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For over 15 years, I advised clients as a lawyer in complex business transactions. My key advice was consistent, no matter the particulars of the business relationship: Make sure everyone’s incentives are aligned.
Following this basic rule is the best way to avoid conflicts of interest while hiring an M&A adviser to sell your company. There are many different types of advisers and a host of issues to consider when hiring one, but if you create a relationship that aligns your incentives with your adviser’s, you’ll minimize the chances for trouble later.
Comparing Your Goals to Those of Your Adviser
The first step is to look at what your interests are and how they differ from those of your adviser.
If you have chosen to sell or recapitalize your company, your goal is most likely to generate the highest after-tax value for your company. However, this simple sounding goal is more complex than you might initially think. Is your goal to create the highest value today or the highest value over time? Do you want to stay in the business or retire? What are the tax ramifications of various structures?
In contrast, your potential adviser’s goal is pretty straightforward. He would like to generate the greatest possible amount of fees over the shortest amount of time. Because ultimately, advisers are selling their time, there is an important tradeoff to consider between fees generated by one transaction vs. fees generated overall.
Retainer or Not?
Generally, there are two components to an M&A adviser’s fee: an upfront retainer and a success fee.
I believe that a success-fee only model is the better way to align a business owner’s incentives with his adviser’s. As a business owner, you are retaining an adviser to sell or recapitalize your company. If your adviser succeeds by helping you achieve those goals, then you should be ecstatic to pay him! But, if he doesn’t, then what has he delivered? Why would you pay him? And certainly, why would you pay him a fee upfront before he has done anything for you?
But, the Adviser Needs Certainty as Well
While I don’t believe that retainers serve business owners well, there is a tradeoff to asking advisers to take risk. They’ll want to make sure that your incentives are aligned with theirs as well. If you would like not to pay a retainer, don’t be surprised if an adviser asks you for a significant exclusive period and a period of time after the exclusive period ends where their work is protected, and for other similar risk sharing mechanisms.
Success Fee Percentages
Historically, success fees have tiered downward as the value of a transaction increases. However, it is important to recognize the possible conflict this creates. Often, for large transactions, the incremental fee for the last dollars of the purchase price in a large deal is very small (1% to 2%). The question this should raise for a business owner is whether this incremental fee incents the adviser to get the best deal. From an adviser’s perspective, why push too hard for another million in purchase price if it will only generate another $10,000 in fees. Better to close the deal and move on to the next deal. Consider what the right incentive structure is for the transaction you are doing.
The Conflict You Can’t Avoid
No matter how well you align yourself with your adviser, you’ll never be able to avoid the final conflict – your adviser gets paid when your transaction closes. Consequently, at some point, his incentive will be advise you to complete the transaction, regardless of other considerations. At this stage, while you have hopefully established a trusting relationship with your M&A adviser, you’ll want to make sure that you have other advisers that aren’t similarly incented (e.g., your lawyer and/or your accountant).