Holly also founded ExitPromise.com and to date has answered more than 2,000 questions asked by business owners about starting, growing and selling a business.She also offers consulting services to business owners as they choose their M&A advisors.
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Business Brokers, M&A Advisors and Investment Bankers may use or reference the Lehman Scale when discussing their compensation method with a business owner considering the sale of their business.
The method to compute the advisor’s compensation was originally developed in the late 1960’s and used by the Lehman Brothers when raising business capital for their clients.
Today, the Lehman Scale is also referred to as the Lehman Formula and has been adapted since its inception. It is widely applied to compute the commission paid to the business broker, M&A Advisor, Investment Banker or other professional serving as an intermediary in the sale of businesses of all sizes.
The Original Lehman
Before the Lehman brothers developed their scale, the fees charged by different institutions would vary widely, some reaching upwards of 15%. This method of compensation standardized these fees and was widely used up until the 1990s. The original formula applied to transactions above $1 million and followed a 5-4-3-2-1 tiered structure:
- 5% of the first $1 million
- 4% of the second $1 million
- 3% of the third $1 million
- 2% of the fourth $1 million
- and so on, with a 1% charge on everything above $4 million
The Lehman Scale Modifications
A $5 million transaction was very large when the scale was first introduced, but inflation made the formula unsustainable. Now, the Double Lehman or Modern Lehman formula is more popular as a method computing the advisor’s investment banking fee. Each percentage is doubled: 10% of the first $1 million, 8% of the second $1 million, and so forth. A Modified Lehman is also used, which charges 2% of the first $10 million and a smaller percentage of the remaining capital.
How the Lehman Formula Translates into a Commission Payment
The Lehman Formula is calculated by million dollar amount. For example, if a business owner is selling $5 million worth of stock, his fee would be totaled as follows using the Double-Lehman Scale:
- 10% of the first million: $100,000; plus
- 8% of the second million: $80,0000; plus
- 6% of the third million: $60,000; plus
- 4% of the fourth million: $40,000; plus
- 2% of the fifth million: $20,000.
- Total commission payment or fee paid to Broker or M&A Intermediary: $300,000
Expenses and Other Costs Related to the Lehman Payment Method
The Lehman Scale typically refers only to the success fee paid to the Business Broker or M&A Intermediary for successfully closing a deal. In addition to the success fee, firms also charge a retainer, which is intended to cover some of the costs associated with marketing the business for sale. Retainers are normally nonrefundable and are often credited against the success fee.
It is also important to keep in mind that the Lehman Scale is based on the value of the deal, not how much cash the seller actually receives. If the business owner has outstanding debts or liabilities, the amount they net from the sale transaction will be reduced whereas the total enterprise or deal value may be used to compute the success fee paid.
How to Negotiate the Lehman Scale or Commission Paid to Sell a Business
Understanding the Lehman Scale is a good starting point to know what you should expect to pay your Business Broker or M&A Advisor when selling your business. While variations of the Lehman Scale are still popular today, you should always talk with your advisor about how they calculate their fees and ask for plain language regarding what is to be included (or excluded) from the basis of the computation.
You should carefully consider whether the proceeds from the sale of the business, usually paid in the form of an earn out payment in the years that follow a transaction’s closing, are to be included or excluded from the Lehman formula. Also consider paying this success fee when, and only when, the business owner receives his or her payment through an earn out agreement.
As it is customary for the business owner to reimburse the Business Broker or M&A Intermediary for their out-of-pocket expenses during their engagement, it may be wise to negotiate a cap or at least retain the right to pre-approve such expenses.
Fee structures are often negotiated on a case-by-case basis, and you should consider all the factors of your transaction when considering the sale of your business.
We sold our business using a well-known broker agency and the structure for the fee was a flat success fee + an additional 10% for any proceeds over a target amount. Is it normal practice that the “bonus” percent would be also paid on a positive net working capital adjustment payment? I recognize we will pay whatever the signed agreement states, but at the time we signed the agreement, we did not have an understanding of NWC as it relates to a transaction. Just wondering if this is normally considered part of the business sale amount subject to fee.
Hi Stella,
First, congratulations on the sale of your business! It is always great to hear this news.
When I’ve been involved with M&A, the Net Working Capital adjustment (if positive or negative) has not been included in the success fee computation. And that’s because it’s the seller’s money (NWC) that is being returned to them at the closing table. Ethically, I’d have a problem expecting a commission/success fee for returning to the seller what belongs to them on the business’ balance sheet.
That said, your agreement with the broker or investment banker may have spelled out that the success fee includes the positive NWC adjustment when computing the success fee.
Again, I don’t think it’s fair to a seller to include it.
Nor do I believe the broker or investment banker would think it was fair if their success fee was reduced as a result of a negative NWC adjustment!
Hope all turns out well for you.
Again, congrats!
What are the updated tranches for the scale for 2022? We’re trying to negotiate fees with a banker for a business worth $25-35MM and they want a flat 5% – this seems absurdly high.
SP – there are no set scale for how investment bankers charge fees. A market fee for a transaction in that range is likely closer to 3%. Like anything, this can be negotiated with incentive structures and other ways to align the seller and the investment banker. I’d be happy to discuss with you how we price these types of transactions as we have sold multiple businesses in this range over the last twelve months.
SP: We sell a lot of businesses your size and did $220M in closed transactions last year. For all the clients between $15M and $100M that we supported last year, we charged a flat 3% fee for a mutually agreed FMV level; and then to the extent we get over that amount (We don’t put a price on our clients and let the professional process determine final price) we get 5% on the excess. This aligns interests with our client and us as we all are shooting to get a valuation that is premium and above market. If we just get market, the fee is 3%. I’ll share that all these transactions ended up well over the estimated FMV because we found exceptional buyers who could add a lot of value to those companies only if they were the owner of those companies. Clients are happy because this method for all intents and purposes, ends up paying for the overall fee and still puts more dollars in the Seller’s pockets. Happy to discuss valuation and fees further if you’re interested.
Matt Bradbury
Is a loan formula different than an equity raise or sale if a business.. also if the borrower puts up cash against the loan
Hi Bruce,
I think you are asking if the Lehman formula applies to capital sourcing (debt or investment).
If so, no.
The Lehman formula applies to the fees paid to brokers and investment bankers who represent a business for sale.
If that’s not what you were asking, please clarify and I will give it another whirl.
Do businesses pay finders for multiple rounds of investment (Series A, B, C,…) or is it generally limited to 1 or 2 rounds, or is there a different formula?
Thanks
Hi Steph,
Business owners will pay an investor finder whatever they agree to — it’s up to the two parties.
As for the formula/fee, it’s always negotiable.
All the best…
I am trying to find a financial organization for a refinance deal of $61 million. I am not a registered broker, I run my own business but was prompted to source a financial organization for the purpose. I want to find out if I can apply Lehman Formula for getting the two parties connected once the deal is successful?
Hi ADS,
Typically the fees for raising capital at this level/amount are closer to 1/2 to 1 percent of the amount raised.
Be certain you consult with an attorney before you propose your fee arrangement between the parties!
All the best…