That little jewel about M&A advisors and investment bankers was buried in Warren Buffett's 2010 letter to Berkshire Hathaway's shareholders. It was his dig at investment bankers and the incentive system that has evolved for corporate "advice" on mergers and acquisitions - namely that bankers are paid a success fee only if a deal is completed. Other than a small retainer, investment bankers typically do not earn anything if a deal does not close, giving them, in Mr. Buffett's opinion, little reason to recommend against a transaction.

Unfortunately, the success fee concept is not one that investment bankers came up with on their own - clients virtually require it.

Most M&A advisors believe they "have delivered real value when you keep your client from making a mistake, but that's not the way it works," according to Doug Hendrickson, Co-founder of MidCap Advisors. "Most clients love the concept of a success fee because it rewards the investment banker for helping to arrange a successful transaction, and it reduces the amount of money the client has to spend if the deal does not go through. In some ways that is irrational, but that's what clients insist on."

The System is Skewed

The problem, Mr. Buffett admits, is that the system is skewed. Companies are willing to pay advisers a supersize fee when and if they do a deal because then the fee is a part of the transaction and not an operating expense.

Mr. Buffett made a interesting suggestion that won't sit well with most clients. "[Clients] should hire a second advisor to make the case against the proposed [deal], with its fee contingent on the deal not going through."

For many companies it would be hard to justify a big fee if there were no deal, so success fees have evolved into an all-or-nothing game that clients like. Investment bankers are willing to play along, because the rewards can be high.

Getting Objective and Unbiased Advice

"Mr. Buffett makes an interesting point," said John Poppe, Co-Founder of MidCap Advisors, "This is why we advise our clients on the best alternatives to a transaction. Some say it is not in our firm's best interest, but we believe in long-term relationships."  MidCap Advisors regularly offers clients the opportunity to pay a flat monthly or quarterly fee for its frank and objective advice on deals. According to Poppe, however, "Very few clients go that route. Some claim that a flat fee structure could foster an environment of indifference or prolonged negotiations by the advisor. So, ultimately it comes down to truly trusting your advisors."