Outcome-Based Pricing in M&A: Aligning Advisors with Founders
One of the first documents a founder reviews when engaging an M&A advisor is the engagement letter. Buried within the legal definitions and exclusivity clauses is the fee structure. For many founders, this is their first encounter with the cost of selling a business, and the numbers can be stark.
It is natural to view these fees purely as a transaction cost. However, in the high-stakes environment of mid-market M&A, the fee structure is actually a mechanism for behavioural alignment. It dictates how your advisor thinks, how hard they negotiate, and ultimately, whose side they are really on when the process becomes difficult.
There is a significant difference between a broker who is paid simply to close a deal and an advisor who is incentivised to maximise the outcome. Understanding the mechanics of outcome-based pricing ensures that you are not just hiring a service provider, but partnering with a team that has a mathematical vested interest in your success.
The Anatomy of M&A Fees
To understand alignment, we must first define the standard components of an M&A mandate. While every firm operates slightly differently, professional mid-market advisory generally relies on a hybrid model comprising two distinct elements:
- The Work Fee (or Retainer): A fixed monthly fee or staged payments paid during the preparation and marketing phases.
- The Success Fee: A percentage of the final Transaction Value (Enterprise Value), paid only upon a successful closing.
In lower-quality volume brokerages, you may see "contingency only" models (no upfront fees). Conversely, in large-cap investment banking, retainers can be substantial. For the mid-market technology founder, the ideal structure lies in the balance between these two.
The goal is to create a structure where the advisor is compensated for their intellectual capital and time (the retainer) but makes their profit on the outcome (the success fee).
The Function of the Retainer
Founders often ask: "If you are confident you can sell the business, why do you need a retainer?"
This is a fair question. However, it misunderstands the economics of a high-touch deal process. A proper M&A process requires hundreds of hours of senior attention before a buyer is even approached. This involves building the financial model, writing the Information Memorandum, and structuring the equity narrative.
The retainer serves two primary functions:
1. Resource Allocation It covers the cost of the advisor’s team during the intense preparation phase. Without this, the advisor is financing your deal from their own balance sheet. This creates a perverse incentive to rush the preparation to get to market quickly, rather than correctly.
2. Mutual Commitment Selling a business is invasive and demanding. A retainer signals that the founder is serious about the exit. It philtres out "tyre kickers" who might withdraw the moment due diligence becomes difficult.
When a founder pays a retainer, they ensure the advisor is not distracted by other clients who are paying. It buys dedicated focus.
The Success Fee: Engineering Alignment
The success fee is where true alignment occurs. This is usually calculated as a percentage of the Enterprise Value. However, a flat percentage is often a blunt instrument.
Consider a business expected to sell for £40 million. * Flat Fee: A 2 per cent fee yields £800,000 for the advisor. * The Conflict: If a buyer offers £35 million, the advisor’s fee drops to £700,000. The advisor might advise you to take the quick £35 million deal to secure their fee, whereas holding out for £40 million requires significantly more work for only a marginal gain in fees.
To solve this, sophisticated mandates often use a Ratchet Structure (or tiered pricing). This involves setting a benchmark valuation and increasing the fee percentage for any value achieved above that benchmark.
Example of a Ratchet Mechanism
Let us assume a target valuation of £50 million. A tiered structure might look like this:
- Base Fee: 2 per cent on the first £50 million.
- Incentive Fee: 10 per cent on any value above £50 million.
If the business sells for £50 million: * Advisor Fee = £1.0 million (2.0% effective rate)
If the business sells for £60 million: * Base Fee = £1.0 million * Incentive Fee = £1.0 million (10% of the incremental £10m) * Total Fee = £2.0 million (3.3% effective rate)
Why this works: In the second scenario, the advisor earns double the fee for achieving a 20 per cent higher valuation. The founder pays more in fees (£1m extra) but pockets significantly more in proceeds (£9m extra).
This structure ensures that when the negotiations get tough in the final hours, your advisor is fighting tooth and nail for every increment of value, because their upside is directly tied to yours.
The Dangers of "No Win, No Fee"
It is tempting to look for advisors who work on a 100 per cent success fee basis. This appears to de-risk the process for the founder. In reality, it transfers risk in a way that can damage the final outcome.
Advisors operating on a "contingency only" model are essentially playing a numbers game. They need to close deals to survive. This creates a strong bias toward: 1. Speed over value: Accepting the first credible offer rather than creating competitive tension. 2. Volume over quality: Taking on too many clients, hoping a few will stick. 3. Conflict of interest: They cannot afford to tell you "no" or advise you to walk away from a bad deal, because walking away means they earn zero revenue for their time.
A firm that charges a retainer has the financial stability to give you honest advice. If the market conditions turn, or if the offers are not good enough, a retained advisor can advise you to pause the process. They are paid to protect your value, not just to wash a transaction through the system.
Tail Provisions and Exclusions
Finally, it is worth noting two technical elements of the fee agreement that often cause confusion: the "Tail Period" and "Exclusions."
The Tail Period This clause protects the advisor’s work after the mandate ends. It typically states that if the founder sells the business within 12 months of terminating the advisor, to a buyer introduced by the advisor, the success fee is still due. This prevents a scenario where a seller meets a buyer through the advisor, fires the advisor to save the fee, and then closes the deal privately. It ensures the advisor can introduce their best relationships without fear of being circumvented.
Carve-outs and Exclusions If you have already been speaking to a specific strategic buyer before hiring an advisor, it is reasonable to discuss a reduced fee if that specific buyer acquires you. However, be cautious here. A good advisor will often improve the offer from a known buyer by introducing competitive tension from unknown buyers. The value of the advisor is not just the introduction; it is the negotiation leverage created by the process.
Summary
When reviewing a fee proposal, look beyond the headline percentages. Ask yourself how the structure influences the advisor’s behaviour.
- Retainers ensure commitment and fund the heavy lifting of preparation.
- Success Fees should be structured to reward outperformance, not just completion.
- Ratchets create the strongest alignment, ensuring the advisor is motivated to push for the highest possible valuation.
The cheapest advisor is rarely the one with the lowest fee percentage. The most expensive advisor is the one who sells your business for less than it is worth because their fee structure incentivised a quick sale over a good one.
In M&A, you are not paying for time; you are paying for an outcome. Ensure your advisor is remunerated in a way that makes your best case scenario their only goal.
If you are thinking about an exit and would value a discreet, no-pressure conversation, you can contact us here: https://leverapartners.com/contact/