I don't think Goldman did anything illegal, but they certainly did a terrible job serving their client. In my view, investment bankers have an obligation to offer whatever financial and strategic advice the particular client needs, which is a function of that client's sophistication. Some clients are highly sophisticated, don't need any advice, and just want you to find them a buyer at a good price. Others can, for example, simply be good technologists but otherwise not be particularly business or finance savvy, and so will need additional guidance along the way.
To look at this particular case, moving from a 50/50 cash/stock deal to an all-stock deal without an increase in total consideration, or without the client REALLY loving the stock of the acquiring company, makes no sense. Guaranteed money upfront is always preferable (unless there are unusual tax circumstances, which I don't see being the case here). This should have been a major point of discussion and negotiation. And if an all-stock deal was decided upon, the client should've been advised with no ambiguity that there are substantial risks involved in such a deal.
In any case though, even for the 50/50 deal, substantial due diligence on the acquirer should have been recommended. Spending $50k to verify the quality of $290mm+ in sale proceeds is a no-brainer. This legitimately falls outside of the realm of responsibility of the banker to conduct this due diligence though, and should've been performed by a third party with guidance and oversight by the bankers. The bank here is conflicted anyway - their incentives would clearly be to give the "all clear" sign. Falsified revenue is extremely easy to catch - just follow the cash.
I guess the lessons here are don't work with service providers who don't value you, and always keep in mind that ultimately, as the client, you're the one that has to live with the decisions that get made.
I'd be remiss if I didn't mention that there are better sources of financial advice. At my firm, we take pride in deeply aligning ourselves with our clients by only charging fees upon successful completion of a transaction, and by being compensated in the same form that our clients are (e.g. had we advised Dragon, we would've been compensated in L&H stock, and would've therefore been highly incentivized to strongly recommend due diligence!). The Dragon/L&H deal is actually one of the case studies that inspired the genesis of our firm. I'd love to chat if this resonates with you: lharris@belstone.com.
Having worked for a Big Four firm in an exceedingly junior role, it's quite clear how this happened, and how it could happen anywhere. These big firms attach their names to work done by very junior people. The companies have a lot of experience at what they do, so their processes tend to be okay at producing an acceptable end result, but so much of their work is done by utterly clueless junior folks, that it's amazing things don't go sideways more often. Then again, an accounting opinion is just that -- an opinion. In the end, the liability tends to be very limited.
To use a legal word I don't fully understand, it seems Goldman was completely negligent here, but not necessarily in a criminal way -- if that's possible. They had a client that needed a lot of hand-holding, but it was small potatoes to a big bank, and they utterly failed to serve their client's interests.
Of course, because they're the big fish, they've probably covered their asses pretty well in a legal sense, and won't owe a dime. It's not right, but it's probably what will happen, legally.
> These big firms attach their names to work done by very junior people.
Can confirm, work at a pretty large firm. Most stuff is drafted by junior dudes and signed off by their superiors. But I've also seen how the superiors sign, and mostly they do some basic checks and sign off. Further, companies tend to work with a four eyes principle that requires two signatures to sign off, and what tends to happen is that the second person says 'oh, I see xyz signed, so it must be okay' and signs it off without really checking. In fact we have folders of docs drafted by juniors that an assistant walks around with to collect the relevant signatures, which are stamped, not written.
Essentially everyone is overworked and manage way too many clients and the budget is being squeezed. And there's a bit of a race to the bottom, the sales people have clients telling them 'this office can do it for $270k per year, you're offering us $350k'. And the sales people say 'alright we'll match it', which means they're going to have to generate cost-cutting measures of $80k on that client that year, which mostly involves shifting the work to interims, interns and juniors who get $15-20 an hour and invoice $150 to the client.
"Our client agreements state that for any flights exceeding 5 hours, you may fly business class." (except what they don't tell you is you NEVER fly business class, because some engagement manager is trying to impress their senior and the client by billing as little as possible).
"NEVER eat hours, because it's critical that we are able to estimate the time for each engagement in the future. If we need to find cost savings, the engagement manager will make that determination and simply bill less if necessary." (Except everyone, from the most junior plebe, all the way up to engagement manager and beyond, are all trying to impress the person above them so hours get eaten at each and every level)
Yes in the sense that all employees except the management hate the current regime because they're having their budgets and teams cut and workloads increase, so me and my peers would fully agree with you. Less cost cutting, less profit, but a more sensible workload.
No in the sense that the prices to the customer aren't coming down to cost-price. The reason for this is that we deliver ridiculous value (i.e., with $250k of annual legal work, which is puny, you can generate millions in cost savings). You'd think then, that competing business would quickly arise and drive prices down, but the industry is so cyclical (and doomed to die as lots of things get automated etc), that it's not a great industry for new entrants to compete with the incumbents (which have consolidated with lots of mergers the past 20 years become quite massive firms with strong brand names that drive tons of inbound leads, besides if you're a small new entrant you tend to get bought out anyway)
Hell these firms are all in private hands and have been for a long time, the shareholders appoint a board to squeeze as much profit... which is why I concur with the OP, a lot of the business is driven by cheap juniors under the guise of a strong brand name, where senior staff spend the majority of their time on sales rather than actual work, and are called 'vice presidents' for that reason.
