Questions for a Potential M&A Adviser, Part II: Work Fees and Retainers

Click here for Part I of this series, which deals with advisor commissions.

In the first part of this series, we discussed how different advisor commission or success fee rates might look on a mergers and acquisitions project.

Our main conclusion was that while there were some rough guidelines, there was no real industry standard “one size fits all” form of commissions. Most success fee structures will be subject to negotiation and customization for the individual deal. Even so, some basic background gives some starting points and guidelines for discussing commissions with a potential M&A adviser.

In Part II, we are going to discuss another element of advisor fees: upfront fees, retainers, or other “work fees.”

QUESTION: “What kind of upfront fees or retainers are paid to the advisor?”

Without proper fee structuring, your advisor’s goals may not be properly aligned with your own.

Is the advisor motivated to seek the highest possible transaction price? Are they incentivized to get the deal done as quickly as possible, even if it entails a lower transaction price? Is there an incentive to aggressively sign clients up for work agreements and then dilly-dally on actually doing what it takes to actually sell the company? These are questions to be considered when deciding what fees are reasonable and fair.

Success fees make sense. But what about upfront fees?

The M&A advisor requires upfront work fees to get the project off the ground. This covers getting a valuation of the business, site visits, consultations to develop a strong understanding of the business, preparing marketing materials (like blind executive summaries and full confidential business profiles), and research needed to find and screen potential targets.

There is a relationship between the size of the deals and the retainers required. A big investment bank might need $250,000 upfront, but they are dealing with $100M+ transactions and their commission is proportionally low (like 1%), while a business broker selling restaurants might not require a retainer at all, but their share of the completed transaction is much higher.

These fees are almost always negotiable based on the nature of the prospective deal. There are no “easy” deals, but a project with an especially high likelihood of success might involve a lower retainer — or possibly no retainer in exceptional cases.

On the other hand, a prospective deal that involves many special challenges might require higher upfront fees.

In any case, when the deal is closed, many advisors will credit some or all of the work fees paid toward the commission.

Retainer are usually paid as a lump sum, or in installments during the early life of the project.

A potential client might ask why upfront fees are required at all. If an advisor is confident in his ability to market the business, drive negotiations, and close the transaction, shouldn’t their fees be entirely success-based? Should the client seek an advisor that requires no upfront fees?

Assuming such an advisor actually exists (they don’t — everyone requires upfront fees to get a project started), an advisor offering to take on a project with no upfront fee would suggest that he is inexperienced or unreasonably optimistic.

Seller’s remorse is a real thing.

Consider this scenario: a business owner or a board of directors seeks out an M&A firm to sell their company. The advisor completes a valuation and believes the business can be sold for, say, a fair market value of $20 million or more. The owners are eager to proceed and instruct the advisor to seek a buyer at that level.

The advisor reaches out to the marketplace, conducts initial negotiations, and brings in three offers to purchase. All three offers are inline with what was modeled in the valuation.

But the process takes time, and circumstances sometimes change from initial signup to the point where offers are on the table.

However, the client decides not to proceed with the transaction. Perhaps the offers are higher than expected and the owners want to stay on for awhile longer. Perhaps the offers are less than expected and the business requires some further grooming to increase sellability. Or maybe the offers are roughly what was expected, but circumstances have changes and the owner wishes to keep the business for any reason.

What service has the adviser performed in this case? Well, aside from getting a valuation and some nice marketing materials created, he has demonstrated what the market would be willing to pay. This is very valuable to a business owner because regardless of what number comes out of a valuation, only the market decides what a company is really worth.

A Warning about Retainers

As discussed above, retainers or work fees are fair in principle. But a word of warning is appropriate here:

Closing deals is very difficult. Because of this, some advisors will compensate for a low success rate by making unrealistic promises about the transaction and having larger upfront fees.

Some advisors might promise the client an unrealistically high sale price, but they can’t actually get any offers at that value. So the business doesn’t really have a chance to be sold, but the adviser gets some big retainers regardless.

But that’s not all. In addition to false promises about value, the exclusivity aspect of work agreement means that any transaction needs to go through the adviser. If the advisor can’t get a deal closed, that could be two or three years where your business doesn’t sell! Lost time can be a lot more devastating to a potential transaction

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