Exit and Growth Strategies for Middle Market Businesses

Investment Banking Fees Should Reflect the Transaction Risk

By Brian Ballo | Feb 10, 2008

Business owners interested in selling their business can readily see the benefits of hiring an investment banker to identify qualified buyers. However, the issue which routinely arises in negotiations between the business owner and the investment banker is whether or not the owner will pay an initial retainer and/or monthly work fee.

Owners often maintain that they only want to pay for the result of an actual sale, and, therefore, are willing to pay success fees upon closing, but they are not willing to pay any up-front fees. However, this view assumes that the risks of not closing a transaction depend solely on the investment banker’s performance, whereas, in fact, closings also depend upon the owner’s determination that he is receiving the highest price, the best terms or the business is being sold to the “right buyer.”

As specialists in particular industries, investment bankers are able to measure the calculated risk of identifying qualified buyers, a process over which they have certain control or influence. They also know that a definite amount of work must be done to prepare the documents necessary to market the company for sale (a Descriptive Memorandum), including perhaps a valuation analysis.

However, since whether a transaction closes also depends upon the discretion of the owner to accept an offer, the investment banker wants to know that the owner is committed to the process, which is demonstrated by the owner having some “skin the game”. Bankers also want to work for client sellers who will reasonably accept offers, commonly generated in auctions and reflecting market value. Therefore, to hedge against the risk that the owner will decide not to conclude a transaction priced at market terms, bankers wisely only allocate their resources of time and effort to clients that will pay retainers and work fees.

Notably, some transactional attorneys and accountants tell owners never to pay any up-front fees to investment bankers, to avoid “getting burned.” Yet, these are often the same professionals who work for hourly fees, and who refuse to work only for contingency fees. In short, with all forms of professional services, you get the level and quality of service that you pay for.

Accordingly, owners should not expect investment bankers to assume all the risks in connection with a sale transaction closing. Rather, a sound business decision by both owner and investment banker, is to enter into a professional engagement relationship that involves an initial retainer and/or an ongoing monthly work fee that fairly compensates the investment banker for his time and effort, in addition to a success fee upon closing.

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