The Mysteries of M&A Fees

KEY ARTICLE TAKEAWAYS

  • Understand the importance of getting qualified, experience help when selling your company
  • Learn about the different types of fees you should expect to incur when selling your company
  • Learn how investment banking fees are charged and the different ways their success fees could be calculated

The Mysteries of M&A Fees

Don’t try this on your own. Selling your company is potentially the most important transaction of your life. Most business owners sell their business just once – you don’t want to leave money on the table. Self-medicating or trying to manage a transaction on your own if you have never sold a company before will likely yield poor results (most of us don’t do our own heart surgery…!).

Selling a business is like any other critical business process – if you execute it on an ad hoc basis without a proven process and with inexperienced people, it is highly unlikely you will maximize value or minimize headaches during the process. Conversely, if you hire an experienced team (comprised of an investment banker, attorney, financial advisor and accountant), you will maximize your odds of success and reduce the stress and strain of a transaction.

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Merger and acquisition fees – you get what you pay for

In our experience, most successful entrepreneurs are religious about one of the cardinal rules of a successful business: control your expenses. As a result, many entrepreneurs have an allergic reaction to paying accountants, lawyers, or investment bankers for services related to the sale of their business because it is hard for them to understand the value these parties bring to the table because they have never been through the process of selling a company. For most business owners their business is their primary asset. Therefore, hiring an expert when it comes to the process of buying or selling a business is usually a good investment because an advisor can help you avoid the expensive mistakes that can often occur during the course of a transaction.  When done skillfully, an advisor’s participation can enhance the value you receive for your business.

Types of merger and acquisition fees

Selling a business will involve legal fees, accounting fees and investment banking fees. Legal and accounting fees are typically charged by the hour and will be incurred whether or not the deal closes. Investment banking fees are largely success-driven – other than small retainers paid to the investment bank, the large majority of an investment banker’s fees are paid when and if the deal successfully closes.

Legal fees

Anyone contemplating the sale of their business should hire competent, experienced deal counsel – an attorney who does lots of deals every year. Hiring your friend or your corporate attorney who does not have a lot of deal experience will end up costing you in the form of a less efficient process, higher risk of a busted deal, and potentially higher legal exposure post-closing. In managing over 100 transactions, I have seen legal fees on the low end of $25,000, and on the high end over $300,000. There are many factors that impact how much you will pay in legal fees:
  • the complexity of your business (is it highly regulated, does it have environmental or intellectual property issues, does it have unique labor or employment issues, etc.);
  • the nature of the process you and your investment banker run (will it involve multiple bidders or just a single bidder);
  • the attorney representing the buyer (are they competent, experienced, practical attorneys or are they inexperienced or overly aggressive);
  • whether or not the transaction will require regulatory filings like a Hart Scot Rodino filing (required for larger transactions);
  • the level of complexity around taxes and how aggressively you want to avoid taxes;
  • and several other factors.
This is why it is sometimes difficult for an attorney to give you a solid estimate of the likely fees in your particular transaction – there are just too many variables to nail down a precise figure. When hiring an attorney, pay less attention to their billing rate and more attention to their experience and expertise. An attorney with a higher billing rate can end up costing you less in dollars and aggravation than a less experienced and qualified attorney with a lower billing rate. Likewise, a larger firm with several different areas of legal expertise (tax, regulatory, intellectual property, labor, employment, etc.) will typically have higher bill rates than a one-person shop. However, the larger firm will be faster to identify and resolve issues than the one-person shop – time kills deals, so having a legal team that can be responsive and efficient is critical to ensuring the success of your deal.

Accounting fees

The buyer for your business is going to dissect and analyze your financial statements ad nauseum. In most larger transactions (say, over $15 million), the buyer will perform a “quality of earnings” review which is usually performed by an outside accounting firm and is an exhaustive review of your financials. I refer to a quality of earnings review as an “audit cubed” – it is not just a review of your historical financials, it also attempts to validate key assumptions going forward to validate your financial forecasts. Smart sellers will prepare for this type of due diligence by having their own accounting firm perform a similar analysis prior to take the company to market. As a seller, you do not want to be surprised during due diligence with a financial issue that will lower the purchase price – you want to identify, rectify and be able to explain any issues that come up with your financials, and in order to do this, you need to have an outside accounting firm examine your books in detail just like a buyer will. To have an accounting firm perform this analysis (what is sometimes called a “seller-prepared” quality of earnings review) can cost anywhere from $35,000 to over $200,000, depending on the type of firm performing the analysis and the complexity of your company’s financials. Big Four accounting firms will charge the highest rates (having a brand name like this do your work brings credibility to their analysis) and smaller firms will charge less. In our experience, the fees paid for a seller-prepared quality of earnings review are well worth it. Having this level of analysis and scrutiny speeds the buyer’s due diligence process, eliminates surprises, and in many cases can identify one-time upward adjustments to earnings that can pay for the fees you pay to the team preparing the report.

