Hi, it's CJ Gustafson and welcome to Looking for Leverage.

Last week I wrote about how banker success fees get structured. A reader wrote back the next day about a founder he'd just met who was trying to terminate his engagement letter and had (unfortunately) read his tail clause for the first time in the process. The clause covered buyers the bank had never introduced (yikes!)

The reader had seen worse versions cross his desk at a prior job… fees asserted because someone's name showed up in an email six months earlier, transaction types nobody thought they were signing up for, post-closing payments pulled into the fee base. Horrors.

So without further adieu… today's term: the tail.

Let’s say you terminate the bank in March. You hire a new banker in August. And you sell the company in November. If the tail is long enough, the original bank (also) gets paid.

The concept takes like five seconds to understand. But the damage is spread across five parameters:

You should be aware that all five are negotiable. But people spend way more time negotiating the fee percentages in the front of the engagement letter than the tail language that resides in the back next to the super boring indemnification language.

The tail is not, on its own, a scam. A bank spends nine months building a buyer list, running management meetings, and getting multiple parties to the table. If you could fire them in month eight and sign with one of those buyers in month nine, no bank would take sell-side work. The tail protects work that was actually done.

What gets stretched is the scope. Five things to check:

Duration: Twelve months is market. Eighteen is common, and twenty-four gets signed more often than it should, because sellers are overly optimistic and don’t have any intention that day of firing anyone.

Who's covered: The version you want is a written list of specifically identified parties the bank introduced, delivered to you within ten business days of termination, capped at a set number of names. The version you’ll be handed (and should redline) covers any party “contacted” during the engagement, with no list and no cap. Under the second version, the bank never has to tell you who’s covered. It decides after your deal is announced, reading the press release and gets to work backwards.

Affiliates: If a listed party includes its affiliates, subsidiaries, successors, and portfolio companies, then one mid-market sponsor on the list drags in every company that sponsor owns. You can imagine how this potentially proliferates - imagine you put four sponsors on a 61-name list and suddenly you’ve covered a couple hundred sub-entities nobody ever introduced you to.

What counts as a transaction: A sale of stock or assets is obvious. Watch for minority investments, recapitalizations, refinancings, joint ventures, and licensing arrangements. I’ve seen minor debt deals trigger a tail. In one instance I heard of a dividend recap eleven months after termination triggering a full M&A success fee because “Transaction” was drafted too broadly.

What counts as consideration: Earnouts, rollover equity, seller notes, assumed debt, and retention payments could get pulled in. As we discussed last week, each one lifts the fee base above the cash that actually arrives in your bank account at close. You want this part to be as narrow and straightforward as possible (i.e., cash consideration paid to company upon close).

Keep in mind: An engagement letter binds the company, not the person who signed it.

The CEO who signed it can leave, the whole team underneath can turn over, and the obligation lives on. Unfortunately, nothing in your reporting calendar will surface this artifact, as it isn’t a covenant, it doesn’t appear on the compliance certificate, and no auditor asks for engagement letters.

Let’s imagine a $180M sale, with two banks in the picture:

Which leaves two closing dates:

The delta is $3.7M, which is reason enough to pause and think about when the deal should actually close.

By the time we ran our process, most of the management team had been replaced. The CEO who signed the company’s original engagement letter had been gone more than a year, along with the bank he hired. Nobody currently in the building had been in the room for any of the prior bank negotiations.

We had a signed LOI and a buyer working through confirmatory diligence when that letter surfaced. The tail was still running. The bank had never been required to produce a list of covered parties, which meant the list lived in their files and would very likely include the party we were selling to. Paying it would have meant paying two banks a comparable fee for one sale, and only one of them had done work on it.

So we waited. We slowed the close, held the tail out past expiration, and signed roughly two months later than planned. Two months is a long time to ask a buyer to hold. Which was a tough ask. Financing commitments age, diligence findings go stale, and a management team that has already mentally moved on has to keep showing up for calls. Plus, from the CFOs perspective, a single bad month in the interim would have landed in the buyer’s updated model and perhaps triggered a retrade.

Luckily, nothing broke. But we spent the final stretch of a multi-year hold managing around a document signed by someone who no longer worked there, which was a total pain and added risk to a deal that we really didn’t need.

Inventory what’s already live: Pull every engagement letter the company has signed in the last twenty-four months, including the ones signed before you arrived and the ones for processes that died.

Ask your predecessors’ counsel, not just your own: If there’s been a CEO change, the letter you’re looking for may never have made it into the current document management system. Prior outside counsel usually still has it.

Demand the list: If you’ve terminated a bank inside a live tail, send a written request for the covered parties. If a bank won’t put names on paper, assume it will try to work backwards to its preferred outcome, and have your lawyers ready.

Negotiate the next one before you need to:

Wishing you a short tail and a list with actual names on it,

CJ

Looking for Leverage breaks down one PE term, clause, or mechanic each week, written for the CFOs and finance leaders who actually have to live with these things. If this got forwarded to you, subscribe at lookingforleverage.com. If there's a term you want broken down, reply and tell me. I read everything.

Thanks for reading, and make sure to check out our sponsor, Netsuite.

Readers of Looking for Leverage can try NetSuite Next for free.