Investment banking services

What to negotiate on your investment banking advisory engagement letter

If you have a profitable, but slow growing business, which complements another larger existing company in a relatively small market, you will have the opportunity to shop your company for sale.

Many founders who have organically (customer funded) or via outside investments (VC / Angel funded) grown their company, get the 7 year and 10 year itch to sell their company.

Whether you have decided to sell your company or just wanting to shop it to see the potential value, you will likely run into investment bankers who will offer their advisory services to help position, pitch and sell your company,

An investment banking firm is typically a partnership, (similar to a legal or accounting firm) with the founders having the capability to leverage their connections and expertise of certain markets, to create “synergies” for new companies.

Investment banking services
Investment banking services

When an investment bank is hired by a company that wants to acquire other companies, they represent the “buy side” and if they are helping you sell your company to acquirers, they are known as representing the “sell side”.

If you engage with an investment bank to help shop your company to acquirers you are giving them a “mandate“. Most, (likely all) investment banks will expect an exclusive mandate, meaning, you cannot have anyone else shopping your company to potential acquirers. Even if you do have others and they end up selling the company, your investment bank will likely get a portion of the sale.

I was going to focus this post purely on sell side services of investment banks. The agreement letter or advisory letter or “letter of agreement” is a contract between the investment bank and your company.

Most entrepreneurs get hung up over just the commission or the “rake” the investment bankers take for the transaction – that’s only one part of the agreement – similar to your valution. Most bankers typically charge between 2% (highly unlikely, but possible if you are a hot company, with a high probability of sale at a large price) to 7% (smaller transaction, < $5 Million).

The analogy I hear from a lot of entrepreneurs is similar to a “HR consultant” or a recruiter, who works on a non-exclusive basis to fill a position. I do get questions as to why investment consultants demand exclusive rights. To which, I’d say that even the best HR consultants and those that work on executive positions work on a exclusive mandate.

There are 3 things that investment bankers like to call their “service value proposition” – their knowledge of the industry to help you navigate the buying landscape, their connections to potential buyers and their expertise in helping you structure and negotiate your final sale agreement.

Thee are 5 items you want to pay attention to in your advisory agreement:

  1. Term of the agreement – Since most M&A transactions take 3-6 months, these agreements will last at least for that duration. Most agreements also specify that if your company gets sold for 6-12 months after the start of the engagement, the investment bank will likely get a portion of the sale, even if they did not make the introduction or help negotiate the final sale. While many will claim it is standard to have a 12 month clause, there is no “standard” – it is all negotiable.
  2. The engagement fee or retainer: To help prepare your documents, pitch deck and start to position your company, the company will ask for a retainer fee between 10% and 20% of the expected final sale price (or about $25K to $100K) – whichever is lower. This fee is purely for them putting the time and energy to get your documents together and is independent of whether they final sale happens. If your company is “hot” many will waive this fee. If you are looking to sell, expect to pay this amount – 50% before they start and 50% after 3 months of the final completion of the agreement whichever is earlier.
  3. List of preferred buyers or list of buyers already in agreement. In your agreement sometimes, you will have a list of companies you might suggest to the banker to not approach since you have already been taking to them or the opposite – you have a term sheet from one buyer which you are not 100% happy with, so you want to shop for more deals. In this case you might specifically ask for a certain company to be on this list to be shopped to.
  4. Other considerations. If the buyer directly does not approach you, then in a lot of cases, you will find them to want some protection clauses, such as 3 year commitment for the founders to stay at the company etc. To ensure this happens, they will have an “earn out” amount associated with the sale. That is usually counted as part of the acquisition price, but is paid over time. An investment banker, typically will not have the patience to wait for that period of time or control over the longer term outcome, so they will want their “fee” to be paid in full for the net amount. That’ s something you can negotiate as well.

There are a few other negotiable clauses, but these are the main ones. At the end of the day, I would say that like most agreements, it depends on who needs who more. If you are eager to sell, expect to give in on certain parts of the agreement. If your banker, however needs you more, they will be willing to give you more leverage.

Finally in certain cases entrepreneurs use bankers to help raise their series B investment round, so most of these clauses hold good for that type of agreement as well.

2 thoughts on “What to negotiate on your investment banking advisory engagement letter”

Comments are closed.