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Considerations For Engaging an Investment Banker in a M & A Transaction-Sell-Side

by | Nov 15, 2023 | Business Law

If you are considering selling your business and have not identified a buyer or want to potentially create a competitive bidding process, you should consider engaging an investment banking firm to facilitate the transaction.  If you select the right investment banker, you stand a good chance of substantially increasing the purchase price and negotiating better terms and conditions with respect to the transaction documents.  Investment bankers are financial experts who have significant expertise in purchase and sale transactions.  If you are considering using an investment banker, significant consideration should be given to making sure you make the right choice.  A seller should look at many factors, such as the size of the deal and the investment banker’s experience, given the nature of the business being sold.  Certain investment bankers may also specialize in particular industries.  This blog is directed to closely held companies regardless of size.

Preliminary Considerations:

References.  Hiring an investment banker is like hiring any other professional. Before finalizing the engagement, you must conclude that the firm you engage is right for you and your company.  It is always a good idea to speak with several firms.  Attorneys and accountants are good sources for referrals or suggestions.  Sellers will not want to discuss it with too many individuals because they don’t want the word to get out. The internet can also be a resource to locate firms.  Most investment banking firms advertise the deals they closed on their websites or in publications like Crain’s Cleveland Business and will let you contact former clients for recommendations.

Non-Disclosure Agreement.  Before you have any in-depth discussions with an investment banking firm, you should obtain a robust NDA to protect your proprietary and confidential information.  There should also be a provision that requires the firm to treat the fact that your company may be for sale as confidential.

Experience.  The investment banker that is right for you and your company will likely have experience in buying, selling, or financing similar businesses in size, geographical area, and type of products sold or services rendered by your company.  You should also pay particular attention to which employees of the investment banking firm will be working on your engagement.  If the firm is a good fit, but the team assigned to your account is not, the process will not be seamless.

The Role of the Investment Banker in Sell-Side Engagements:

Gather and Organize Information.  The investment banker will do a deep dive into the company’s books and records, including financial statements, important contracts, computer licenses, intellectual property, key employees, existing product lines, etc., to become familiar with the company and perhaps even the industry.

Analyze and Valuation.  An important function of the investment banker is to analyze the company to identify potential opportunities, such as synergies that a buyer might obtain, run a calculation of normalized earnings, and present a valuation to the owner.  If the owner and the investment banking firm are not on the same page, then it would be in the best interest of both parties to part ways.

Pitch Book or Pitch Deck.  Once the investment banker has completed its analysis of the information gathered, the next step is to prepare a Pitch Book, Pitch Deck, Confidential Memorandum, or Offering Circular.  The pitch book is designed to present a summary of the company at a high level and provide sufficient information so that a potential buyer can readily determine if it has an interest in the company.

List of Potential Buyers.  Typically, the investment banker presents a list of potential buyers for consideration to the seller.  The seller should approve the list to make sure that the list does not contain any inappropriate parties.  Once the list is approved, the investment banker discreetly contacts the potential buyer to see if there is any interest.  If a potential buyer expresses an interest, the investment banker will obtain an NDA and set up a meeting to discuss the opportunity and solicit offers or indications of interest.  This process could easily take several months.

Evaluating Offers.  Once buyers start presenting offers, the investment banker typically will sit down with the seller, the seller’s attorney, accountant, and other valued advisors to review and evaluate the offers.  The investment banker will use its negotiating skills to increase the offers until the seller accepts a suitable offer.

Due Diligence.  A good investment banker will assist the seller in responding to detailed due diligence requests and work towards a closing.  The due diligence period typically takes a couple of months.

Transaction Documents.  The investment banker will likely work with the seller’s attorney to review and provide comments on the agreements necessary to close the transaction.

The Engagement Letter:

General.  Upon selecting an investment banker, you will be presented with an engagement letter.  Most engagement letters take the same form.             

Scope of Engagement.  The engagement letter should have a detailed description of the services that the investment banker will render.  Generally, the letter will summarize the scope of the work.

Exclusivity.  The engagement letter will require the seller to agree that it will not use any other party to solicit offers.  It will usually require that all offers received by the seller, whether solicited or not, must be referred to the investment banker.  The letter will require the fee to be paid regardless of the amount of work that the investment banker does.  A seller should be careful; if certain potential buyers have already expressed an interest in the company, the seller may ask for a different fee structure for these potential buyers.  If possible, these buyers should be pursued before the investment banker is engaged.  Occasionally, the seller can provide a list of excluded buyers or negotiate a lower fee if the company is sold to a previously identified party.  As one might imagine, this is only popular with some investment bankers and can be a deal breaker for the investment banker in many cases.

Retainer and/or Consulting Fee.  Most investment bankers require a retainer to be paid upon acceptance of the engagement.  This fee is earned upon payment and is used by the investment banker to cover its overhead for the project.  Depending on the size of the project, the retainer could be anywhere from $15,000 to $300,000+.  Given this provision, selecting the right investment banker is extremely important.

Success Fee.  Success fees are generally paid upon the transaction’s closing and are based upon a percentage of the consideration received by a seller.  The consideration may include cash, promissory notes for deferred payments, debt assumptions, non-compete payments, or consulting payments above market prices.  This provision is unquestionably one of the most important provisions of the Agreement, and the prudent seller will spend a significant amount of time with their advisor to understand the magnitude of the calculation of the success fee prior to signing the engagement letter.  Success fees vary significantly and could be 1% of the price to 8%.  Typically, the bigger the deal, the lower the percentage.  Some success fees are tiered, and the percentage changes based upon the purchase price.  For example, an investment banker could get 2% on the first $2,000,000 and then 5% on the balance.  It is also common for investment bankers to seek a floor, meaning that it is willing to receive a minimum fee in the event of a sale, regardless of the purchase price.  Success fees vary between firms and are negotiable.

Term and Tail Period.  Most engagements start with a set term.  A typical term is 6 to 9 months and can only be terminated upon a breach.  Further, most engagement letters include a tail term, which provides that if a sale is made after the term to a party introduced by the investment banker during the term, then the success fee must still be paid.  A seller must be careful not to step into a trap.  If, upon termination of the first engagement, the seller engages a second firm, and there is not an exclusion for a previously introduced party, the seller could end up paying two fees.  The seller should request an exclusion in the second engagement or at least a reduced fee.  A prudent seller should also negotiate a smaller fee if the sale takes place in the tail period, especially if the first investment banker was not involved.  This would have to be negotiated upfront.

Indemnity.  Engagement letters typically require the seller to give the investment banker a broad indemnity.  The indemnity provision can be a paragraph to several pages.  This is another provision that should be scrutinized closely and fiercely negotiated.  In all events, the negligence and misconduct of the investment banker should be excluded.  It is extremely rare for an investment banking firm to delete the indemnity.  Also, the indemnity provisions are rarely mutual.

Reimbursement for Expenses.  Investment banking firms almost always require reimbursement for out-of-pocket expenditures.  The seller should negotiate a cap or require written approval for expenditures over a certain amount.

Venue and Jurisdiction.  Most engagement letters start with out of state jurisdiction, and most sellers don’t pay attention because it seems like a boilerplate.  However, if you are an Ohio company and must sue or are sued in Delaware, you will quickly realize that a costly mistake was made.

Engagement. The engagement of an investment banking firm is a complicated transaction, and there are many traps for the unwary.  Careful consideration should be given to selecting the investment banking firm and the details set forth in the engagement letter.

If you are considering engaging an investment banker to sell your company, you will benefit from a discussion to further understand your options. Contact Hal Maxfield or any attorney from our business law practice at 216-621-7860 for more information.

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