Success fee for corporate deals
For financial transactions, the success fee is the compensation, usually a commission which is paid to the advisor for the deal for successfully finalizing a transaction, usually a merger or acquisition, business sale. Typically an investment bank will be the advisor for the deal and the fee is a percentage of the enterprise value of the company. The fee is only paid after the deal is closed. Though the fee may appear to be high, it ensures that the advisor works so that the seller gets the best possible deal. The investment banker is taking some risk handling a deal in which they do not get paid, if the deal is not finalized. A highly rated investment banker is usually able to increase the value of the deal significantly, and the fee is a fraction of the increased price of the deal.
In cases where the investment banker is only paid a flat fee for successfully closing the deal, the banker may try to finalize the deal at the earliest, without trying to get the best possible price or the best buyer. Hence to get a better price for the business, the seller should finalize the compensation structure so that the banker will get a higher amount, if the price is higher. If the seller receives a offer which is the minimum he is expecting, the banker will receive a success fee of less than 3%. On the other hand, if the offer received is much higher than the expected price, the advisor could receive a 7% additional compensation for the difference in offer price and minimum expected price.
Benefits of having a fee structure
There are multiple reasons why businesses will have insist on a fee structure for finalizing a deal. The fee structure will align the interests of the advisor and client . The business will reduce their expenditure and save some money since no fee will have to be paid, if the deal is not finalized. Since a higher priced deal will get the advisor a higher commission, he will be motivated to get the best possible price. It is also easy for all those involved in understand the fee structure which is specified.
Drawbacks of a fee structure
A business owner should be aware of the disadvantages of having a success fee while finalizing a transaction. If the probability that the deal will be finalized is less, the advisor may not be interested in the deal, and make less effort, since they are not likely to get any commission. For a flat fee structure, the advisor is likely to want to finalize the deal at the earliest, since he will make the same amount, irrespective of the value, so that he can work on other deals. In this case the interests of the advisor and client are differing, and the seller will not get a good deal.
The advisor is also taking a lot of risk since he is taking the effort to finalize the deal, spending a lot of time and is not getting paid anything if the deal is not finalized. Hence in some cases, the advisor may receive a nominal amount, for the time spent, effort, even if the deal is not finalized. The success fee could be more expensive for the seller compared to a fixed fee, or work charges.
The success fee varies depending on the region where the deal is being finalized and also industry. The seller should be aware that the fee is negotiable. For deals of enterprise value less than $1 million, the fee is 8-10% while for deals of value $500 million or more, the fee is typically 0.5-1.5%