Investment bankers that broker the sale of your company have a fairly standard schedule for retainers and success fees. But there are idiosyncrasies and potential pitfalls to watch for. So, let’s take a close look.
The Retainer: Most investment bankers charge a retainer to prepare your company for sale, often around $50,000. The retainer pays for ongoing expenses to prepare the “deal book” a.k.a. informational memorandum or “IM”, that is used to shop the deal to acquirers. But the retainer should be paid out monthly (e.g. $10,000/month), not all upfront. In many cases (as is true with our firm, 1st West M&A), the retainer is entirely refunded to the seller in the event of a successful transaction. If the success fee turns out to be $250,000, the first $50,000 is refunded to you when the deal closes.
Beware an investment bank that asks for the entire retainer in advance. After paying it all out, you might find it hard to get the investment banker’s attention in three or four months, especially for relatively small deals, e.g. under $10 million. The retainer pays the investment banker for the substantial hours his staff puts into creating the IM, as well as subscription fees to the expensive databases that are used to develop target lists and obtain the very latest deal values for similar companies that have been recently sold.
Investment bankers will insist on a retainer not only to defray preparation costs, but to make sure sellers have “skin in the game.” That way, a seller won’t just cavalierly commission an IM (often 40+ pages of company background, with complete financial analysis) only to take the IM and walk away, or represent the company themselves using the investment banker’s work.
The Success Fee: In addition to the retainer, most investment bankers charge a success fee based on the percentage of the deal value. A 5% fee is typical.
Some sellers will also ask for a cap on the cash value of the fee, which might make the fee worth less than 5% of the overall deal value. The cap amount depends on the total paid for the company, and it’s more likely for an investment banker to agree to a cap if the deal size is substantially over $10 million in value, where a cap on the success fee of $500,000 or $600,000 might be viewed as reasonable. But note that the success fee can also be staged, paying 5% of the first $10 million, and then a smaller percentage for between $10 and $20 million, etc. It’s all negotiable. If the proceeds of a sale are paid out over time (an earn-out), the success fee should be paid as the seller is paid over time.
Beware the investment banker who asks for a guaranteed success fee, no matter the deal size. A guaranteed success fee is often requested for smaller deals, with transaction values under, say, $5 million. If an investment banker seeks a guaranteed $400,000 fee on a deal worth, say, $4 million, he’s really asking for a 10% success fee, twice what he would normally receive. A customer-focused investment banker will typically not ask for a guaranteed fee and is happy to share the risk of the sale with his client.
Is the Success Fee Worth It?
In most deals (and this has invariably been the case with 1st West), the investment banker earns back more than his success fee just with credits to EBITDA that the clients would have otherwise missed. In other words, in the investment banker’s financial analysis, he finds non-recurring charges, inventory credits, working capital credits, or charges that can be credited under new ownership which, when multiplied by today’s valuation multiples (between 5X and 7X), more than earn back what the seller pays in success fees. In that case, the seller is effectively accessing the full range of the investment banker’s services at low-cost/ no-cost, including the informational memorandum, financial analysis, deal valuation, management of the auction/ letter-of-intent processes, as well assistance in drafting the definitive purchase agreement, representations and warranties, asset declaration, and closing processes, to say nothing of help through due diligence.
Although many companies balk at the 5% fee, make no mistake: Investment bankers offer a service that avoids common seller errors, maximizes the sale value of your company, avoids pitfalls, and perhaps most importantly, allows a seller to run his business without distraction (and without the substantial demands on his time) from the complicated acquisition process.