What is a Fee Tail?
A Fee Tail is a provision that is included in an engagement letter relating to the termination of an investment banker’s engagement in a sale transaction. The services of the investment banker handling the transaction may be terminated before closing the deal, and the fee tail provision offers guidance on how the banker will be paid. The provision requires that if a new transaction is sealed within a pre-established tail period (usually 12 to 24 months) with a client that was introduced by the investment banker, the latter should receive the original fee that was agreed upon during the engagement.
However, for the fee tail to be effective, the investment banker must meet certain conditions. First, the future transaction must occur within the predetermined tail period indicated in the engagement letter. Also, the future transaction must occur with a banker who signed a Non-Disclosure Agreement (NDA) with the company during the engagement term. Lastly, the termination of services must occur “with no cause” as stipulated in the engagement letter’s terms and conditions. If there was a “good reason” for the termination, or the banker voluntarily terminated his/her services, no fee tail is due to that banker.
Fee Tail period
The tail period refers to the time duration during which an investment banker working on the company’s transaction is entitled to receive compensation after the deal closes, even after the termination of his services. The tail period is indicated in the banker’s engagement letter, under the termination of services clause.
An engagement letter is signed when a firm that wants to sell enlists the services of an investment banker to help them find potential buyers. The banker may receive a retainer fee at the start of the transaction or agree to receive a percentage (1% to 3%) when the deal ends. The engagement letter details the terms and conditions of the work, including the payments and termination provisions.
Depending on the company, the tail period ranges from 12 to 24 months. If the banker’s contract is terminated before the transaction is complete but within the tail period, he/she is entitled to receive the agreed full fee. The tail period protects bankers who spent time and effort to identify potential buyers, but whose services were terminated before closing the deal.
Fees Payable to the Investment Banker
Progressive fee structure
The fee structure and the mode of payments to the investment banker are contained in the engagement letter. In most cases, the fee paid to the investment banker is calculated as a percentage of the final price for which the company is sold. The investment banker may negotiate for a progressive fee structure where the negotiations with a buyer may result in a higher selling price than the seller expects. The progressive fee structure is designed in a way that the banker’s fee increases when the selling price reaches certain levels. In some circumstances, the client and the banker may agree on minimum or maximum fees for the transaction.
Retainer and success fee
Apart from the progressive fee structure, some bankers prefer to be paid a retainer fee and a success fee when the transaction is closed. The engagement letter may require the payment of a certain retainer fee after the achievement of specific milestones or events. For example, the signing of the letter of intent, receiving the first batch of payments for the sale of the company, etc. The success fee is paid when the transaction has been completed and fully paid. Some bankers may agree to offset any amount owed as a success fee against the retainer fee. Bankers try to lock in the success fee to protect themselves against termination of their engagement before they are able to close the deal.
The engagement letter should include a provision that requires the client to reimburse the investment banker for all the expenses he/she incurred in the course of the engagement. The company may put a limit on the amount of expenses that the banker will not exceed, and any further expenses beyond the cap require the client’s approval. The limit could be on individual expenses, aggregate limits, or monthly limits.
Timing of the Fee Tail
The engagement letter also includes provisions relating to the timing of the fee owed to the investment banker. For example, the potential buyer of a company may express concerns over the projected future revenues of the company he wants to buy but is willing to pay an additional fee if the projections turn out to be correct. In such a case, the company/owners may not want the investment banker to collect any fee payments until they’ve been paid all the amounts due. Therefore, in such a situation, the engagement letter must stipulate that the investment banker only gets paid after the purchase price is earned and paid. If the banker objects to the clause, he may agree to factor in only the received payments at the closing date when calculating the fee owed to the banker.
Investment Banker’s Services
For the investment banker to receive payments from the engagement, he must offer services that are provided for in the engagement letter. These services may include reviewing the company’s past financial reports, preparing future financial projections, identifying and negotiating with potential buyers, conducting due diligence on potential buyers, and coordinating negotiations for the sale of the company.
If the client requires additional services not disclosed in the engagement letter, the banker may request an additional fee for the services. The engagement letter should also include a provision stating that the company is the final decision maker on matters such as accepting and rejecting an offer, engaging a bidder in further negotiations, and preparation of marketing materials. This helps reduce conflicts of interest between the company and the banker.
CFI is the global provider of the Financial Modeling and Valuation Analyst (FMVA) designation, an intense online program designed to transform anyone into a world-class financial analyst. To continue learning and building your career, these additional CFI resources will be helpful: