This post originally appeared in Money Stuff.
A pretty simple model of startup financing is:
- When you want to raise money from private markets, you go to venture capitalists.
- When you want to raise money from public markets, you go to investment bankers.
Investment bankers, in this model, are specialists in public markets. If you’re a startup founder, you have no reason to have any expertise in how public markets work, but investment bankers do, so you hire them and pay them for their expertise (in structuring deals, pricing stocks, complying with securities laws, and marketing your stock to a long list of public investors).
On the other hand if you want to raise venture-capital money you don’t hire investment bankers. Investment bankers aren’t specialists in private markets: They don’t know the “market” way to structure deals, they don’t necessarily have a good sense of how venture capitalists value startups, and they don’t have a long contact list of venture capitalists whom they can call up and get to buy private stock. And private investors don’t expect to do their investing through investment bankers: Venture capitalists expect to source their own deals rather than get pitches from bank salespeople, and to negotiate directly with founders rather than through bankers.
But those are all just rough traditional generalizations and there is nothing essential about them. Here is a story from Bloomberg’s Sonali Basak and Olivia Zaleski about Morgan Stanley’s success in getting initial public offering mandates for tech companies. Part of this — which we have discussed before — is that Michael Grimes, the co-head of U.S. technology banking at Morgan Stanley, likes to do stunts:
On the road, he relies on Airbnb Inc. to book accommodations and rent out his house, according to people familiar with his technique. Before leading Zynga Inc.’s IPO in 2011, he mastered its “CityVille” game on his phone. While pitching Ancestry.com, he showed the company an elaborate family tree he and his mother created together. For Uber, he moonlighted as a driver.
(Tragically “Grimes became an avid reviewer on Yelp Inc. before its IPO in 2012” but did not end up leading the IPO, and imagine writing lots of Yelp reviews and not getting paid millions of dollars for your trouble.) But a more practical advantage is that Morgan Stanley is also good at raising money privately:
Yet Grimes and his colleagues, many of whom have worked as bankers for 20 to 30 years, have another asset that’s even harder to mimic: The firm helps raise money for young companies in private markets, often tapping high-net-worth clients in its $2.5 trillion wealth management unit.
This is good for Morgan Stanley because it is generally hard for an investment bank to prove its worth to pre-IPO companies: If those companies don’t need investment bankers until they are contemplating going public, they have no basis on which to evaluate different investment bankers, and the usual investment banking approach of winning big mandates by doing other investment-banking business for the company doesn’t work. (Thus, often, stunts.) But if Morgan Stanley can expand the category of investment-banking business — to advise not only on public-market financing but also on private financing — then it has an advantage in building pre-IPO relationships. It is also good for Morgan Stanley because private financing is lucrative: “The bank has earned about $60 million in fees arranging private funding for” Palantir Technologies Inc., “about equal to what it could earn handling an IPO.” And it’s good because it’s a nice selling point for the high-net-worth franchise: If Morgan Stanley can hand out Uber and Airbnb and Palantir shares before they go public, and other banks can’t, then customers who want those shares will choose Morgan Stanley.
Still my basic model seems kind of correct? It is not like Morgan Stanley’s main approach here is calling up venture capitalists and getting them to invest in fledgling startups. It’s just that the work of a public-markets investment banker has expanded into markets that are, technically, private. Morgan Stanley is helping large established companies raise billions of dollars from institutional investors and high-net-worth individuals. Now it is doing that in private markets, but not too long ago, you would have called a deal like that an IPO.
