To The Letter

Going Forward

The moment you have the underwriter's letter of intent in hand is, in effect, the start of negotiations, Moceri says. But before you load up for bear, make sure your attorney reads the letter of intent. (And if, for some unimaginable reason, you've gotten this far in the process without any legal counsel, it's time to get some.)

As for the issues at hand, there may be several of them, but, says Moceri, the ones sure to raise the most dust are the underwriter's compensation, the valuation of the business and the future share ownership or capitalization of the company. Valuation and future capital structure are the subjects of several hefty tomes, the life's work of many financial professionals and, therefore, beyond the scope of this article. But what is not-and what just as frequently scuttles the deal-is compensation.

"There are few, if any, underwriters who will negotiate their fees," says Moceri. The compensation investment bankers can receive on an initial public offering is regulated by the National Association of Securities Dealers Committee on Corporate Finance. According to Moceri, the maximum allowable compensation is often structured as a 10 percent commission, a 3 percent nonaccountable expense allowance, a consulting agreement with a monthly retainer, and warrants, which are options to buy additional shares of common stock. All this is spelled out in the letter of intent.

"It may seem like the underwriter gets paid an awful lot," says Moceri, "but in reality, it's hard for us to make money on fees." Aside from large costs of their own, a sleeping giant lurks in the underwriter's cost structure. If investors start selling your stock two months down the road, guess who's got to step up to the plate with millions of dollars and start buying? Of course, if the stock takes off, the underwriter's warrants will be worth millions. But by then everyone is rich, so who cares?

The moral of the story: Don't kvetch about fees because you will never win, you will always lose face, and you will very likely blow the deal.

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This article was originally published in the January 1996 print edition of Entrepreneur with the headline: To The Letter.

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