AVOIDING SURPRISES FROM YOUR INVESTMENT BANKERS
By James Verdonik

Have you ever ordered something over the Internet and instead of picking the price, size, color, etc. you click on a button that says "Just surprise me!"

Of course not.

Yet, this often happens when companies hire investment bankers to raise money in private placements. Contracts with investment bankers describe in detail the fee to be paid if securities are sold, but often do not address valuation or what is being sold and to whom.

The result is that investment bankers are often hired with the expectation by companies that a transaction will have a certain valuation, or certain terms or certain types of investors as discussed with the banker. The contract, however, often provides that the banker earns the same fee for any deal that is closed with any investor on any terms. After several months trying to sell a deal, a company is often forced to close on a less attractive deal than it originally contemplated, but pays the same fee. You buy a Toyota for less than a Lamborghini, but you pay the same investment banking fee for all types of deals. To minimize unpleasant surprises at the end of your deal, you should:

• Specify in the contract a target valuation, types of investors, target date and primary terms.
• Structure a fee that rewards the investment banker for bringing a deal that meets the agreed specifications and provides a lower fee for a deal that does not meet the specifications.

Be prepared to meet resistance to this concept when you propose it. Specifications for deliverables are normal for most contracts you sign, but it is thought of as an unwelcome innovation by many investment bankers. Nevertheless, this is a tactic worth pursuing.

In dealing with investment bankers, you should know what terms are standard for the industry and those that are not, so that you can concentrate on the terms that can be changed through negotiation. Contracts with investment bankers usually contain the following provisions.

• Exclusivity. Exclusive rights to sell securities for a stated time period, generally in the range of three months to six months, but it can be longer. Although some freelance placement agents or brokers are willing to work on a nonexclusive basis, it is generally futile to attempt to get a reputable investment banker to agree to work on a nonexclusive basis. In some larger deals, however, that are similar to IPO's in scope, the deal may have a second investment banker or a co-manger.
  
  
• Term. Most contracts have a term of three months to one year. Since being tied to a banker who is not producing can harm your company, you should seek to be able to terminate on thirty days notice.
  
  
• Tails. Most investment bankers insist on being paid for money received after their services are terminated if it is raised from investors they introduced. This provision is called the "tail." Virtually all investment banking contracts have a tail of some kind, but the duration varies from one deal to another. A tail prevents companies from circumventing the investment banker's fees by delaying the closing or closing in installments. The tail usually lasts between three months and two years, but one year is the most common. In some cases (especially for longer tails), the investment banker's fee is reduced as time goes on.
  
  
• Company Investors. A company that is seeking to raise $10 million may know that it can sell $2 million to existing investors or to potential investors that it already knows. Investment bankers often seek to earn a fee on such sales. In many cases, however, they agree to a reduced fee for these sales. In other cases, no fee is paid.
  
  
• Investor Selection Process. It is extremely important to control both the number and the nature of investors an investment banker contacts to sell your deal, especially if you have any doubts about the quality of the banker you have retained. First, you want to select your investors and not just settle on the first investor who responds to a mass mailing. Second, if a solicitation is too widespread, the contract's tail provisions will give the banker a claim to a fee for almost any offering the company later does. Third, if a banker with poor connections does a widespread solicitation, it may impede your ability to later sell to these prospects. To avoid this, your contract should state that the banker will not contact any investor without your permission. When the investment banker submits a list of potential investors, ask questions to determine the best prospects. For example, ask to which prospects has the banker sold deals recently, how many, the type of deals and did the investor make a profit?
  
  
• Indemnification. Standard investment banking agreements require the company to indemnify the banker against any claim even if the banker was negligent. Typically, only gross negligence and willful misconduct are excluded from the indemnification. On the other hand, investment bankers usually do not indemnify companies for the banker's misdeeds. This may not seem fair or balanced, but it is standard and you just have to live with it.
  
  
• Follow on Deals. Investment bankers often seek the right to represent companies in transactions that will occur later, including a later IPO or sale of the company. This is a one sided commitment by the company. The banker has no obligation to do a later transaction. In many cases, the banker can be persuaded to drop this provision, but if the provision survives, the company may have to make economic concessions to the banker to obtain a waiver. Limiting this provision to one year and conditioning it on the banker delivering the agreed upon deal can make this more palatable to the company.