Business Brokers and M&A Intermediaries may use or reference the Lehman Scale when discussing their investment banking compensation method with a business owner contemplating 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, investment banker or other 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
- 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.
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.
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We are about to close a loan agreement with an investment fund of more than 500 M, what is the finder fee that should be paid to whoever brought the parties closer so that this investment fund contributes the money to the company?
I’m setting up an M&A firm for mainly acquiring SMEs business estimate transaction size range from US$500k to 50m or higher. I am engaging (with top regional or Big4) third-party legal and accounting firm for DD and/or Audit works. Purpose is to have a good reputation for getting debt financing from investment banks. Those potential partner offered me with some upfront fees when the work start however I like to negotiate to get deferred or delayed fees payment only after deal closed. As soon as I get the deferred or delayed fees possible I am willing to pay a slightly higher than market price. Appreciate if you could kindly advise what should be the range since my transaction size are involve below 1m and above 1m please. Or Lehman 5/4/3/2/1 formula applied to my scenario. Thanks a lot.
Hi Watana,
Happy to offer you my thoughts…
The range of your proposed deals in your firm is very large. I’ve yet to see a single M & A firm representing deals from $500,000 to $50 Million and that’s simply because the skills of the dealmaker, selling process and network of buyers differ tremendously for main street business transactions and middle market transactions.
And that means the way in which an M & A advisor is compensated will be very different as well. Not just in the dollars paid to them.
Selling a $50 million dollar business typically requires research/preparation fees, retainers, travel and other deal-related expenses.
Not so for a main street deal. Retainers and other out-of-pocket expenses are typically minimal in a smaller deal, at best.
My observation of the transaction fees charged to business owners selling their businesses or raising capital is that they truly vary greatly from firm to firm. The Lehman scale is a starting point for consideration.
Good luck with your new firm!
Hello,
Brokering a deal for building a logistics park in Saudi by bringing both the investor in Saudi and the developer from Hong kong.
What is the fair finders fee percentage of the total project cost?
Talking about a deal worth from $200m-$300m
Also how much equity should i ask for?
Adding that i will ask from both sides
Appreciate your thoughts and wise counsel
Thank you