Investment banking fees

The fees that your investment banker will charge you will vary significantly from firm to firm and will depend on transaction size and complexity. In general, smaller firms will charge less than larger firms, but this is not always the case. Investment banking fees are typically split into two different categories: retainers and success fees.

Investment banking fees – retainers

Depending on the size of the investment bank and the team that will be working on a transaction, retainers can be monthly, a one-time up-front retainer, or a milestone-based retainer. Monthly retainers can range from $5,000-25,000 per month, flat fee retainers might range from $25,000-100,000, and a milestone-based retainer might be $50-100,000 charged over time as different steps of the process are completed. In some instances these retainers are credited toward the success fee, and in other cases they are not. There are several different success fee structures. In smaller transactions, a “reverse Lehman” formula might be used – this pays a declining percentage of each successive million dollars. For example, this might be 10% of the first million, 8% of the second million, 6% of the third million, and 4% of each dollar thereafter. In larger deals this might be reduced to 5%/4%/3%/2%/1%. For example, in a $10 million transaction, the fee might be $520,000 as shown below:
  • 10% of the first $1 million, or $100,000, plus
  • 8% of the second $1 million, or $80,000, plus
  • 6% of the third $1 million, or $60,000, plus
  • 4% of the remaining consideration ($7 million), or $280,000
  • For a total of $520,000, or 5.2% of the total transaction value.

Investment banking fees – success fees

Fees can also be a flat fee, a fixed percentage or a lower percentage up to a target dollar amount with a higher percentage for amounts that exceed the target dollar amount. Many clients prefer this latter structure as it appropriately incentivizes the investment banker to get the highest valuation possible for the company. For example, the client and investment banker might agree to pay 3% up to $20 million, 5% for amounts between $20 million and $40 million, and 7% for amounts exceeding $40 million. A similar structure might be used, but instead of dollar amounts being the different cut-offs, multiples of EBITDA paid by the buyer based on the company’s trailing twelve months of EBITDA might be used. In our example, the client might pay 3% for amounts up to 4 times EBITDA, 5% for amounts between 4 and 8 times EBITDA, and 7% for amounts exceeding 8 times EBITDA. This method can be complicated in the event actual EBITDA as diligence by a buyer turns out to be less than the EBITDA represented by the buyer in its selling materials. In general, the smaller the transaction, the higher the percentage fee will be. Roughly speaking, fees for a $10 million deal might range from 5-8%, fees for a $20 million deal might range from 4-6%, fees for a $50 million deal might range from 2-4%, and fees for a $100 million deal might range from 1-3%. However, the fees will depend on the specific structure agreed to by client and investment banker – for example, a client might be willing to pay a much higher percentage on amounts that exceed their highest expectations for a transaction (if the client’s expectation is that the most they would ever receive in a transaction is $100 million and the investment banker delivers a deal for $200 million based on a well-executed process with multiple bidders, the client might be willing to pay a much higher percentage than normal for this excess $100 million in value). Some investment bankers also have minimum fee amounts, regardless of the fee calculation method. Many larger investment banks have minimum deal fees of $1-3 million for mid-market transactions.

Merger and acquisition fees – assessing your advisor’s value

Each deal is unique, so it is hard to assess what structures your banker might propose, but ultimately you need to assess the value your advisor is adding to assess whether the fees they charge are reasonable. When checking references, be sure to ask whether the seller feels they received adequate value for the fees they paid. If your advisor has done a solid job understanding and positioning your business, has found several solid buyers, has helped negotiate a good transaction at maximum value, and has helped you navigate many of the pitfalls which accompany a sale transaction, they will have more than paid for their fees.

Selling your business? Talk to our M&A experts

If you are considering a sale of your business and want to understand what type of fees you might be charged, please reach out at [email protected]. If you’d like to learn more about how prepared your business currently is for a sale, click the red banner above to take our CoPilot Assessment. CoPilot will help you identify what specific risks your business has that decrease company value and reduce your certainty of close. The assessment identifies over 90 different types of potential risks your company could have that will make your business less valuable in the eyes of an investor. Get the test ahead of time and build value today with CoPilot.
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