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How to Use Warrants to Pay Investment Banking Fees

Qualified investment banks usually
charge monthly retainers and a cash success fee when they help business
owners raise capital, growth equity, or other outside financing. In this
article, we explore how to incorporate warrants into the overall
compensation business owners pay to investment bankers when raising
equity capital. We also discuss some of the pros and cons of using
warrants versus straight cash compensation.

As we discussed in "How to Structure the Investment Banking Engagement Letter",
typically investment bankers charge a non-refundable deposit or
retainer plus a success fee based on closing a capital raise. A portion
of that success fee can be structured as equity compensation which
allows the investment bank to realize additional compensation should
there be a subsequent liquidity event such as a sale or IPO of the
company. Usually, equity compensation paid in exchange for investment
banking services is in the form of warrants. Warrants give the investment bank the right, but not the obligation, to purchase stock of the company sometime in the future. A good overview and description of warrants can be found here.  

Using the same example from "Business Valuation: An Introduction to Pre/Post Money Valuation",
suppose you and a partner start a company. You initially issue
1,000,000 shares of stock and divide them equally between you and your
partner. After some success, you decide you need additional capital to
continue to grow your business and you hire an advisor to help raise
funds. They charge a success fee of 10%, with 5% of the fee in the form
of cash compensation and 5% in the form of warrants.

So when the advisor finds an investor
willing to invest $5 million at a post-money valuation of $15 million
(giving an implied pre-money valuation of $10 million and the investor
500,000 shares) the intermediary will receive a success fee of $250,000
in cash plus 25,000 warrants.

Now suppose it is a few years later, the
capital has helped the business grow and through some great
strategic decisions and exceptional management, your company is in an
excellent position. You sell your company for $45 million. The
intermediary will exercise the warrants which will give them 25,000
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