In this post, we will provide you with a simple overview of the standard M&A advisory fees that investment banks commonly look to put in place for sell-side transactions (i.e. when selling a business) and highlight some of the key aspects that are open to negotiation.

When it comes to selling your business, appointing an experienced investment banker can help you achieve a far higher sale price than you might otherwise be able to secure on your own.

Investment bankers are experts in helping companies identify and market themselves to the most likely purchasers and are also highly skilled in strategically driving negotiations to achieve the highest possible sale price.

(For an overview of CFSG’s approach and track record with regards to business sale transactions, please click here).

Before looking at the specific M&A advisory fees that investment banks typically charge clients, it is worth understanding the two key objectives investment banks have for M&A fees:

• First, running a business sale process is time consuming. There is a lot of preliminary work that an investment bank needs to undertake to understand the business in question and to prepare the necessary promotional and support material to run the sale process. In addition, reaching out to prospective acquirers, conducting negotiations and assisting with due diligence and closing are also labour intensive. Therefore, the first motivation of an investment bank’s M&A advisory fees is to compensate the team for their significant time investment in running the process.
• The second objective of an investment bank’s M&A advisory fee structure in M&A transactions is to align the interests of the bankers with those of the owners. At its most basic level, this means providing the investment bank with a clear economic incentive to maximise the sale price that the owners achieve. The thinking is that by providing those incentives, investment bankers will “go the extra mile” for the owners because they too have something to gain by doing so.

M&A Advisory Fees – Upfront Fee

Most investment banks will look to put in place an upfront fee (sometimes also called an establishment fee, a retainer fee or an advisory fee) at the commencement of an engagement. This M&A advisory fee, as explained above, is intended to compensate the investment bank for the level of work that necessarily goes into running a business sale process, which will typically run for many months and demand a high level of commitment from the investment bank’s internal resources.

In addition to paying the investment bank for its time, a retainer fee is also a powerful signal that the seller is serious about doing a deal. By being prepared to pay a reasonable amount of money upfront, it proves to the investment bank that the seller is committed to the process and will not flippantly walk away part-way through after the investment bank has invested significant time and effort trying to achieve a result.

While the exact structure of any upfront fee will vary from engagement to engagements and will always be subject to negotiation between the parties, they will typically involve the payment of a monthly fee payable over an agreed number of months. The number of months is usually capped (normally for between six and 12 months) so that the business owner will not find themselves paying upfront fees indefinitely if a transaction takes longer to complete than expected.

The exact quantum of upfront fees will vary according to several factors. The perceived level of a transaction’s complexity and the expected level of difficulty in completing a deal will influence how an investment bank will price its upfront fees. In addition, some investment banks are simply more expensive than others due to their larger size and cost base. Another determinant of upfront fees will be the level of competition between investment banks pursuing the relevant mandate. Having said all that, for most mid-market transactions, an upfront fee of between $50,000 and $250,000 would not be unexpected.

Occasionally, the upfront fee may be rebated against a success fee (described below) when and if such a fee is ultimately paid. It is also possible that an upfront fee may be negotiated to be paid in full on commencement for a discount.

What is always important is that a fair balance is struck between the upfront fee and any contingent fees that are to be paid. The investment bank deserves to be compensated for its time in working on a deal via the upfront fee. However, the proportion of the upfront fee when compared to the total level of fees potentially payable should remain sufficiently modest to keep the bankers motivated to drive hard to achieve a positive outcome for the company.

M&A Advisory Fees – Success Fees

A success fee, as the name implies, is a M&A advisory fee that is only payable on the successful completion of a transaction. In a well-structured agreement between the investment bank and the selling company, the success fee should be a sufficiently large component of the total fees payable under the agreement that it motivates the investment bank to work hard towards achieving a transaction rather than merely satisfying itself with receipt of the upfront fee.

