One of the first steps most companies take before raising capital or seeking a strategic acquisition or sale is the engagement of an investment banking firm. We believe that the benefits of engaging the right investment banker, far outweigh the fees required to be paid for such services. The failure, however, to carefully review and tailor an investment banking engagement letter presents significant risks to the company. Set forth below are some of the key terms that should be carefully considered:
• Retainer Fees. For various reasons, most credible investment bankers charge a retainer. Ensure that the retainer is reasonable, and is paid on a monthly basis, rather than in one lump at the beginning of the engagement. In addition, the aggregate retainer should be capped, and not open-ended. Try to provide for the retainer to be deducted from any future success fees.
• Success Fees. A success fee is generally based on “transaction value”. The transaction value should be calculated net after the deduction of all transaction expenses. With respect to M&A transactions, try to limit the transaction value to the actual purchase price and not any additional value that may be attributable to collateral arrangements such as consulting agreements, guarantees, leases and employment agreements. Portions of the fees based on future payments to the seller or buyer, or future investment instalments, should be due only when and if the contingent or future payments are received. In a capital raising engagement, exclude from the calculation of the success fee, investments made by the company’s existing investors and third parties with which the company is already negotiating. In an M&A engagement, try to exclude from the success fee, a transaction with a third party with which the company is currently in discussions. Finally, avoid minimum success fees.
• Tail Periods. Investment Banking Agreements often include tail periods as long as 18-24 months following termination of the agreement, during which time the advisor is entitled to receive fees if a transaction is closed, whether or not introduced by the advisor. This is a reasonable provision to protect an investment banker whose efforts in marketing a deal may lead to a transaction that closes after the agreement has terminated. This, however, can be unfair where the investment banker does very little during the engagement, and then comes knocking on the door when an unrelated transaction closes 18 months later. Tail periods should be reasonable (i.e., 6-9 months). If a long tail period is negotiated, include a provision that decreases the amount of the fee based on the length of time after termination that closing occurs. Try to limit the tail period fee to transactions with third parties introduced directly by the banker.
• Exclusivity and Termination. Investment banking agreements often include long exclusivity periods. If the banker does not perform, the company may be contractually restricted from terminating the agreement and engaging another banker. If you are not happy with the services, you should have the right to terminate the agreement for any reason, on some reasonable period of notice such as 5 days, and not be restricted from engaging with another advisor.
• Expenses. Clearly define reimbursable expenses and require that large expenses, all third-party expenses (such as outside legal counsel) and travel expenses be approved, in writing, in advance.
• Future Rights of the Banker. Engagement letters often provide the banker with the unilateral right to be the company’s financial advisor for future IPOs, M&A assignments, or fund-raising. A company should not bind itself to the investment banker for future engagements. If the banker performs well on the particular assignment, then the company can later evaluate whether it makes sense to hire the banker for a future transaction.
The information contained in this article is strictly for educational purposes and is not intended to be legal or tax advice or to be relied upon by anyone without doing their own research, and consulting with legal and tax advisors.