Negotiating the investment banker engagement letter
Selecting an investment banker is a lot of work. Below are the things you need to watch for in the engagement letter with an investment banker.
Term. The term of the engagement is generally set at 1 year. Anything beyond that is non-market. Note that to run a responsible sales process, it will likely take 6 to 9 months from the day you sign the engagement letter to the day you get a check from a buyer, so a 1 year term is reasonable.
Cancellation & Tail. The engagement should be cancelable by either party at any time for any reason, thereby cutting the Term short. Once you cancel, it’s normal to have a “Tail” which means if someone the banker contacted buys you within 6 to 12 months of cancellation, you owe the banker their fee. Whether during the Term or Tail, the banker should only be paid if the buyer is someone they introduced you to or if they represented you directly during the process with a buyer. That distinction is important and often overlooked. 9 months is a normal tail.
Retainer. Almost all reputable bankers won’t start work unless they’re paid a retainer up front. We see retainers ranging from $25k to $85k. Some of them were paid up front, while larger retainers were paid over installments during the term. The thing to remember about the retainer is that it should be proportional to the bank. In other words, if the investment bank is a one or two man shop, it’s not appropriate for them to ask for a retainer that’s so large they can live off just collecting retainers all year — retainers shouldn’t cover overhead, they’re meant as a good faith deposit. Likewise, if you’re a company that is low on cash or needs the cash to get to profitability, you can make a very good argument for a low retainer, because a material retainer for you could be $15k or $25k, which is good faith enough relative to your cash position. $50k is a normal retainer for most mid-market software transactions.
Fees. The investment banker makes their livelihood of the transaction fee for selling your business. Market is a flat fee of 2% to 6% depending on the the outcome. Sometimes bankers want a floor. Most times the fee is laddered whereby a better outcome results in a better fee.
Warrants. A banker may ask for warrants. This is bullshit. Strike any ask for equity of any kind.
Prospective Acquirers. A banker should be paid only if they interact with an acquirer, and only if that acquirer purchases the company during the engagement or during the Tail. If there was no contact between the banker and acquirer, then no payment. Note that even if you are the one that introduced the banker and the acquirer, it is normal for the banker to get paid because they negotiated on your behalf. You should introduce all of your contacts that could be potential acquirers to the banker and should not attempt to negotiate anything on the side.
Abandonment Fee. Some banks will require that should you walk away from a deal that was all cash at some minimum level, then they still get paid as if that deal was done. This isn’t an abusive term, but it’s not market either. Strike it if you see it.
Expense Reimbursement. A banker will expect you to reimburse travel and lodging expenses, deal room expenses, etc related to your deal. Ask for a cap on this, or at least require approval before major spend is incurred. A banker will stay at Four Seasons and eat at steakhouses if you don’t cap the expense or require approval, so have a mechanism in place to keep expenses in check.
Picking a banker is hard. Don’t be shy about asking to speak to former CEO’s they’ve worked with. You should also reach out cold to founders they’ve worked for before, without telling the banker. Make sure they provide a list of relevant transactions they’ve done in your space, review past materials created for other companies, and be sure they can articulate the intricacies of your space, who the big players are, and who the buyers are. Do make sure they have a reasonable number of warm contacts at the prospective buyers. To the extent you can, go with a banker that has 10+ partners and a laundry list of completed transactions in your space. In my view, a good banker should reach out to at least 50 prospects and up to 120. Finally, if their pitch materials don’t look pristine and their pitch to you isn’t impressive, walk away.
If you want referrals to great bankers we like, just email me.