Success fees are most commonly calculated on transaction enterprise value rather than, say the company’s transaction equity value. It is generally accepted that bankers should be rewarded for selling the company as a whole rather than on the final proceeds that flow to the owners. As an extreme example, if a company is valued at $100m, but due to a high debt load its equity value is only $5m, the bankers would typically look to have their success fee calculated on the $100m.

(For a detailed overview of the difference between enterprise value and equity value, please click here).

There are several different approaches for calculating a success fee and they each have their respective strengths and weaknesses. Further, the specific terms of any success fee may include aspects from more than one general approach.

Fixed Fee

Probably the simplest way to calculate a success fee is through a simple fixed fee arrangement. With a fixed fee, the investment bank agrees to receive a fixed fee, say, $250,000 for successfully assisting the seller to complete a transaction. This kind of arrangement does not incorporate any form of incentive for the investment bank to achieve a higher price for the seller. However, it might be a reasonable arrangement when a seller has already identified or even entered negotiations with a buyer and simply wants a banker to help complete the process.

Fixed Fee Plus Bonus

An extension of the fixed fee approach is to stipulate an agreed fixed fee plus a bonus fixed fee payable in certain circumstances. For example, the seller might agree that it will pay the investment bank a fixed fee of $200,000 for successfully negotiating the sale of the business and will pay a bonus of a further $75,000 if and only if the bankers can secure a deal that values the company at more than, say, $25m.

Flat Percentage

Another common way for calculating a success fee is by levying a fixed percentage on the selling company’s transaction enterprise value. For example, if a company is sold for an enterprise value of $150m and the agreed flat success fee percentage is 1.0%, then the investment bank will receive a success fee of $1.5m on closing the deal.

While this approach does incentivise the investment bank to strive for a higher selling price, it is worth noting that the incentive can be quite marginal. For example, the difference in success fee between helping to secure a sale for $150m versus $155m is only $50K. It could be argued that this amount may not be sufficiently compelling for an investment bank to continue working hard to identify a seller that is prepared to pay an even higher price.

Scaled Percentage

An extension to a flat percentage is to put in place an ascending or descending (or reverse) percentage scale where an array of percentages is applied to successive portions of the final transaction value. A well-known scaled percentage is the Lehman formula.

A hypothetical example of both an ascending and descending scaled percentage arrangement is shown below:

The main benefit of this broad approach is that it strongly incentivises the investment bank to achieve the highest possible sale price by identifying the widest range of prospective buyers and negotiating the best possible deal.

It could be argued that an ascending scale provides the greatest incentive for the investment bank to secure the highest possible price. This is because the marginal increase in success fee for every extra dollar of sale price is higher. However, a seller needs to be careful that the thresholds for each step-up in the percentages is well calibrated to sufficiently motivate the investment bank to work hard to achieve the highest possible price whilst keeping the final success fee that is paid fair.

Other M&A Advisory Fee Considerations

The M&A advisory fees payable by a seller will always be carefully stated in a letter of engagement of a similar document.

In addition to the standard clauses relating to the upfront and success fees, there are other issues that a letter of engagement should consider:

• Earn-out arrangement. It is not uncommon for a sale agreement to contain an earn-out arrangement in which the full value of the transaction is not known on day one because it is contingent on the future performance of the company. Indeed, there may be multiple payments provided for based on an earn-out. As a result, there should be a provision in any letter of engagement that addresses how the success fee will allow for an earn out. (For a detailed overview of earn-outs, please click here).
• Non-acquisition transactions. It is possible that in the course of negotiating a sale, the parties decide to pursue some other form of transaction or arrangement such as a strategic alliance, partnership, joint venture and so on. As a result, there should also be a provision in any letter of engagement that addresses how the company and its adviser will treat the success fee in such circumstances.

Fee arrangements are a critical consideration in any decision to appoint an investment bank as a business sale advisor. CFSG prides itself on maintaining the most reasonable and responsible fee structures in the investment banking industry. If you would like to discuss how CFSG can help you prefer for and successfully complete the sale of your business, please contact us.