As companies in the  transportation and  logistics industry  continue to see  transactional activity,  many are considering  hiring an investment  banker either for growth  capital needs or for a  control transaction where the owners would  seek a change in control with a buyer. One of the  phenomena that has occurred over the past 10  years is that many companies, even those with  EBITDA as low as $4 million, are seeking out a  professional advisor in the form of an investment  banker in order to carry out an orderly process  and create an auction atmosphere, which,  arguably, can maximize the enterprise value of  the seller or the seeker of growth capital.

This article assumes that the seller or the owner  seeking growth capital has carefully analyzed  the appropriate investment banker for the  transaction. Some of the important variables to  evaluate are the investment banker’s experience  in the transportation industry and reputation as  a quality investment banker. It’s also important  to understand who “the team” would be from  the investment banking institution as well as  understanding that smaller enterprise-value  transactions may not be of interest to larger  investment banking firms that have a minimum  dollar amount they need to achieve if the sale or  growth capital transaction is successful. Many of  the larger firms require a minimum investment  banking fee of $500,000, or more in some  cases. Therefore, the owners of the company  should check out the investment firm’s previous  clients who both succeeded and failed in an  auction process in order to be comfortable that  (1) the firm has the right “sizing” and (2) they will  be interacting with senior investment bankers  who are experienced in the entire process.

If you have an accomplished “deal professional”  in your camp—be it a seasoned M&A lawyer  in transportation (always a key to a successful  transaction) or a similarly seasoned financial  advisor—this due diligence can be carried out  effectively and efficiently. Again, most owners  only sell or seek growth capital once, whereas  deal professionals are involved in hundreds  of sales over their careers and have both  knowledge and comfort in this area. However,  many owners do not engage a deal professional  until they have already selected an investment  banker and executed an engagement letter  (without consulting people who have often  negotiated these letters). Those of us in the  business have all experienced a seller or a  seeker of growth capital who has already  executed the engagement letter, with little or no  negotiation, and—trust me—this is not where  an owner wants to be.  

Instead, owners should be aware of the  following key points in an engagement letter and  seek expert advice to get the letter positioned  appropriately for their situation.

  1. Scope of the Engagement. These  provisions specify what the investment  banker will do for the owners; that is,  basically help them coordinate the process,  help them write the “teaser” that goes out  to potential interested parties, work with  their attorney on the NDAs (nondisclosure  agreements) sent to parties expressing  an interest after reading the teaser,  and working with their owners and the  attorneys and accountants to prepare the  Confidential Information Memorandum  (CIM). The investment banker will not create  independent research on the company,  although may help by providing a competitive  and industry description, but rather rightfully  relies on the company for the information. A  key to the scope of the engagement wording  is to ensure that the engagement does not go  beyond what you, the owner, are hiring the  investment banker to do; i.e., not expanding  for debt financings, joint ventures, IPOs and  other transactional matters. The owners need  to be clear that the letter only articulates  exactly why they are hiring the investment  banker and that it is the only engagement.
  2. Team and Termination. It is important to  articulate in the engagement letter who will  be on the team, as you do not want to work  with only junior investment bankers after  being “sold” by a senior investment banker.  No investment bank can promise that a  particular person will always be involved—as  he or she might leave the firm—but you can  get a “best efforts” type of arrangement.  As to termination, most engagement letters  should allow either party to terminate on 30- days’ prior written notice—some investment  banks will ask for at least six months before  this termination can occur, and that may  be reasonable under the circumstances.  As noted below, mere termination does not  eliminate other responsibilities the owner has  to the terminated investment banking firm.
  3. Fees and Reimbursement. Most investment  banks require an up-front fee to show good  faith on the part of the owners. This will vary  depending on the size of the investment bank,  but a fee of, in most instances, $25,000  to $50,000 that is credited against the  success fee is not unusual. As to the fee  on the enterprise value of the transaction  (what is known in most investment banking  agreements as “Consideration”), the fee will  typically be a certain percent up to a certain  enterprise value (a higher percent if a smaller  transaction), with that enterprise value to be  agreed upon between owner and bankers  as likely to be achieved. Thereafter, the fees  are structured in increments above the initial  enterprise value to encourage the banker to  seek a higher valuation. Again, this is done in  increments of dollars and can be stair-stepped  with two or three different increments. As  for a minority growth capital investment, the  fee will start higher, as the total dollars being  sought will be less than in a control situation.  Reimbursement of costs incurred by the  investment banker is usually in the $25,000  to $50,000 range, with any overage needing  prior approval by the owners.
  4. Consideration. This is a key element in  any engagement letter in that the total  consideration is how the banker gets his  or her fee. Consideration will include all  payments to the owners and will also include:  all assumption of debt (but excluding ordinary  payables) by the buyer; excluded assets that  the owners get to  keep after the closing  of the transaction; if a stock exchange, the  value of the stock (be it public or private);  any over-market terms on employment  agreements or noncompetition agreements;  and all “rollover” equity interests where the owners determine to maintain an ownership  position in the buyer. In short, all amounts that  the owners receive, or where they are relieved  of debt obligations, are included. Points worthy  of negotiation are: seller notes that are not  contingent (oftentimes being valued based  on a present value discount); seller notes or  earnouts that are contingent (with the banker to  get its percentage of that payment if and only  when received by the owners); escrow amounts  (sometimes not considered contingent but  sometimes one can negotiate to pay the banker  when the escrow is released in whole or in  part); and any other contingent “Consideration”  deemed worthy of discussion.
  5. Termination and Tail. As noted above,  termination of the investment banker upon  thirty-days’ notice, if not a minimum term as  might be negotiated, requires: that the owners  are still responsible for indemnifying the  investment bank, discussed below; that the  non-refundable fee remains non-refundable;  that the Confidentiality Agreement executed  up front by the investment bank remains in  effect (and should remain in effect for two  years after either completing a deal or having  a termination); that all reimbursements be paid  as noted above; AND the key element is that  the investment banking institution, whether or  not going through a full process, will have what  is known as a “tail period.” During this period,  if any party introduced by the investment  bank, or brought to the investment bank by the  owners (who have the responsibility to disclose  those parties to the investment bank), enters  into a transaction with the owners—and much  negotiation goes on as to whether it is a Letter  of Intent, a closed transaction or something  in between during that tail period—then the  investment bank is owed its entire fee.   

