of deal bias. An advisor who is solely compensated on the deal getting done has a bias towards consummating, whether the best deal possible or not. Because the traditional investment banking model is a numbers game, Jung says, most advisors must continue to chase multiple prospects even as they are advising on existing deals. The economics is simple; in the later innings of a deal, the expected value of the next big deal fee is much higher than any price improvement on the existing one. For instance, a 5% fee on a $1M increase in deal value is only $50k, whereas a new deal might fetch a fresh $1 million, or more. In other words, the percentage fee model provides little incentive to optimize each deal.
“Some clients have asked us, since Embarc’s fees are not tied to success, do we have any incentive to close deals?” Jung mentions. “Well, if we did not close deals, there would be no reason to exist, and we would not be able to hire and retain the top-tier employees that we have worked so hard to recruit.” He adds that for every successful deal Embarc executes, the firm has attracted at least one or two new deals through word of mouth and referrals. This has allowed the firm to triple the size of its team, and grow revenues by a factor of four in the past year.
Still, Embarc poses little threat to the banking industry, for now. “The bulge bracket investment banking world will remain the same for a long time,”Jung says. “There are broader intricacies involved with large corporations, especially public companies whose boards have to deal with fiduciary duties and covenants.” At the same time, he says, the traditional investment banking model disincentivizes the best bankers to work on smaller deals. Smaller deals have smaller fees, after all, but not necessarily fewer headaches or work.
Small, “plain vanilla” deals are Embarc’s sweet spot. “I love working with entrepreneurs and smaller businesses,” Jung says. “That’s my family’s history and part of the ethos of Embarc Advisors. To make it work, we had to change the rules of the game — we had to disrupt our corner of the industry.”
Embarc may not be Goldman Sachs, but it has gained a loyal, and somewhat smitten, clientele. The other day, one of Jung’s clients called him the “Jerry McGuire of finance.” He simply smiled, knowing that he could not have asked for more of a compliment.
