For the last 20 years, I have been in the asset recovery business. In that time, 95% of our recovery contracts have been contingent-based contracts. More specifically, our firm helps companies recover overpaid sales tax and account payable overpayments. During those 20 years, I have negotiated hundreds of contingent contracts and would like to share my insights from both the seller’s and the buyer’s perspective.
My first experience with contingent fees came as a buyer in 1998 while working for a wireless start-up company. Like most start-ups, we had huge net operating losses (NOLs), and at that time the state of New Jersey only allowed a five year carry forward on NOLs. It was guaranteed that we would lose the right to use these NOLs BEFORE we were profitable. During that year, New Jersey introduced a new program for start-ups that would allow our company to sell the benefits of our losses to a profitable company to use against their tax liability. Without getting into the details – this was found money. However, I was not familiar with the program or methodology and as a result, hired a prominent Big Six (at that time) accounting firm to assist us. The firm offered us both a fixed fee and contingent model, and we chose the contingent model. The firm did a terrific job, and soon we had a $2M check, and everyone was happy. I even got to take a picture with the Governor.
Fast forward three years later. At this point, I had left the company, and I received an irate call from the new CFO. Why were we paying this accounting firm huge fees every year for something we could have done on our own? I explained to the new CFO that at the time it was a great deal for everyone, and the accounting firm was taking on significant risk since there was no certainty of our approval, but of course, he was not looking for an explanation, he was looking for someone to blame.
What are the Various Factors to Consider in Negotiating a Contingent Contract?
Whether you are the buyer or seller of the service, the factors are the same. I like to call these factors the THREE R’s:
Risk is the number one factor buyers want in a contingency deal. They do not want the risk of paying a fixed or hourly based-fee and not have a great return for their money. Also, if they are outsourcing this project, they do not want to take on the risk of spending internal resources (employees) without a guarantee of return. However, they are also weighing the risk of success. Buyers must make sure they have consensus on a contingent fee. If the project is a huge success – which everyone hopes for – your peers will question why you paid such a high fee.
In addition, there is one risk that buyers cannot avoid, and that is the risk of time. No matter what firm you choose, this project will cost you time and resources. For our projects, we require three years of data and remote access to the company’s ERP system. That much data will cost your technology team about 8 – 12 hours. We also require 2-4 hours a week of internal resources to review our findings. If a firm is telling you there is no commitment of internal time, throw that proposal away.
Of course, resources can be a way to reduce your contingency fee. If your company can provide better resources in a more timely and efficient manner, you may be able to negotiate a lower contingency rate. For example, our firm will accept a lower rate on an agreement from a client that provides us remote access to all of their systems and documents. If remote access is not an option and we have to bring a team onsite, a higher contingency rate will be required.
From the seller’s perspective, they are generally taking on all the risk. They bear all of the costs for the employees and travel, and if no money is recovered, they will lose money on a project. This is why it is very important to work with an experienced firm. You want to hire a firm that is confident that they will be successful. Maybe so confident that they are willing to reduce their rate.
The last type of risk you need to evaluate is project risk. Project risk is the risk that is taken on jointly between the buyer and seller. Part of our asset recovery process often involves requesting refunds from government agencies. Depending on the specific state and auditor, the refunds could take anywhere from three to 16 months. We would consider this an outside factor. For our projects, we evaluate the outside factors and consider those during rate negotiations. For the buyer, this risk needs to be considered and will be unique to each project. Our firm once uncovered a $2M accounts payable claim with one vendor only to discover that the vendor recently filed for bankruptcy. The result was pennies on the dollars over two years later.
What does the reward or success look like, and how much success will this project have? Let’s take a moment to define success. The reward does not always have to be monetary. For example, in many of our projects, our team will work with management to identify the deficiencies of internal processes and commit to a fixed number of hours to assist with improving these areas.
Buyers should look for an opportunity to bring true value to their companies by broadening the definition of what will be done and the “reward” that will be received. Buyers should work with their internal team to encourage them to learn from this project so they can be more successful in the future. Many times, contingent based projects can create negative feelings when large recoveries are identified, and someone is responsible for those errors. Buyers need to stress the purpose of the project is to LEARN from our past, not PUNISH people for it.
As a buyer, you may be willing to pay a higher contingency fee if the seller commits to certain objectives or additional services. This is a great tactic to employ when dealing with a firm that won’t budge on their rate and also creates good “vibes” on both sides of the deal.
From a seller’s perspective, the reward size will have a direct impact on their ability to negotiate a rate. In our business, we concentrate on understanding a company’s size and type of spend. The larger the pool of expense categories where refunds are typically found, the more likely we will negotiate. Other factors that affect the reward for our business is company location and industry. Each seller will have their own unique factors that will affect the potential reward and their ability to negotiate the contingency rate.
We don’t like to discuss this topic, but for both the buyer and the seller, reputation is a factor in negotiating a contingency fee. It may be helpful for the buyer to understand that the seller is not only negotiating with you but all future (and potentially) past customers. Our firm has faced many opportunities to work with many amazing companies whose logos we would love to have as customers, except for the fact that they were asking for a ridiculously low rate. Most quality firms will not put their reputation on the line for one great client when 100 other clients could be at risk. Buyers beware, if a seller bows out of an RFP because of a low rate, you may have just lost an opportunity to work with the best firm in the proposal.
As a buyer, you want to look like a savvy business person and negotiate the best deal possible. However, rate is not always the only way to look good. One important consideration is time. For example, if the buyer is not budging on the rate, you might consider asking for a specific time commitment from beginning to end of the project. Your company wants to receive rewards from this project but would prefer to receive them NOW instead of later. By negotiating that the seller must complete the project within two months, the company will save time and money on internal resources and can shift its attention to other priorities. A buyer’s reputation will be damaged if they negotiated a low rate, but the project took twice as long as expected.