5-Min Read
January 2024
Is an M&A Advisor Worth the Service Fee? Let's do the Math.
It is logical for owners planning to sell their businesses, whether a full, majority or partial sale, to ask this question.
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Insight Details
There are two elements to consider when answering that question:
First, are the services provided, and therefore, the work performed, such that the fee is worth it?
Second, are the fees paid to an advisory team more than covered by the increased valuation that a well-run process can deliver?
We address the first question in this quick 5-minute read titled New to M&A?, by pointing out that the advisory deal team performs work that most owners, even with their finance and accounting team members, cannot do effectively because it requires specialized training, experience, appropriate bandwidth and, today, the right tech stack and business intelligence tools. Simply put, these tasks don’t get done or they are done sub-optimally to the detriment of the seller. It puts the buyer in control, not the seller.
Addressing the second question, which focuses on whether the net financial outcome will be better or worse for the owner if they engage an advisor and pay a transaction fee, the answer is close to unequivocal. It comes down to the forces of competition. In M&A, the winning bidder is one who puts in the best all-around offer. Conversely, some companies tend to field incoming calls from interested suitors. While it is nice to be sought after, an offer from one party lacking the dynamic that a competitive auction process produces will generally result in a suboptimal offer. How will the seller know this? The seller won’t, which is the point.
We expand on this by bringing simple math into focus. For instance, with an advisory fee of 4% of the transaction total Consideration, the advisory firm’s efforts only need to drive valuations 4.2% higher than what an owner can essentially do on his own to break-even from a financial perspective, apples to apples. And break-even is still likely a positive for the seller because the seller’s team would not have had to perform the advisory work itself. The market would have spoken, leaving no doubt about optimal value potential.
Given that a sale process run by an adept advisory team creates a competitive marketplace for the seller’s business, the 4.2% is an easy threshold to exceed. This is because a managed auction process produces high quality indications of interest (IOIs) by multiple prospective buyers at one time versus one offer by one suitor, as previously noted, who knows they are the only suitor. A lone suitor will naturally start with the lowest logical IOI in a scenario with no competition. Furthermore, the owner working solo would need to negotiate valuation up from this low point. That takes effort, skill, and information. This almost never results in movement to the level of a managed, competitive sale process led by the advisory team.
A more specific example highlights the financial upside more clearly. If a seller can attain a $50 million purchase price for her business without an advisor, what could she earn with an advisory team that charges a 4% transaction fee and runs a competitive process? As we illustrate in Exhibit A, below, if the competitive process pushed valuation up by just 7% to $53.5 million, the seller would receive 2.7% more in net proceeds after covering the fee, or an additional $1.36 million. If the process resulted in a valuation 15% higher, those values jump to 10.4% and $5.2 million, respectively. A 20% uptick in value nets the seller 15.2% or $7.2 million more.
For smaller transactions, if advisory fees are based on a higher percentage of Consideration, the benefit to the seller is still meaningful. If the advisory fee is 5% of Consideration, by example, and if the seller can get $20 million for his business without assistance, the firm would need to drive valuations only 5.3% higher to break-even. At 7% higher, the seller would receive 1.7% more, or an additional $330,000. A 20% uptick in valuations in this situation would result in net proceeds to the seller improving by 15% or an additional $2.8 million.
To round out this exercise out, we believe these examples to be understated. It has been our experience that the impact of hiring an experienced advisory team that leads a managed auction process results in a 50% - 100% improvement in valuation over selling on one’s own. The fee one would pay to an advisor, in other words, is self-funded – meaning, in effect, no out-of-pocket expense to the seller.
The takeaway here is that creating a competitive dynamic for the seller will never result in a valuation lower than that which the seller can obtain on his or her own.
Bottom Line
A well-run process by a skilled advisory team will almost always result in a higher valuation, more than covering the advisory fee by a meaningful amount. In other words, the owner receives significantly more in net proceeds.
Jenifer "Jak" Kihm, PhD
Jenifer “Jak” Kihm has led successful engagements producing sustainable outcomes related to M&A integration, growth acceleration, talent acquisition, due diligence, and process improvement. She has an accomplished record of working with C-suite leaders to help optimize people, process, and systems for global brands.
Jak brings multiple perspectives to the firm having led large-scale M&A integration initiatives including a 22-company rollup, a merger of two $150M equals, and exit for the CapStreet Group of national brand Talent Tree, a Houston-based business services firm.
An industrial psychologist, she plays a vital role in applying and considering client objectives throughout the deal process, including negotiations.
