You’ve decided to sell your company, and you’ve engaged a financial advisor to find a buyer. The financial advisor sends you its standard form of engagement letter, and you sign it. Agreeing to pay the financial advisor a commission based on the sales price seemed reasonable at the time.
The engagement letter contains the following provisions (based on an actual engagement letter):
“Success Fee: If, during the term of this agreement, the Company consummates a sale of stock or assets, the Company agrees to pay financial advisor in cash at the closing a success fee
in the amount of $225,000 plus three percent (3.0%) of the Selling Price.
“Selling Price” means the sum of the fair market value of any consideration received by the Company and/or its owners including:
(a) Cash, notes and/or other securities from the purchaser, plus
(b) The fair market value as of the closing of any assets including cash, other working capital and any other assets, less liabilities retained by the Company or distributed to its owners, plus
(c) Any interest-bearing debt of the Company as of the closing that is assumed by the purchaser or is satisfied by the Company and/or its owners as of the closing; plus
(d) Any contingent payments, noncompete agreements, consulting agreements, employment contracts and other forms of remuneration associated with the transaction received by any of the owners of the Company.”
Congratulations, We’ve Got a Deal!
A buyer for your company is found and a deal is consummated! The agreement calls for the purchase and sale of all of the outstanding stock of your company for an aggregate purchase price of up to $15 million, consisting of $10 million paid on the closing date and $5 million in the form of an earn-out (i.e., payment is contingent on the achievement of certain financial milestones after the closing).
The success fee is due and payable at closing
At the closing, the financial advisor determines the Selling Price to be $18.5 million, consisting of:
Accordingly, at closing the financial advisor receives $225,000 plus three percent of $18.5 million, for a total success fee of $780,000.
Unfortunately, things don’t work out as anticipated
As it turns out, the buyer was in over its head and didn’t understand your industry. It files for bankruptcy and defaults on the $5 million seller note. Before filing for bankruptcy, however, the buyer is successful in obtaining indemnification payments for the full escrow amount of $1.5 million. Needless to say, the earn-out milestones are not achieved, so neither you nor the other sellers receive any of the $5 million earn-out. In the end, you paid a success fee based on a “Selling Price” of $18.5 million but only received $2.5 million after paying off the $1 million line of credit. (You shake your head at the concept of paying a commission on debt that you pay off. That’s just crazy, you think.)
Had you paid a success fee based on what you and the other sellers actually received, it would only have amounted to $300,000. In hindsight, you overpaid the financial advisor by $480,000, or 160%. You’ve been stung by the success fee.
How to avoid being stung by the success fee
As this example illustrates, it is critical to get advice from experienced counsel before you engage a financial advisor for the sale of your business. To avoid being stung by a success fee in an M&A engagement letter:
We’re here to help. Please contact Iain Mickle or any other member of the Boutin Jones Corporate and Securities Group if you have any questions regarding this article.
Legal disclaimer: The information in this article (i) is provided for general informational purposes only, (ii) is not provided in the course of and does not create or constitute an attorney-client relationship, (iii) is not intended as a solicitation, (iv) is not intended to convey or constitute legal advice, and (v) is not a substitute for obtaining legal advice from a qualified attorney. You should not act upon any of the information in this article without first seeking qualified professional counsel on your specific matter.