We’re currently hiring an investment banker to represent one of our companies in a sale. It’s exciting, but just selecting a 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 about 6 to 8 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 introduced you to buys you within 1 year 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.
Retainer. Almost all reputable bankers won’t start work unless they’re paid a retainer up front. We saw 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.
Fees. The investment banker makes their livelihood of the transaction fee for selling your business. We generally saw this at 5%+. One bank wanted 4% + $120k. Another bank wanted 5% for the first $10mm of any sale price and 8% for each dollar above $10mm. A third bank wanted 8%. A 4th bank wanted 7% for the first $5mm, 6% for the next $5mm, 5% for the next $5mm, etc. The most reasonable fee in our view was the 5% for the first $10mm of any sale price and 8% for each dollar above $10mm. It incentivizes the banker to push and is a reasonable pay day. You can negotiate on fees, but a good banker will push back hard on you, as the transaction fee is the reason he’s in business.
Warrants. A banker may ask for warrants. This is bullshit. Strike any ask for equity of any kind.
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 any spend is incurred. A banker will stay at the Regis 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, asking for a list of relevant transactions they’ve done in your space, 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. Good luck!
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