Fee Event Dramatization

MegaBank A is approached by a client to help them advise on a purchase of their competitor funded by a mix of debt and externally issued equity.

My god, this will be a $50 billion dollar deal. 10 basis points means a $50 million dollar fee! – Coverage/M&A banker

They will also need to issue $10 billion of debt, where the indicative rating is BB-. We should have 30% of the economics with Credit Suisse also being a bookrunner which means 200 bps on 3 billion for a $60 million fee event! – LevFin banker

They will also need to issue $10 billion of external equity through a fully underwritten deal at 3% and we have 30% share of wallet which means $90 million! – ECM banker

Don’t forget that we will bridge to this and clip another 200 bps and the loan will never be drawn! – Loan syndications/corporate banker/LevFin banker

The vendor take-back equity can be hedged out with equity derivatives!

Part of the bonds will be floating and must be swapped back to fixed with IRD!

We will make money trading the equity and bonds post transaction! – Trading desks

*Preferreds, subordinated convertibles excluded from capital structure but you get the point

The investment bankers’ eyes all roll to the back of their heads and they collapse into a heap of euphoria.

Investment Banking Fees

Investment bankers are corporate finance experts. From the lowly level of analyst, investment bankers develop strong technical skillsets before moving on to execution and relationship management at the VP and director/executive director levels.

However, like all other client facing professional service jobs, the real moneymaker is a sales guy.

The smartest investment banking MD in the world, if he/she cannot communicate that to the client, will not be a rainmaker.

So the favorite topic for senior investment bankers is fees, fees, fees. Junior investment bankers can also get excited about massive fees but they are losers because none of that really trickles down to their bonuses unless they work in some weird bucketshop peddling junior cannabis or blockchain equities for a 10% commission.

Bonuses for senior bankers are determined by what they bring to the table that year, so a material amount of time is spent looking at what fees are market – which will involve junior bankers doing fee studies.

Investment banking junior staff will have an excel database of fees paid by transaction – both for ones the bank has worked on and from market intel on what other banks charged. M&A fees are mostly confidential and sensitive market information and the bankers will only have access to their own internal deals. However, they can sometimes be backed out from public disclosures.

Each product group will have these – although debt capital markets bankers and equity capital markets bankers have a more robust database as fees will be included in public disclosures and are very standard. When products become more structured (private debt), fees can vary.

You will notice that M&A fees are actually the smallest versus the financing arms (ECM, DCM) relative to the size of the transaction – at least by %. This is slightly offset by the advising bank getting the whole M&A advisory fee versus what is usually syndicated out in ECM or DCM.

This may be counterintuitive to people new to investment banking as mergers & acquisitions is the most well known division, but in a lot of ways M&A advisory is a loss leader for banks that use their balance sheets to underwrite capital.

When negotiating an agreement to work for a client, investment bankers will generally send along a fee proposal. If the client approves, the banker and the client will sign an engagement letter. Sometimes, the banker gets a verbal engagement and the engagement letter is sorted out later.

Investment Banking Engagement Letter

Every engagement letter is different, but generally they will have some of these components. There is a scope of work that is outlined (which of course leaves a lot of room for interpretation) and a few mechanisms for payment.

Retainer – Similar to legal or any other professional service, investment banks can be paid a monthly retainer. This retainer obviously ranges based on the size of the company and scope of work. If there is a successful fee event such as M&A, a restructuring, a capital markets issuance or some other outcome as defined in the engagement letter, the retainer can sometimes be partially or entirely deducted from the final payment.

Success Fee – Similar to a real estate transaction, the investment bank will be paid a commission for a successful corporate finance transaction as defined in the engagement letter. So for example, if there is an M&A transaction for $15 billion there may be a 15 basis point fee. There may be most favored nations clauses that prevent another advisor from making more. The larger the deal, the lower the percentage fee. Most banks will have fee floors where they are not willing to work on anything for less than $500,000 for instance. For elite boutiques, this number can be in the multi-millions.

For buy side mandates for M&A, investment bankers will often work for a success fee only.

Expense Reimbursement – The client will reimburse the investment bank for any reasonable fees generated during work for the client. So dinner expenses and flights will be costed back to the client. This is where the PwC accountants squeal about their Michelin Star dinners that they otherwise would not be able to afford with their meagre salaries.

Tails – similar to exclusive listing agreements that you would have with a real estate agent, this ensures that if the client transacts within a predetermined period (for example 12-18-24 months), the investment bank that was engaged will get paid some amount.

Where this becomes contentious (similar to real estate) is if the client does not use any of the work or an unforeseen circumstance arises before any work can be done and the client ends up transacting.