Before engaging an M&A advisor or investment banker, it is crucial to negotiate the terms of the engagement agreement (sometimes called an “engagement letter”).

In this article, we’ll discuss five essential clauses to negotiate in this agreement to protect your interests and to ensure a successful transaction. By understanding these clauses, you’ll be better equipped to negotiate a fair and comprehensive agreement with your advisor.

The process of negotiating the letter can also provide insight into a prospective advisor’s priorities and operations and reveal whether your interests are aligned. Even if your company’s legal counsel is managing negotiations, it is essential to understand the agreement’s key terms and how they represent (or do not represent) your company’s interests.

1. Scope of services

It’s important to specify your corporate advisor’s role and the ultimate objective of the engagement – whether it’s a financing transaction, a sale, or an acquisition. This ensures that both parties’ objectives align and that the proposed fee structure makes sense.

Some of these services may be obvious and applicable to almost every engagement, such as reviewing financials and soliciting investors or acquirers. However, others may vary depending on the advisor and your company’s needs, such as developing marketing materials, coordinating pre-transaction due diligence and providing valuation services.

2. Exclusivity

It’s common to feel uneasy about exclusivity clauses. Even with extensive research, entrusting one advisory firm with your business can be daunting.

However, you’re not going to get a high-quality advisor unless you agree to exclusivity. From your advisor’s standpoint, a retainer alone is insufficient to cover the many hours they will devote to getting your company ready for a sale or financing. Also keep in mind that liaising with several advisory firms would be a difficult task for you and your team and will lead to confusion and uncertainty.

So, it’s not about whether to give exclusivity. Instead, the discussion should revolve around how long exclusivity should be granted to the advisor. While they may push for extended exclusivity periods, sellers prefer shorter ones. In most cases, six months to a year is standard. Still, the duration can vary depending on the transaction’s complexity, the level of preparation required before going to market, and other factors.

3. Tail Period

The tail period is linked to exclusivity – negotiate them together.

If your transaction occurs within the tail period, your corporate advisors will be entitled to their fees even though it does not happen during the term of your engagement with their firm. A typical tail period is 12 to 24 months.

Deals often experience delays, and issues frequently arise that are outside your advisor’s control. When a transaction is started within the engagement period, but is completed after the engagement ends, the advisor is protected from missing out on fees by the tail period.

It is essential to bear in mind, however, that there are several circumstances in which a transaction may close during this tail period without the involvement of your advisor. When negotiating the engagement agreement, you must add safeguards to the tail provision to ensure that you do not owe fees for transactions that complete without their involvement or if you have terminated the engagement for cause.

4. Fees

Typically, the two primary fees are retainer and success fees. The retainer fee is a fixed amount, frequently paid monthly during the engagement’s duration.

The success fee is directly linked to the success of your transaction, serving as an incentive for both parties to work together towards a positive outcome. This fee is typically a percentage of a completed transaction and varies based on several factors, including the deal type, type of ownership, and transaction value.

In some cases, other fees may be applicable, such as a fee triggered by signing a term sheet or announcing a transaction. You should aim to avoid any substantial fees triggered by non-binding term sheets or letters of intent since deals can collapse after these stages.

5. Expenses

In most cases, you will be responsible for covering an advisor’s reasonable expenses while they represent you. These expenses can include travel, research, and other expenses. You must manage this.

Typically, clients place a cap on expenses and require pre-approval for any costs exceeding that limit. It is common for expenses to be limited to third-party fees, meaning that your advisor shouldn’t charge for the cost of their own staff, for example.

Takeaways

Negotiating the engagement agreement is a crucial step in the process of selling or acquiring a business. As the client, you have the power to shape the terms of the agreement to ensure that your interests are protected and that you get the most value out of the services provided by your M&A advisor or banker.

By paying attention to the five essential clauses we’ve discussed in this article, you can enter into a professional relationship with confidence, knowing that you have taken the necessary steps to set clear expectations and to establish a fair arrangement.

Remember, a well-crafted engagement is the foundation for a successful transaction, so take the time to negotiate it carefully and thoroughly.