Merchant banking, the perfect canonical business 

​

April 2024

​

  MY idea of the perfect business is getting paid a tremendous amount of money for your words. Just your advice. The old-school merchant banks and M&A boutiques like Lazard and Allen & Co. are pretty close to the perfect business. Someone has decided that your wisdom is so worthy that they are going to give you millions (sometimes hundreds of millions) of dollars for it. They require no capital, they are hugely cash flow accretive, and you can generally build equity by investing in the deals that you are advising on.

 

   At one time, many of the dominant financial institutions in the world were merchant banks. Think Rothschild, M.M. Warburg, J.P. Morgan, and Lazard. A merchant bank’s services can run the gamut from big-picture strategy of the sort offered by a McKinsey or Bain & Company, to organizational psychology to the kind of intimate, delicate counsel usually tendered only by the closest consigliere.

​

    The great merchant bankers advised kings and railroad barons, bankrolled the Dutch East India Company and the California gold rush, and underwrote the bonds for North Sea oil drilling. Of that group mentioned above, just Rothschild and Lazard operate in anything approaching their old form. And neither is likely to touch a client with less than half a billion dollars a year in annual revenue. The conventional attitude has been, “Why focus on it? The deals are too small. We can’t make enough money.” This is just structurally incorrect. There’s tens of thousands (if not more) of these wonderful niche businesses across the country. They aren’t sexy. To the average citizen, they are incredibly boring, but they are the lifeblood of the American economy and will be continue to be a fertile hunting ground for M&A activity.

​

   I’ve been lucky enough to work with dozens of these niche, cash-flow gushing businesses since starting my career just a few years ago. The vast majority of them were started by some scrappy guy with some random skill or passion that had just come home from the war and decided to strike out on his own. These businesses have now reached maturity and often there is nobody within the immediate family that is willing (or qualified) to take the helm. This will ultimately result in the largest wealth transfer in the history of the United States as these businesses trade hands over the coming decades.

 

   There’s this idea I came across recently that theorizes that world-class organizations have either selection or treatment effects. An example of selection effects would be Harvard or a modeling agency like IMG or Ford, where most of the prestige comes from picking the people, whereas the Navy Seals is more of a treatment effect – you become a different person by going through its program. I think the best merchant banking firms in the next few decades will do both. By virtue of being hired by the company, it will help you for your entire career from a reputational standpoint and it also gives you something tangible in the form of enhanced skills. I really admire certain organizations where you can just tell someone has been at one of the elite consulting shops or been at a really good bank by just the way they think or do something as simple as write a good email. There’s a certain polish. It’s often the same with people that served in the military.

 

   I think there will be a smaller-scale renaissance to the merchant banking days of old as a few world-class boutique advisers emerge to cater specifically to the tens of thousands of lower middle-market businesses that must trade hands in the coming decades. What this ultimately boils down to is leverage. Being compensated very highly for your words is pretty close to just speaking money into existence.