Investment bankers, or business brokers, play an important role when you sell your company. For business owners, hiring an investment banker creates value in two ways:
- They establish a competitive process for the sale of your company. This process ensures that all buyers are putting their best foot forward for both the price and the terms of the sale. Without the threat of competition, a single buyer has no reason to immediately provide their best offer.
- Investment bankers bring buyers to the table that a seller wouldn't have otherwise contacted on their own. Most business owners think they know who the buyers of their business will be. In reality, it is often the buyers that the investment banker brings to the table that end up providing the best offer. An investment banker keeps a very active list of available buyers in each industry.
These two factors generate value for business owners looking to sell. For that reason, hiring an investment banker can be a wise financial choice.
How do investment bankers get paid?
A retainer payment
Most investment banks charge two sets of fees. The first fee is a fixed amount called a retainer. The retainer assures the banker or the broker that a seller is serious about going through the sales process and covers some (but not all) of the upfront expenses related to selling the company. Typical middle market retainers range between $50,000 and $100,000. Most of the time, the retainer can be credited against a success fee at the end of the transaction.
As part of the sales process, an investment bank has a number of upfront expenses. The preparation of the Confidential Information Memorandum can take between four and 12 weeks, and involves a great deal of writing and research on the part of the banker. In addition, the investment banker will spend some time with the company and the management team, which can involve travel and hotel stays.
The success fee
Where an investment banker garners the majority of their earnings is through a success fee. This fee is usually a percent of the final transaction price. Fees can range from 2 to 5 percent for middle market transactions and will decrease to 1 percent or below for transactions over $100 million.
The success fee is paid only when a transaction happens, which is why investment bankers are so concerned that a seller is intent on selling the business and not simply "shopping" for a value. A transaction on which a banker has worked for months that doesn't ultimately happen is a money-loser, despite the retainer paid at the beginning of the process.
Because investment bankers earn the bulk of their income from a success fee, they are motivated to complete a deal. Also, because success fees are based on a percent of the purchase price, the investment banker is incentivized to get the highest price possible. In this way, the motivations of the seller and the investment banker are aligned.
Many investment bankers and brokers will consider alternative structures that are deal-specific. For example, if you believe that your business is worth $50 million, you can structure a transaction that pays the banker the normal, agreed-upon percent for a purchase price of up to $50 million. If the purchase price exceeds that amount, a higher percentage success fee can be paid to the banker.
Some investment bankers will consider a flat fee up to a certain value and then a percentage above a certain purchase price. Other banks or brokers will consider an hourly rate, but this is not the norm or an ideal structure, because it removes the incentive to complete the transaction in a timely fashion.
If you agree to an alternative structure, it is important that both the seller's and the banker's interests are aligned. Both parties need to be incentivized to complete a deal at the highest possible price. If the target for the alternative structure becomes unreachable (and comprises a large part of the investment banker's earnings on the deal), your banker might lose focus on completing the transaction.
Recent media stories of investment banks charging huge fees might persuade business owners to sell their business on their own. However, this is a bad economic decision as investment bankers generate more value than they charge in fees. If they didn't, it would most certainly be a dying industry. This is especially true in the middle market, where there is little transparency on prices, and buyers can be more difficult to find. Don't let the fear of fees force you into a decision you may later regret. Knowing how investment banker fees work before you engage the services of one can help you feel more comfortable with the process.