Are you thinking of hiring an investment banker to help you sell your company?
If so, remember that investment bankers are pros at doing deals and you will need to be prepared for the negotiation of their engagement letters. Sharpen your pencil and pay close attention to the following seven critical tips, so that you start the banker relationship on solid footing:
1. Know Who You’re Getting Into Bed With
We have seen first-hand the value that a high-quality investment banker can bring to a transaction. Simply put, a good investment banker can help a seller identify prospective buyers and negotiate the best (i.e., highest) purchase price and shift other deal terms to the seller’s advantage. In these cases, the investment banker has delivered real value and should be compensated accordingly.
But hindsight is 20/20 and you won’t know the fate of your transaction when you sign the investment banker’s engagement letter. What if the investment banker doesn’t play a meaningful role in helping you, the seller, secure the best deal possible? Should they still be compensated, even after the relationship has ended? We realize that the sale of your company is likely to be among the biggest business deals of your life. For that reason alone, we encourage sellers to avoid rushing into a relationship with an investment banker, and to really understand the terms of the engagement before signing on the dotted line. Good investment bankers know how to do deals, especially their deals.
2. Understand What You’re Signing
We may never understand why some companies hesitate to negotiate with prospective investment bankers. Perhaps it is the excitement and urgency of the company sale, or the misperception that investment bankers are unwilling to deviate from their standard “form” agreement. Similarly, we sometimes see companies negotiate engagement letters without involving their counsel. We have a different perspective, which is rooted in experience: many companies often did not appreciate what was at stake in the engagement letter and learned the hard way when it came time to pay the investment banker’s tab. Somehow, too many companies fail to appreciate that, before the engagement agreement is signed, they as the sellers often have significant leverage in the budding investment banker relationship. The reason is obvious – the investment banker wants your business and wants to make money. If the investment banker makes you feel otherwise, then remember that the investment banker negotiates for a living.
Don’t make the mistake of signing an engagement agreement that you don’t fully understand. In all likelihood, the investment banker will prepare the first draft of the engagement letter based on its form. Expect the first draft from the investment banker to lean (perhaps heavily) in favor of the investment banker and yes their standard form can (and should) be discussed and negotiated.
3. Establish Expectations
Before you engage an investment banker, it is important to scope out your objectives and where you are in the deal process, which should help you drill down on what you need from your investment banker. For example:
- Are you hiring the investment banker to solicit prospective investors or acquirers? Have you confirmed whether your investment banker has applicable industry experience and contacts?
- Will the investment bank be involved in due diligence and/or establishing a virtual data room? Are there any diligence issues that should be socialized with interested parties early in the process?
- What written materials will need to be prepared for this process? If so, who is preparing what and by when?
- Will the investment bank be responsible for negotiating key terms on your behalf, including valuation?
- Have you confirmed that your investment banker is licensed?
Do you have relationships with any prospective investors or buyers? If so, will and to what extent will the investment banker be compensated with respect these parties in comparison to new parties that are introduced solely by the banker during the engagement?
4. Align the Economics
What objective are you trying to achieve? Take the time to identify your key financial objectives, so that you can establish an arrangement that maximizes your likelihood of success. As an example, your arrangement could contain a fee schedule that pays different rates if different valuations are achieved. Also, watch out for double dipping – if the engagement agreement provides that the investment banker will receive upfront fees or retainers, then make sure that such upfront fees and retainers apply towards the seller’s payment of the investment banker’s transaction fee if a transaction is consummated.
5. Align the Payments
It is very common for M&A transactions to include various types of contingent payments, e.g., milestone closings, escrow or holdback funds and earn-out payments. Keep this in mind when negotiating payment terms with your investment banker and watch out for broad definitions of “transaction value,” which could include amounts that may never be paid or that should not factor into the investment banker’s fee. We believe that companies are reasonable in insisting that the investment banker’s fees for deferred or contingent payments should be calculated and paid based on and when and if such payments are actually made to the sellers.
6. Watch Your Tail
All engagement letters have a “tail” provision, which enables the investment banker to be compensated for specified transactions even after the engagement has terminated. In theory, the concept of a “tail” makes sense – if the engagement is easily terminated, then it could terminate during the course of a deal that otherwise would result in fee compensation for the investment banker. In practice, these provisions often go much further by extending the “tail” period beyond six to twelve months and covering transactions that the investment banker did nothing to generate. So be careful – don’t agree to a tail provision without a clear understanding of what it covers and for how long.
7. Terminating the Engagement
Pay close attention to the termination provisions, which should terminate the engagement automatically or upon prior written notice after an initial term. The initial term should not be longer than your expected timeframe for the transaction (e.g., if you are planning on a deal to occur within six months, ask for a six-month term), and you should be able to terminate the engagement at any time if there is a tail provision. Termination of the engagement triggers the beginning of the clock on the tail, so it is in your best interests to terminate the engagement early on if your investment banker is not performing as expected.
These issues are not the only issues that we would expect to negotiate in an engagement letter with an investment banker, and there is no substitute for reading the agreement and understanding its terms. Expect that your advisor is paying careful attention to how much, when and in what circumstances it is to be compensated for its services. As a seller, your job is to educate yourself on the key negotiation points that are in play with your investment banker, and to ensure that your agreement matches your expectations.
Have you dealt with an investment bank in the past? Tell us your experiences.