What if your dentist gave away his services for free? Would prevention still matter? Would you still floss? What about your attorney or any other professional services firm?
In my work as an investment banker, we often charge up-front fees for the work we do. Such fees include preparation for pitchdecks, marketing lists and actual manual deal sourcing. It’s a way for us to mitigate our own deal risks, but is also puts some of the onus on the client. When we are not paid for the time rendered, we are not only taking the ride with our clients (something that only equity holders should do, in my opinion), but we are also saying to our clients, “we are not that confident in our services.” In other words, we put the same amount of value on our services that you do–which in this case is zero.
There is likely always going to be a valuation gap between the value we place on our deal preparation and deal marketing services vs. what our clients will put on them. That is always up for negotiation. However, when we do not charge for our services, we also are not as accountable to our client for lack of service. We value the client deal less and hence the client deal would get lower-rung priority. There value is 100% diluted on both sides of the table.
Client and banker together will place value on services rendered. We also do not want clients to walk. In some cases, we may have a client who–after a quality deal comes to the table–decides to walk. While break-up fees typically cover this type of scenario, in the absense of a break-up fee, lost up-front engagement fees have a positive psychological affect against cutting the cord early, regardless of whether such a decision violates the “sunk cost” principle.
While an alternative title to this post is, “you get what you pay for,” it does not paint the story accurately enough. Users of investment banking services should understand that you also have power in what you pay for. Paying an investment banker means s/he should be at your beck-and-call. You own his/her time. You also should have clear accountability and reporting on services rendered.
If the deal is a quality, lay-down opportunty (which usually means it is a quality sell-side M&A opportunity) you may be able to get a feeding frenzy among competing investment bankers in a beauty contest where up-front fees get asymptotic to zero, but in most cases, you pay for what you want done and you value and receive precisely what you pay for–at least when a true fluid market exists.
The reverse is also true. The more an investment banker values a deal, the less s/he is willing to charge. When an investment banker charges a $250K up-front engagement fee, what is the signal you are receiving?