First, the time of the tail. Oftentimes 12–24 months will be suggested by the  investment banker. This varies with each  investment bank, but one should try to get  the “tail” down to 12 months after the  official termination. Second, the parties  introduced. This is usually based on anyone  that the investment banker or the owners  suggest might be the buyer or the growth  capital provider. Now, it is not unusual for  the investment bank to simply suggest that  after the termination it shall prepare such a  list of those parties that would qualify for the  12-month period. It is more desirable to have  a list as an exhibit to the engagement letter,  where both the owners and the investment  bankers have agreed that these parties were  discussed and, whether or not they were sent  “teasers” (a brief, anonymous description  of the company usually involving one or two  pages), if they were discussed and even  rejected by the owners, they should still go  on the list.   

Owners who are unschooled and do not have  experienced deal professionals helping them  may simply agree that anyone who enters  into a transaction with the company—with  no agreed-upon list—within 12 months  (if that is the tail period) will allow the  investment banker to get his or her fee. The  “tail” discussion as to length and the parties  on the list, if a list, is a sensitive issue to the  investment banker, as he or she does not  want to have excluded from that list parties  who in fact might be buyers and were talked  to by the owners but not put on the list. This  is a key element of a termination, and the  discussion requires significant experience to  iron out the details. It is important to be fair to  both the owners and the investment banker.

  1. Other Banker Duties and Competitors.  The investment banking firm is obligated  to communicate with the owners as to all  parties with whom it has discussed the  potential transaction. In addition, oftentimes  the owners will negotiate a provision that will  not allow the investment bank to represent  a competitor in a transaction while it is  representing the company. This is a carefully  negotiated provision, as the investment bank  does not want to be precluded from helping a  competitor as long as it does not directly affect  the owners’ transaction. These are parts of  the engagement letter where a seasoned deal  professional can be of great help.
  2. Indemnification. Of all of the provisions in  the engagement letter, this is the provision  that is the most “sacred” to investment  banking firms and little negotiation can  occur. Basically, the company is required to  indemnify the investment bank for any and  all claims arising out of the transaction, or  the process if the transaction does not occur.  Unless it can be shown that the investment  bank was completely creating the liability  due to its “wanton misconduct or gross  negligence” as determined by a final nonappealable court decision (highly unlikely, of  course), then the indemnification stands.    

The other part of this indemnification that  annoys owners is that in all cases, even  if the investment bank is found to be fully  creating the liability, its total indemnification  cap is the amount it received pursuant to  the transaction. Now, many owners read  these provisions—usually as an exhibit  to the main body of the agreement—and  are not happy with the concept. However,  if one understands that in the great  preponderance of private transactions, or  public transactions, the issues on liability  arise out of the company’s disclosures or  conduct or representations (and remember,  the investment banker makes clear in the  engagement letter that he or she is relying  solely on the company’s information to create  the teaser and the CIM and to conduct the  management presentations), then one can  understand why the engagement letter is  positioned as it is for indemnification. To be  sure, you can achieve a few concessions with  good, experienced deal counsel, but most of  these provisions will remain in place

As you can see from the discussion above, an  engagement letter has many variables, many  complications, and requires a careful review  and negotiation by the owners and the deal  professionals. Ultimately, with experienced  negotiation, all will be worked out and the  owners and the investment banker will be on  the same page and, most importantly, will be  focused on making the transaction a success.