On the other hand, it's not all that crazy. The funny thing is, all the juniors are 100x more educated than the seniors. You've got 23 year olds with a double master's in econometrics and tax law, while you'll find some senior VPs who got into the business in the 70s or 80s who may or may not have a bachelor's in something. Sure the seniors have the experience and the kids are often clueless when they just start out, but they're also usually sharp, hard-working, well-read (in subject material), have quantitative skills and broad competencies. So it's not all that crazy.
Thanks for the reply. It's not all that crazy and I'm glad you elaborated on why new entrants don't come into the market and suck up that profit/inefficiency.
I don't see how that's risky, and might even be beneficial to the Banker. Assuming an acquiring company is $1.5B and Dragon was getting $400m in stocks, it would have been impossible to offload it immediately at a good price.
OTOH, offloading the Banker's 0.3% is far more easier. In fact, if the overall value of the transaction is higher because it is an all stock deal, the Banker gets a better deal (after immediately selling) than if it were all cash.
getting paid only for a successful transaction aligns interests ... if the relationship is transactional and the role of the banker is to get the deal done.
Wouldn't have helped in the Dragon case which was presumably also done that way, the interest of the banker is in making sure a transaction gets completed even if it doesn't align with the client.
It's a terrible outcome, but the dot-com bubble was on fire and Dragon founders apparently wanted to cash out. You would really think they would understand their competitors better. I wonder if they were that naïve or they kind of outsmarted themselves, they knew the valuation was too good to be true and took the risk of being able to unload the stock on greater fools.
To be clear, getting a deal done is the primary reason a company would hire an investment bank.
An investment banker who is effective and has integrity would first determine what a client's expectations are (particularly around valuation and transaction size), and a discussion would ensue about how that aligns with the banker's expectations of the market's appetite for such a deal. If the client is comfortable with the guidance that the banker has provided, the banker then fields offers from investors/acquirers to find the best deal available to them in the market.
If the bids come back at or above expectations that the banker and client have discussed, great, they do the deal. If bids come in below expectations, another discussion ensues on whether the client is willing to accept a lower bid or not.
Bankers' incentives are clearly to get a deal done, but at the end of the day, the go / no-go call is made by the client. And as I've mentioned, the reason a client hires a bank in the first place is to get a deal done, assuming terms are reasonable. It's not like a bank has the power to force a deal down a client's throat.
Also, another dynamic is that banks like Goldman generally charge upfront retainers in addition to success-based fees. Doing that throws a wrench into alignment in the first step, where the reasonableness of exploring a transaction in the first place should be discussed.
if you look for sage advice from people working on commission, beyond getting the thing done that they're getting a commission for, you're gonna have a bad time.
I don't think Goldman did anything illegal, but they certainly did a terrible job serving their client. In my view, investment bankers have an obligation to offer whatever financial and strategic advice the particular client needs, which is a function of that client's sophistication. Some clients are highly sophisticated, don't need any advice, and just want you to find them a buyer at a good price. Others can, for example, simply be good technologists but otherwise not be particularly business or finance savvy, and so will need additional guidance along the way.
To look at this particular case, moving from a 50/50 cash/stock deal to an all-stock deal without an increase in total consideration, or without the client REALLY loving the stock of the acquiring company, makes no sense. Guaranteed money upfront is always preferable (unless there are unusual tax circumstances, which I don't see being the case here). This should have been a major point of discussion and negotiation. And if an all-stock deal was decided upon, the client should've been advised with no ambiguity that there are substantial risks involved in such a deal.
In any case though, even for the 50/50 deal, substantial due diligence on the acquirer should have been recommended. Spending $50k to verify the quality of $290mm+ in sale proceeds is a no-brainer. This legitimately falls outside of the realm of responsibility of the banker to conduct this due diligence though, and should've been performed by a third party with guidance and oversight by the bankers. The bank here is conflicted anyway - their incentives would clearly be to give the "all clear" sign. Falsified revenue is extremely easy to catch - just follow the cash.
I guess the lessons here are don't work with service providers who don't value you, and always keep in mind that ultimately, as the client, you're the one that has to live with the decisions that get made.
I'd be remiss if I didn't mention that there are better sources of financial advice. At my firm, we take pride in deeply aligning ourselves with our clients by only charging fees upon successful completion of a transaction, and by being compensated in the same form that our clients are (e.g. had we advised Dragon, we would've been compensated in L&H stock, and would've therefore been highly incentivized to strongly recommend due diligence!). The Dragon/L&H deal is actually one of the case studies that inspired the genesis of our firm. I'd love to chat if this resonates with you: lharris@belstone.com.