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Negotiating with your investment banker

We’re currently hiring an investment banker to represent one of our companies in a sale. It’s exciting, but 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 had contact with 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 see 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. Market is a flat fee of 5% to 7%. Sometimes bank want a floor, such as 4% + $120,000 in all scenarios. Another bank wanted 5% for the first $10mm of any sale price and 8% for each dollar above $10mm. The most reasonable fee in our view is the latter. It incentivizes the banker to push and is a reasonable pay day that should average out to about 7%. 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.

Prospective Acquirers. A banker should be paid only if they interact with an acquirer, and only if that acquirer purchases the company during the engagement or during the Tail. If there was no contact between the banker and acquirer, then no payment. Note that even if you are the one that introduced the banker and the acquirer, it is normal for the banker to get paid because they negotiated on your behalf.

Abandonment Fee. Some banks will require that should you walk away from a deal that was all cash at some minimum level, then they still get paid as if that deal was done. This is a normal provision (the banker needs to be paid for their work even if you get cold feet), but make sure the minimum level is all cash and adequately high. For instance, someone offering you the minimum level in some junky crypto token shouldn’t count. Often times, bankers will scratch this clause.

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, asking to review past materials created for other companies, 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. To the extent you can, go with a banker that has 10+ partners and a laundry list of completed transactions in your space.

Good luck!

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