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Mergers & Acquisitions Part 2: Boutique Banks on the Rise

Aroop Gupta, 12/6/2016


As part of the previous post, we highlighted some of the emerging trends in the Mergers and Acquisitions (M&A) space. Towards the end we tried to look at the scenario through the lenses of disruption theory and understand what theories would possibly explain this phenomena. In the end two competing theories emerged that would possibly explain the Low End Disruption and the theory of Integration and Modularity. As part of this post we try to narrow down on which theory possible better explains the situation any why.

To narrow down on the theory that would possibly explain the current scenario, we look at the different dimension of the theories. To analyze if this is a potential Low End Disruption in the making, we try to answer the following questions

  1. there a specific performance metric on which there exist a low end customer base?

  2. Is there a new business model that entrants leverage to address the low end customers?

Looking at the available data (as shown in the figure 1) from one of the studies[1], it appears that the activity of Boutique banks is limited to the smaller value deals of few billions. The average deal value for a full service investment bank is nearly 6 times that of a small boutique investment bank. This answers one of the potential questions of the performance metric and low end customer base. While full service investment banks are motivated to take up larger deals, smaller boutique firms are able to address the low end of the market profitably.


Figure 1 - Difference in deal size of Full Service Investment Banks Vs Boutique Banks (Source: Battle for dominance in the M&A advisory business Bulge-brackets vs. the boutiques Deloitte)

The same holds good for the corporate development teams that are going into M&A deals without the investment bankers. As table 2 shows, a majority of the deals that happened without the involvement of an investment banker are in few billions versus the one’s that full service investment banks do. So it is not difficult to visualize that the activity of the new entrants is at the low end of the market. However what essentially sets a potential disruptor apart from all others is a business model that is difficult for the incumbents to replicate.

When we try to look at the business model of the entrants to evaluate what’s new, we find very little differences. The boutique investment banks may have a leaner cost structure (because of limited capabilities) as compared to the full service investment banks but the profit formulas and the resource very much remain the same. In majority of the cases the boutique banks still work with the same profit formula of retainer fee and success fee. They leverage the same technology and resources that a full service investment bank. Hence it may not be difficult to conclude that the business model is not significantly different from that of the incumbents.


In case of corporate development teams, it is difficult to justify that they have a similar business model as the incumbent. In order to do so we would need to separate out the business unit that helps the company in the M&A process and analyze them. As majority of such team are closely integrated with the corporate teams, it is rather difficult to segregate all associated details and draw conclusions on the business model. It may be a case that these teams work very similar to a typical investment bank or may have a completely different business model. However what we do see is that there is a change in how Corporate Clients are looking at M&A today and the current offerings of investment bankers may not be very helpful in such scenarios.

To understand the context, we take a slight deviation to understand the priorities driving a company to look for acquisition targets. For this we refer back to an article published in March 2011 issue of Harvard Business Review[2], where the authors narrow down corporate acquisitions into broadly two categories. We discuss about each of them in short here

  • Leverage My Business Model (LBM) – These kinds of acquisitions are more targeted towards improving the current performance of the company. As part of these acquisitions, the acquiring company acquires the resources of the target company and discards the business model. As a result of which the acquiring company is able to improve its current performance and the target company loses its identity. It is not difficult to say that majority of these deals are targeted towards sustaining and efficiency innovations.
  • Reinvent My Business Model (RBM) – In such deals the acquiring company brings the target company under its umbrella but does not disturb its business model. The resource of the company may or may not have the potential to improve the performance of the core business. However the acquired company is kept away from any influence from the core business and is allowed to operate independently. Over a period of time as the business grows, the acquired company assists the growth of the parent company.

As discussed in the article, majority of the M&A transactions are focused on acquiring resources than a business model. However this perception may be changing today. In our research we could find at-least two surveys which indicate a shift in corporate priorities driving M&A today.

One of the survey by Deloitte[3], points out that CEO’s today are increasingly looking for deals that drive innovation within their organization and trigger the next phase of growth. Also deal originations are more from internal teams rather than external entities re-emphasizing the fact that corporate strategies today are more of a bottom up approach than a top down one. In other words corporate teams are moving more towards an emergent strategy than a deliberate strategy. In line with the changing needs, the survey also points out that past competencies of evaluating a target business need to be supplemented with new capabilities. Acquiring company need to have either in-house skills or advisory teams that help evaluate startups at very early stage and asses their disruptive potential.

