The Pitfalls of Success Fee Arrangements in Business Transactions

Success fees are often touted as an attractive option in business transactions, particularly in mergers and acquisitions (M&A).

On the surface, they seem like a win-win: clients pay only if the deal closes, aligning the interests of both parties. However, the reality is far more complicated and these arrangements frequently fall short of delivering the desired outcomes.

Here is why working on a success fee basis rarely works as intended.

Misaligned Incentives

While success fees ostensibly align the interests of the advisor and the client, they often create misaligned incentives. Advisors under a success fee model are primarily motivated to close deals, sometimes at the expense of the client’s best interests.

This can lead to rushed deals or agreements that are not optimal for the client but generate the advisor's fee.

For instance, an advisor might push for a sale even if the timing is not right or the terms are unfavourable. The focus shifts from getting the best deal to simply getting any deal done. This misalignment can result in suboptimal outcomes that may hurt the client in the long run.

Quality Over Quantity

When advisors work on a success fee, there’s a tendency to prioritise quantity over quality. The advisor might juggle multiple deals simultaneously, aiming to close as many as possible to maximise their earnings.

This can dilute the attention and effort devoted to each individual transaction, leading to less thorough due diligence, weaker negotiation strategies and potentially overlooking critical deal-breakers.

In contrast, a fixed fee or retainer fee structure incentivises the advisor to devote adequate time and resources to each transaction, ensuring a thorough and meticulous approach that enhances the chances of a successful and beneficial outcome.

Financial Pressures and Ethical Concerns

Success fee arrangements can place significant financial pressure on advisors, particularly smaller firms or individual consultants.

The uncertainty of payment can lead to ethical compromises, where advisors might prioritise their financial survival over the client’s best interests.

Furthermore, clients might face inflated valuations and over-promising as advisors, eager to secure the success fee, paint overly optimistic pictures of potential deals. When reality sets in, these inflated expectations can lead to disappointment and distrust, damaging the client-advisor relationship.

Short-Term Focus

Success fees inherently promote a short-term focus. Advisors are motivated to close the deal and move on to the next, often disregarding the long-term implications for the client. This short-termism can result in agreements that look good initially but may not stand the test of time, potentially leading to legal disputes, integration issues or even buyer’s remorse.

Long-term advisory relationships based on retainers or hourly fees encourage a more strategic approach, where advisors and clients work together to achieve sustainable growth and long-term success rather than quick wins.

The Value of Commitment

When clients commit to paying a fixed fee or a monthly retainer they are more likely to be serious about the transaction. This mutual commitment fosters a more collaborative and dedicated working relationship, enhancing trust and communication between the advisor and the client.

Success fee arrangements, on the other hand, can attract clients who are less committed or less serious, hoping to get advisory services without upfront investment. This can lead to wasted time and resources for both parties, with no guarantee of a successful outcome.

Conclusion

While success fees might seem appealing due to their perceived alignment of interests and risk-sharing, the reality is that they often lead to misaligned incentives, ethical compromises, and suboptimal outcomes.

A more balanced fee structure, where advisors are compensated for their time, expertise and execution rather than the mere completion of a deal, fosters a more dedicated, thorough, and client-centric approach, ultimately leading to better and more sustainable business outcomes.

The old adage holds true: you get what you pay for.

Investing in quality advisory services through a monthly retainers or fixed fees might seem costlier upfront, but it pays dividends in ensuring that the client's best interests are truly at the forefront of every deal.?

#BusinessStrategy #MergersAndAcquisitions #SuccessFees #FinancialAdvisory #DealMaking