What are typical investment banking fees?

Answer 1

Overview of Investment Banking Fees and Issues

Companies considering using an investment banker for the first time often question the high fees and value of such services. However, it's not just the fee amount that should concern companies. Several common engagement practices often work against the best interests of the Company and its equity holders.

Typical Investment Fees and Approach

Investment banking fees often include three components: an upfront or monthly retainer, a cash fee paid upon closing and additional equity compensation. Most investment bankers charge fees that equate to between 3% and 10% of the total capital raised. The larger the capital raise the more lucrative the fees become even though it's the same amount of work involved. For this fee the banker will typically develop a business plan, solicit investors, receive proposals (called 'term sheets'), negotiate proposals and help the company close the transaction.

Common Conflicts

In practically every investment banking engagement, there are two contractual approaches which almost always create conflicts of interest between the investment banker and company seeking to raise capital.

Fees vary based on the type of capital raised - Advisors that raise capital on a percentage basis usually charge two to three times the percentage fee to raise equity capital versus debt capital. Most bankers charge a fee of 1-3% for debt and between 5% to 10% for equity capital raised. This difference in percentages creates a strong incentive for an advisor to recommend or guide a client towards equity sources over debt sources. In addition to doubling or tripling the investment banking fee paid by the company, it can needlessly dilute the owners' equity.

Additional Equity Compensation - In addition to significant cash fees, most investment banking fees include equity compensation. Most equity compensation is paid in the form of warrants. Warrants are generally a number of shares equal to 5% to 10% of the number of shares sold by the investment banker. The warrants usually have an exercise price equal to 100% of the price of the securities sold in the deal. Under this approach, the banker actually has more upside from the value of his warrants the lower the valuation of the business is at the time of the capital raise. In short, bankers have an incentive to complete a deal but necessarily at the terms that are best for the company.

Other things to avoid

Over the years, we have heard all sorts of schemes for raising capital. Smaller companies are particularly vulnerable. The best way to guard against poor advice is to use common sense. Avoid overly complex schemes or approaches you don't understand. Also, be leery of 'one trick ponies' that only have expertise in one type area such as reverse mergers, ESOPs and even bankruptcies. Chances are their advice will always lead back to their specialty whether or not that's the best approach for your company.

The ideal approach

All bankers say they have good intentions and integrity. The key is to make your contractual agreement match their good intentions. The easiest way to do that is to eliminate all variable based pricing and equity compensation and pay bankers an attractive all-cash fee based on a successful funding. Should your investment banker become an on-going advisor, equity compensation may make sense for both parties but you can best determine that after the initial engagement is complete.

Ultimately, investment banking fees should be based on a successful completion of the project, as is the case with any other project. The best advisors strive to deliver not just one financing proposal but a variety of financing options that gives a client an opportunity to pick their best option. When bankers deliver a variety of financing alternatives for a reasonable total cost, clients perceive the value delivered to be far greater than the fees paid.

Overview of Investment Banking Fees and Issues

Companies considering using an investment banker for the first time often question the high fees and value of such services. However, it's not just the fee amount that should concern companies. Several common engagement practices often work against the best interests of the Company and its equity holders.

Typical Investment Fees and Approach

Investment banking fees often include three components: an upfront or monthly retainer, a cash fee paid upon closing and additional equity compensation. Most investment bankers charge fees that equate to between 3% and 10% of the total capital raised. The larger the capital raise the more lucrative the fees become even though it's the same amount of work involved. For this fee the banker will typically develop a business plan, solicit investors, receive proposals (called 'term sheets'), negotiate proposals and help the company close the transaction.

Common Conflicts

In practically every investment banking engagement, there are two contractual approaches which almost always create conflicts of interest between the investment banker and company seeking to raise capital.

Fees vary based on the type of capital raised - Advisors that raise capital on a percentage basis usually charge two to three times the percentage fee to raise equity capital versus debt capital. Most bankers charge a fee of 1-3% for debt and between 5% to 10% for equity capital raised. This difference in percentages creates a strong incentive for an advisor to recommend or guide a client towards equity sources over debt sources. In addition to doubling or tripling the investment banking fee paid by the company, it can needlessly dilute the owners' equity.

Additional Equity Compensation - In addition to significant cash fees, most investment banking fees include equity compensation. Most equity compensation is paid in the form of warrants. Warrants are generally a number of shares equal to 5% to 10% of the number of shares sold by the investment banker. The warrants usually have an exercise price equal to 100% of the price of the securities sold in the deal. Under this approach, the banker actually has more upside from the value of his warrants the lower the valuation of the business is at the time of the capital raise. In short, bankers have an incentive to complete a deal but necessarily at the terms that are best for the company.

Other things to avoid

Over the years, we have heard all sorts of schemes for raising capital. Smaller companies are particularly vulnerable. The best way to guard against poor advice is to use common sense. Avoid overly complex schemes or approaches you don't understand. Also, be leery of 'one trick ponies' that only have expertise in one type area such as reverse mergers, ESOPs and even bankruptcies. Chances are their advice will always lead back to their specialty whether or not that's the best approach for your company.

The ideal approach

All bankers say they have good intentions and integrity. The key is to make your contractual agreement match their good intentions. The easiest way to do that is to eliminate all variable based pricing and equity compensation and pay bankers an attractive all-cash fee based on a successful funding. Should your investment banker become an on-going advisor, equity compensation may make sense for both parties but you can best determine that after the initial engagement is complete.

Ultimately, investment banking fees should be based on a successful completion of the project, as is the case with any other project. The best advisors strive to deliver not just one financing proposal but a variety of financing options that gives a client an opportunity to pick their best option. When bankers deliver a variety of financing alternatives for a reasonable total cost, clients perceive the value delivered to be far greater than the fees paid.

Additional places to see examples of investment banking fees and the expected fees for a capital raise: www.lanternadvisors.com/investment_banking_fees.html