In another survey[4], Accenture points out that “As companies shift their M&A focus from scale and synergies to enablers and capabilities, they will need a new approach to both pre- and post-deal activities. They will:

  • Look for different targets, often small, nascent businesses operating in new industries, not large competitors in the same or an adjacent industry with complementary offers
  • Assess the value of the targets differently, relying on proxies and new criteria such as R&D spend, disruptive potential, and magnitude of strategic impact instead of classic valuation techniques

    Focus on innovation and transformation during integration rather than removing redundancies and maximizing synergies”

Looking at all this it may not be difficult to imagine that corporate priorities driving an M&A are changing. The focus is shifting to more towards companies that drive innovation and that too in very early stages. The challenge from the acquiring company’s perspective is that such acquisitions have to be done on a completely different set of parameters which are not quantitative.

Financial models like Discounted Cash Flow and Internal Rate of Return are not very useful in such cases because majority of the times at an early stage, startups do not have any cash flow or revenues. In such a scenario, some corporates have come up with their own methods like the ‘Toothbrush Test’ of Google. However disruption theory tools like Jobs to be Done (of the target customer), Integration and Modularity, and analysis of the business model (value proposition, Profit formula & Cost Structure, Processes and Resources) of the target company may be helpful here. Venture Capital industry is another example of this where the bets made by the early stage investors are more on the people, technology, product than on the projected revenue or cash flows (though each of the investors have their own way of valuing startups).

With this context, it may not be wrong to say that the current skills of investment bankers need to be supplemented with capabilities that address the non-quantifiable parameters. While for complex deals with predictable revenues and cash flow, the skills of investment bankers may still command a premium, for small early stage deals, there remains a void to be filled. In such a scenario, some corporates that primarily look at M&A through the lenses of innovation and growth may not find the advice from investment bankers very useful.

To look at the context from the perspective of Capitalist Dilemma, today some clients are increasingly looking at leveraging M&A to drive Market Creating Innovation whereas the advice from investment bankers is more towards Sustaining and Efficiency innovation. This is an indication of shift along the performance trajectory that the customer can absorb and calls for re-integration along all elements of the value network of an investment bank.

Going back to our original discussion of theory selection, it seems that the current scenario can be looked at through the lenses of integration and modularity. From the perspective of an investment banker, it calls for re-integrating all the elements of the value network and forming a new consulting arm that has no influence from the core. In other words technology, people & other resources need to start a fresh, create a new process of looking at startups and come up with a cost structure and profit formula to deliver the new value proposition. Also from the perspective of the customer (corporate development teams), with almost no entities that can help corporates with their acquisition objectives, corporates may be re-integrating. Corporate Development Teams today may be taking top talent from the investment banking industry and molding their skills into their investment strategy to meet their objectives.

Amongst all these elements of the value network, people (or experienced bankers) seem to be the performance defining component. The ability of the boutique investment bankers to take away market share from the incumbents and the appetite of the Corporate Development teams to pick top talent from the Investment Banking industry may explain this. In other words as the Law of Conservation of Attractive Profits would say in a modular system, the ability to command a price premium rests with the performance defining component.

So to summarize as part of this post we saw that, the current situation needs to be looked at through the lenses of the integration and modularity. The change in what a consumer values, calls for an integrated approach of addressing the consumer value proposition. As corporates increasingly look for innovative companies at their early stages, financial tools of discounted cash flows and internal rate of return may not be very useful in such a context. M&A decision are now increasingly based on non-quantifiable parameters and disruption theory tools may be helpful here. That opens up an opportunity for investment bankers to create a new business model which would be focused on addressing the new value proposition of their clients. Also today, as Corporate Development teams do not find alternatives to address their M&A priorities, they are integrating all necessary elements to come up with their own solutions. In the end people (experienced bankers) seem to be the performance defining component in the entire system.

As part of our next post I would try to lay down as to what the theory would say may happen if this trend continues.