The investment banking industry refers to a retainer as a fee paid up front which is generally credited against a success fee, but foregone if a transaction is not consummated. A more appropriate term for such an upfront fee would be an engagement fee, not to be confused with a retainer which is only used to pay out of pocket expenses. The typical engagement fees for lower mid-market sell side transactions ranging in size from $5 million to $50 million is $25 thousand to $100 thousand. At a $10 million transaction size the common engagement fee is $50 thousand. The fee can be paid all upfront or in monthly installments or a combination, such as $25 thousand upon engagement and $5 thousand per month starting in month 4.
In general I don’t have a problem with engagement fees charged on larger deals in which the transaction size exceeds $25 million or so. The issue I have with engagement fees on smaller deals is that the vast majority of intermediaries which execute smaller deals have relatively low overhead, as such these firms often make a living from the engagement fee itself. This is often the source of numerous potential conflicts.
Bias Toward Overvaluing the Business
How do you think a real estate agent might persuade you to engage them to sell your house? Their number one tactic would most likely be to convince you that they can fetch a higher price then the next guy. They might tell you that they can get $1 million, for example, when they know that the value of the house is really in the range of $900 thousand to $950 thousand. You then execute a six month exclusive agreement, and now they own you. The agent then brings multiple offers that are all in the $900 thousand to $950 thousand range and gives you all sorts of reasons why you house is not fetching the $1 million price tag. In broker lingo, they call this “bringing you to school”. The broker knows that if you are motivated to sell you will eventually lower your price to meet the market’s valuation. So, the broker misled you in order to convince you to hire him, and he was not even asking for any upfront fee. Now imagine how he might mislead you if he were asking for a $50 thousand upfront engagement fee!
Accepting Low Probability Engagements
According to a information published by the International Business Brokers Association, the average closing rate among US intermediaries representing transactions valued in the range of $10 million is approximately 30%. This just does not make any sense to me. Why would someone pay a $50 thousand engagement fee for a 30% chance of success? Not to mention that there is generally significant work required by the Owner in any exit process, as well as a risk of a confidentiality breach which can harm the business. Wouldn’t one just be better off to put their $50 thousand on red at the roulette table! When the business broker or investment banker can make a living from the engagement fee it’s not hard to imagine that they may not be very selective. Our experience at LockeBridge, a registered Boston based Investment Banker, is that about half of the businesses for sale are not saleable; with the reason often being that the typical sell-side broker will take any engagement in which they can earn a $50 thousand upfront fee.
In addition to the above, large upfront fees can also result in several other potential conflicts such as a low commitment to success and low investment in resources devoted to the engagement. So what’s the alternative? Unfortunately the de facto standard among seasoned investment bankers is to charge a significant engagement fee. Contrary to the legal profession, which has been around for thousands of years, mid-market investment banking has only been around in any formal way for less than 50 years, and the demand for seasoned, unbiased representation has simply not been met with an adequate supply of investment banking services in the lower end of the mid-market. In fact, at the sub $20 million transaction size it is difficult to find truly seasoned expertise even if you are willing to pay a hefty upfront fee. If one is seeking both seasoned expertise and an engagement agreement without potential built-in conflicts (i.e. no substantial upfront fee) then be prepared to look for a long time. In our experience the combination of high expertise and no engagement fee in the lower end of the mid-market is practically non-existent. This situation is not an issue in the legal profession, which seems to have worked out the demand and supply gaps over the last thousand years. In the legal profession, everyone knows that the standard contingent agreement, with no upfront engagement fee, is accompanied by a success fee of 30%. Hopefully it won’t take hundreds of years to meet the demand for high level, uncompromising mid-market investment banking representation.