An investment banker engagement letter is a critical document that outlines the terms of agreement between an investment bank and its client. It lays out scope of work, compensation structure, confidentiality, and other key details. For clients hiring investment bankers for transactions like mergers, acquisitions, IPOs, or capital raises, having a strong engagement letter is essential. This article will provide an overview of investment banker engagement letters, typical content included, and tips for negotiating favorable terms as a client.
Purpose and key sections of investment banking engagement letters
The primary goals of an investment banking engagement letter are to clearly define the services to be rendered, expected deliverables, timelines, compensation structure, confidentiality, and termination clauses. Key sections in a standard letter include: Scope of Work – Detailed description of the services the bank will provide, such as financial modeling, valuation analysis, pitching to investors, transaction execution, etc. Deliverables & Timeline – List of specific project milestones and target completion dates. Fee Structure – Breakdown of all fees to be paid, including retainers, success fees, expense reimbursements, etc. Confidentiality – Non-disclosure terms about clients’ private information and deal terms. Exclusivity – Any restrictions on the client working with other banks during the engagement term. Termination – Ability for either party to exit the agreement under certain conditions.
Compensation structures commonly used in investment banking
There are several typical fee structures used in investment banking engagement contracts:
– Retainer – Upfront fixed fee paid regardless of deal outcome, usually to reserve the bank’s services.
– Success Fee – Percentage of the transaction value, paid only if a deal closes. Can range from 0.5% – 2%.
– Time & Materials – Hourly bill rate for bankers’ time, plus reimbursement of direct expenses.
– Hybrid Model – Combination of retainer, success fee, and sometimes hourly fees.
Banks prefers success fee or hybrid models, while clients often negotiate for lower success fees or capped hourly fees to control costs.
Negotiation tips for clients to get favorable engagement terms
As a client, you have more leverage than you think when negotiating an investment banking engagement letter. Here are tips to get favorable terms:
– Shop around and get proposals from multiple banks before committing. Use these to negotiate.
– Ask for reduced or deferred upfront retainers and higher success fees to better align incentives.
– Negotiate lower success fee percentages for larger transaction sizes.
– Cap hourly rates and maximum total hours billable.
– Clarify vague or broad statements of work.
– Limit broad confidentiality and exclusivity provisions.
– Specify conditions needed to earn fees, such as closing transactions or hitting milestones.
– Allow flexibility to terminate for convenience or change advisors if dissatisfied.
Key takeaways for crafting solid engagement agreements
The investment banking engagement letter governs the entire relationship, so it must be comprehensive while protecting the client’s interests. Key takeaways include:
– Use an experienced legal counsel to review the agreement.
– Carefully assess scope of work and fees versus alternatives.
– Push back on vague or unfavorable terms.
– Alignment on expectations upfront minimizes disputes down the line.
– Build in performance-based provisions.
– Maintain flexibility to switch banks if needed.
With proper planning and negotiation, clients can enter into win-win engagements with their chosen investment banking partners.
An investment banking engagement letter defines the scope, timelines, fees, and other crucial details for an advisory mandate. Clients should carefully assess proposals to negotiate terms that mitigate costs yet motivate bankers to succeed. With the right agreement in place, both the bank and client can enjoy a productive, mutually-beneficial relationship.