Last month, we began a seven-part series on “Legal Considerations for Selling an Emerging Growth Company,” and in that post, we discussed six important steps in the merger and acquisitions process that emerging growth companies will need to prepare for, which are: (1) engaging a financial adviser; (2) entering into a non-disclosure agreement; (3) negotiating the term sheet or letter of intent; (4) due diligence; (5) drafting and negotiating definitive documents; and (6) closing. We will continue to dive deeper into each of these steps of the process, and this month, we are focusing on the first step, which is negotiating an engagement letter with a financial adviser.
Engagement Letter with a Financial Adviser Defined
As we discussed in the previous post, an emerging growth company in a potential M&A deal (also called the “target” company) will often work with a financial adviser to represent and guide it through the deal, even if no potential buyers are on the horizon yet. This financial adviser, which is typically going to be an investment bank, will carry out a number of roles in exchange for a variety of fees, and these roles and the fees will be laid out in the engagement letter, which acts as the contractual agreement between the target and the financial adviser.
Finding a Financial Adviser
While the negotiation and finalization of the engagement letter is only the initial step in the completion of a successful transaction to sell your company, remember that the relationship between your company and its financial adviser is a transaction in and of itself with potentially huge financial consequences for your company, and so there are a number of things to keep in mind as you work towards engaging a financial adviser.
The first step is to find the financial adviser you are going to want to work with, and this is critical as you are entrusting that adviser with finding the best possible deal for your company. Your current investing partners may be a source of referrals, as may your legal representation. Several financial advisers may compete for your business in a “bake-off,” during which the advisers will examine your company and then offer competing bids on what they can offer your company and on what general terms.
Negotiating the Scope of the Financial Adviser’s Duties
Once a financial adviser is selected, the next step is to determine what duties the financial adviser will undertake on behalf of your company in the deal. Negotiation of duties and fees is often done concurrently in reaching a final agreement, but from the target company’s perspective, the range of duties should be what drives the justification for the fees.
You may already have a buyer in mind for your company and may have even discussed a sale in depth with that buyer, but, in many cases, a financial adviser may take the lead on finding a buyer for a company. This could take the form of going after a specific buyer, approaching a list of potential buyers, or working to invite in as many potential buyers as possible to, in essence, bid on your company.
Your financial adviser may also provide a valuation of your company based on your current tangible and intangible assets as well as future profits. Related to this, the financial adviser might draft a “fairness opinion” to your company’s board of directors. A fairness opinion evaluates the terms of a buyer’s proposed offer to purchase the company and provides a recommendation to the board of directors in favor of or against the proposed purchase.
In addition to those potential roles, a financial adviser will provide general guidance for your company throughout the deal process, specifically in negotiating the terms of the deal and overseeing the closing process.
Negotiating the Financial Adviser’s Fees
The various fees that your financial adviser will be paid should, again, be based on the services that it is providing your company throughout the deal, and these fees will be the product of a negotiation between you, your representatives, and the financial adviser. Generally, the financial adviser will receive a retainer fee, meaning it will be paid regardless of the outcome of the deal. The financial adviser may also receive interim fees, contingent on meeting certain benchmarks such as finding a buyer. Finally, the financial adviser will typically receive a “success fee” for the successful completion of the deal, and this might be paid in cash, securities in your company, or a combination of both.
Other Issues to be Negotiated in the Engagement Letter
Scope of duties and fees are the major issues to be negotiated in an engagement letter, but, as with any major business contract, there are other issues to be determined as well. These include determining what expenses of the financial adviser the target will be required to pay, how disputes between the target and the financial adviser should be resolved (e.g., binding arbitration), and how the parties might be indemnified in the event of third-party litigation, such as with potential buyers or other investors.
Making sure you have selected the right financial adviser and creating an engagement letter that comprehensively lays out your rights and responsibilities can take some significant work and focus, but making the effort to ensure that these initial steps are done properly can have enormously positive effects on the sale of your emerging growth company in the long run.
This article is for general information only. The information presented should not be construed to be formal legal advice nor the formation of a lawyer/client relationship.
