Negotiating Investment Banker Engagement Letters

Engagement letter investment Banking

Banking Investment / June 17, 2020

It sets the stage for sellside processes, acquisitions, mergers, debt financings, and equity financings. It has an overwhelming effect on the quality and depth of the investment banker’s duties to the client. It outlines the terms and scope of the advisory services provided. It rigorously details the economic points that go to the heart of the relationship.

When negotiated and structured properly, this contract can be remarkably powerful in aligning the investment banker’s interests with yours. High degrees of alignment will productively incentivize the banker to close a deal for you, with the optimal valuation and terms.

However, to successfully negotiate this agreement, it’s imperative that executives understand the perspective of the investment banker and the specific motives that will encourage a top notch transaction outcome.

Here are the seven most decisive points to cover in your agreement.

1. Fee Structure

Investment bankers will typically divide your advisory charges into two functionally divergent groups: a (1) non-refundable deposit or retainer, and a (2) success fee.

The retainer is usually a flat fee. While it’s sometimes paid out at the beginning of the engagement, it’s usually paid on a regular basis over the length of the mandate. The most common schedule is payout on a monthly basis.

While it’s not directly linked to the completion of your transaction, paying a mutually agreed upon retainer is pretty standard and it demonstrates your level of commitment to the sale process. Similarly, the investment banker should be putting a significant amount of work into preparing your company for sale and should correspondingly be compensated for his efforts as the work is completed.

However, the success fee — and not the retainer — should always be the most significant component of the total compensation. This gives both parties the best motives for an optimal outcome.

The success fee is usually paid out at deal close. It’s based primarily on three things: (a) deal type (e.g., buyside acquisition, sellside process, financing, etc.), (b) the type of ownership sold (e.g., equity, senior debt, mezzanine debt, etc.) and (c) transaction value. It’s often expressed as a percentage of the total transaction value and can also include a progressive pricing schedule. In other words, above a certain agreed-upon price threshold, the success fee percentage calculated off the transaction value will rise incrementally with price.

A progressive schedule is an effective way to design a strong incentive for the banker to help you realize a valuation that exceeds your goals.

2. Exclusivity

Giving exclusivity to an investment banker can be a daunting proposition.

Naturally when you mandate an advisor and his or her team fails to meet expectations, it’s a tremendous setback with respect to time and financial resources. Moreover, reaching your goal of a closed deal has been likewise delayed. And finally, when or if you go back to market — presumably with a different banker — the fact you were already out in the market and could not get a deal done could negatively impact investors’ views of your company.