As a boutique investment bank, we at CL King & Associates expand a lot of effort providing high quality advice and service to our middle-market investment bank clients. We understand the need to align our investment banking services and fees with our clients' interests, because ultimately, we act as our clients' advocate. Completing transactions is difficult; we need to be working together. The following is a brief primer related to investment banking fees.
Retainer
A credible middle market investment bank will charge a non-refundable retainer. There are two primary reasons for the retainer: (1) it covers the time and expense incurred in preparing the client to go to market and (2) it serves as a screening mechanism to ensure that the client is committed to the transaction. This retainer may be paid as a lump sum, over time or based on achievement of certain activities associated with the transaction process. This retainer should represent a minor portion of the overall fee. Sometimes retainers or portions of retainers are credited toward the success fee.
Success Fee
The success fee, representing the majority of compensation, is tied to successful completion of a transaction and is structured as a percentage of the deal size.
For capital raises, a fee percentage is applied to the amount of capital raised. The fee percentage increases as one moves from raising senior debt (perceived as less risky and ranges from 1%-2%) to junior debt (more risky) to equity (perceived as most risky and ranges from 5%-10%). Some fee arrangements include an "equity kicker" in the form of warrants. The size of the deal may also influence the fee percentage; the larger the deal the smaller the percentage.
For merger and acquisition services, the fee percentage is applied to the overall size of the transaction. Although many business brokers refer to the Lehman formula, few mid-market investment banks use this structure. Instead, they may quote a straight fee percentage or a performance based progressive fee, which increases based on achieving a certain valuation target.
The higher the company's valuation (the more dollars the seller puts in his pocket), the higher the investment banker's fee percentage. Progressive fee arrangements provide a strong incentive for the investment banker while aligning the parties' interests in maximizing the value of the transaction to the client's owners.
Final Comments
As with most things in life, keep the fee arrangement simple. Haggling over unique, low probability circumstances or creating complex fee structures generally backfires. Complex arrangements tend to cause uncertainty and can result in lack of motivation and focus from the investment banker, not what the client desires.
You get what you pay for. Expect to pay a reasonable, market fee. Receiving an engagement letter containing a low fee (potentially with no retainer), indicates a low level of sophistication. Conversely, an engagement letter quoting an out-of-market high fee indicates someone wanting to take advantage of a client. These are not investment bankers you want handling your important deal.
