Steps to Negotiating M&A Engagement Letters

Engagement letters with investment bankers or business brokers are important components of M&A transactions. Despite appearing simple, they contain essential terms that should be carefully negotiated to protect your interests. Here's a few tips on how to approach negotiating M&A engagement letters effectively.

Understanding the Importance of M&A Engagement Letters

An M&A engagement letter defines the relationship between a client and their financial advisor or investment banker. These letters outline the scope of services, fee structure, term, and other critical provisions. While they may seem non-negotiable, customizing terms to fit your transaction can significantly impact the success of your M&A activities and many of the terms are in fact negotiable.

Key Terms in M&A Engagement Letters

1. Fees

The fee structure is one aspect of an engagement letter and should be scrutinized carefully. Monthly or set fees are often optional and not always included. However, if such fees are part of the agreement, ensure they are credited toward the transaction fee if a deal is ultimately completed.

Transaction fees are typically scaled to the size and type of the transaction. It's essential to define minimum fee thresholds and specify how fees are calculated, especially for components like contingent payments, earnouts, or other considerations. You may also negotiate different fee arrangements for buyers introduced by the banker versus buyers you identify independently, ensuring fairness and cost efficiency.

Additionally, it is important to define whether fees are due for capital raises, the sale of the company, or both. 

Expenses, another key component, should be clearly defined. Establish limits or caps for reimbursable expenses and consider implementing an approval process for any significant costs incurred during the engagement. This approach can prevent unexpected financial burdens and ensure accountability.

2. Scope of Services

The scope of services outlined in the engagement letter often uses broad language, which can leave room for ambiguity. To avoid misunderstandings, ensure the agreement specifies any critical services you require, such as fairness opinions, quality of earnings reports, or other specialized tasks. Clarifying these details upfront will help you set clear expectations and avoid potential disputes.

Additionally, it is important to define whether the engagement includes activities like capital raises, the sale of the company, or both. Tailoring the scope to your specific needs ensures the banker’s efforts align with your objectives.

3. Transactions Covered

Engagement letters should also define the transactions covered under the agreement. For example, you might want to exclude buyers you’ve already engaged with before signing the letter. While such exclusions are not uncommon, they are often limited to specific timeframes. Be clear about these boundaries to avoid unnecessary overlaps or conflicts.

4. Term of the Engagement

The term of the engagement determines how long the agreement remains in effect, including a "tail period" that extends the banker's right to claim fees for deals completed after the engagement ends. Negotiate to ensure the tail provision only applies to buyers the banker introduced during the engagement period. Additionally, try to limit the provision so it applies only to transactions that close during the tail period rather than to deals that merely reach a letter of intent (LOI).

The overall duration of the engagement should also be reasonable and aligned with the expected timeline for your M&A activities. Being precise about these details can prevent unnecessary complications. 

5. Termination

Termination rights are a vital part of any engagement letter. Ensure the agreement allows you, as the client, to terminate the engagement at any time. If the banker includes provisions to terminate the agreement on their end, negotiate terms that minimize the impact on fees you have already paid and define the consequences of such an action. Flexibility in termination rights protects you in the event of unforeseen circumstances or dissatisfaction with the banker’s performance.

6. Exclusivity

Exclusivity clauses are standard in M&A engagement letters and typically prohibit you from engaging another banker during the agreement period. While exclusivity is common, ensure that this requirement aligns with your goals and timelines. 

7. Indemnification

Indemnification clauses are another critical component of engagement letters. These clauses often provide broad protection for the banker, covering liabilities that arise during the engagement. This is all standard. However, it’s important to negotiate exclusions for acts of bad faith, willful misconduct, and fraud. Including these carve-outs ensures you’re not held responsible for significant wrongful actions by the banker.

Negotiation Tips for Success

Negotiating an M&A engagement letter requires attention to detail and strategic foresight. First, tailor the fee structure to reflect the complexity and expected outcomes of your transaction. This customization ensures fairness and helps manage costs.

Second, narrow the scope of the engagement to align with your specific needs and objectives. Being precise about services, transactions, and terms can prevent unnecessary disputes or misunderstandings.

Finally, ensure the engagement includes flexibility through termination rights and well-defined indemnification clauses. Working with an experienced M&A attorney can help you navigate these discussions effectively and ensure the final agreement protects your interests.

Negotiating an M&A engagement letter is a critical step in mergers and acquisitions. By carefully addressing terms related to fees, scope, transactions, duration, and termination, you can ensure the engagement aligns with your objectives and minimizes risks. Taking a proactive approach to these discussions can pave the way for a smoother transaction and better outcomes.

Contact SPZ Legal for help negotiating engagement letters for your startup.