Selecting an investmentbanker is a lot of work. Below are thethings you need to watch for in the engagement letter with an investmentbanker.
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 letterto the day you get a check from a buyer, so a 1 year term is reasonable.
Cancellation& Tail. The engagement should becancelable by either party at any time for any reason, thereby cutting the Termshort. Once you cancel, it’s normal to have a “Tail” which means if someone thebanker contacted buys you within 6 to 12 months of cancellation, you owe thebanker their fee. Whether during the Term or Tail, the banker should only bepaid if the buyer is someone they introduced you to or if they represented youdirectly during the process with a buyer. That distinction is important and often overlooked. 9 months is a normal tail.
Retainer. Almostall reputable bankers won’t start work unless they’re paid a retainer upfront. We see retainers ranging from$25k to $85k. Some of them were paid upfront, while larger retainers were paid over installments during the term. The thing to remember about the retainer isthat it should be proportional to the bank. In other words, if the investment bank is a one or two man shop, it’snot appropriate for them to ask for a retainer that’s so large they can liveoff 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 toget 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 faithenough 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 forselling your business. Market is a flatfee of 2% to 6% depending on the the outcome. Sometimes bankers want a floor. Mosttimes the fee is laddered whereby a better outcome results in a better fee.
Warrants. Abanker may ask for warrants. This isbullshit. Strike any ask for equity ofany kind.
ProspectiveAcquirers. A banker should be paid only if they interactwith an acquirer, and only if that acquirer purchases the company during theengagement or during the Tail. If therewas no contact between the banker and acquirer, then no payment. Note that even if you are the one thatintroduced the banker and the acquirer, it is normal for the banker to get paidbecause they negotiated on your behalf. You should introduce all of your contacts that could be potentialacquirers to the banker and should not attempt to negotiate anything on theside.
AbandonmentFee. Some banks will require that should you walk awayfrom a deal that was all cash at some minimum level, then they still get paidas if that deal was done. This isn’t anabusive term, but it’s not market either. Strike it if you see it.
ExpenseReimbursement. A banker will expect you toreimburse travel and lodging expenses, deal room expenses, etc related to yourdeal. Ask for a cap on this, or at leastrequire approval before major spend is incurred. A banker will stay at Four Seasons and eat atsteakhouses if you don’t cap the expense or require approval, so have amechanism in place to keep expenses in check.
Picking a banker ishard. Don’t be shy about asking to speakto former CEO’s they’ve worked with. Youshould also reach out cold to founders they’ve worked for before, withouttelling the banker. Make sure theyprovide a list of relevant transactions they’ve done in your space, review pastmaterials created for other companies, and be sure they can articulate theintricacies of your space, who the big players are, and who the buyersare. Do make sure they have a reasonablenumber of warm contacts at the prospective buyers. To the extent you can, go with a banker thathas 10+ partners and a laundry list of completed transactions in your space. In my view, a good banker should reach out toat least 50 prospects and up to 120. Finally,if their pitch materials don’t look pristine and their pitch to you isn’timpressive, walk away.
If you wantreferrals to great bankers we like, just email me.