Holly founded ExitPromise.com as well as StartupPromise.com and so far has answered more than 3,000 questions asked by business owners about starting, growing and selling a business.
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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 are a South African based “funding intermediary services” firm (or broker) that facilitates M&A and Private Equity transactions by introducing companies seeking growth capital to PE companies and vice versa. We would like to work with US based PE firms that are looking at such opportunities in Sub-Saharan Africa. My question is, would we be subject to US SEC rules as a South African based company working with US PE firms? Who should we be signing the Mandate Agreement with, the US PE firm or the target company? Typically, who pays for the success fee, the US PE firm or the target company?
Kind Regards
M. Ntsoko
Marks,
I am a partner in a fully licensed (Exempt Market Dealer, or EMD) Canadian-based advisory practice, and we had to arrange a chaperoning agreement with an SEC registered firm for the purposes of running capital raising mandates. So the general answer is yes.
As for fees: typically, the seller or the company / capital seeking entity pays the fee, unless you have a standing buy-side agreement with a PE firm that will compensate the firm for the work required to source and dilligence deals. We have done both.
Hi Andrew
Great answer, thank you! Just for clarity, what you are then saying is that, it doesn’t matter even when the investment transaction happens far away in Sub-Saharan Africa where we are based, outside the US, for as long as we are dealing with a US PE firm, our company will still be subject to SEC rules? You are then suggesting that arranging a chaperoning agreement with an SEC registered firm is the solution?
That’s exactly right, Mark!
Not a broker brought buyer and seller together real estate deal land cost 850k with new building to be built for a tot. Cost of 2.4 mil, how much finders fee can I ask for from buyer or seller or both
Referral-only usually runs about one half of one percent from the seller, if you have asked and agreed in advance. If the buyer is putting up the building, that is the investment for which he purchased the land, and has nothing to do with you.
Hi Holly,
I recently sold my business to a private equity group. They’re now interested in hiring me to find and pursue other similar businesses from my industry which they also hope to acquire. I know the industry pretty well and believe that I can find them several opportunities. Purchase values will likely range between $5 million and $25 million. What is an appropriate commission that I should expect for being in a finder role like this?
Thank you,
Kevin
Hi Kevin,
Congrats on the sale of your business! Nice way to end the year!
What you are proposing to do (charge a percentage of the transaction for sourcing prospective companies for acquisition) may fall under the broker/dealer licensing rules so you should proceed with caution and learn more about what the law may require of you.
If on the other hand, you were employed by the Private Equity Group to source deals, you would not need licensing and could negotiate whatever salary you and the PEG found to be fair. Most of the PEGs I work with have in-house ‘business development officers’.
Hope this helps a bit…
I have a deal where a contact of mine brought a friend of his to our meeting who has an upstart developing company with an opening project of around 30 million dollars. I’m to small of a contractor forth is project but know of a company who would jump at the oppurtunity. How much should I ask for to bring the two together.
Hi Porter,
The Lehman Formula is not typically used when introducing a friend or colleague to another who may do business together. Doing so is a generous and effective way to build your reputation in the business community and will pay off tremendously over the span of your career. The Lehman Formula is used for Mergers and Acquisitions and it is intended to compensate those who bring capital or buyers and sellers together. The work done by such professionals in the context of capital and M&A is extensive if done properly and should not be confused with networking.
At least, that’s my opinion Porter!
Hi Holly,
My group has a medical device, patented, that is unique. For two years we have done much of the work, ie, patent, TMs, collateral, trade shows, packaging, product production, social media,website, HCPC code, etc. This product needs strategy and development General advisement for project funding and marketing execution–we have contacted a marketing group that wants a $25k retainer fee plus a Lehman scale success fee-they claim to have someone interested already–if they are not successful-is it kosher to ask for partial retainer refund?
Good morning Mark,
In my opinion, anything which is ethical and you negotiate with another party is kosher in my book 🙂
That said, here are a few other thoughts I have for your consideration.
In my experience, Marketing companies have expertise in packaging a profound message to attract buyers, investors and other stakeholders. Typically, they do not have contacts such as the investors you are seeking. I’d be cautious about paying them a retainer for successful investment. Pay them (or someone like them) to do what they do best–creating a message to attract what you are seeking.
There is plenty of money in the VC pockets and you should not have any trouble attracting gobs of interest in your medical device.
Keep me posted!
All the best Mark…
I own a medical recruiting firm and have the opportunity to introduce companies that want to be purchased to companies that are interested in buying. Several years ago one of my clients called me and asked me to help them sell their company. They were using Goldman Sachs and were not having any success. Their sales revenue was $90M per year. I introduced them to a large company that purchased them for $450M within 6 months of my introduction. I got nothing, since I was helping a friend. I have a similar opportunity; but this time, I want to get paid. What is a fair amount for me to ask for making an introduction that results in a sale similar to the one mentioned above?
Thanks
Hi Tony,
Based on your question, it doesn’t appear to me that you are licensed to represent a business for sale under the SEC or you State.
The SEC rules which apply to receiving success fees for deals have recently changed. You may have an opportunity to be paid, however you should carefully understand the legal landscape before doing so.
Here’s the letter from the U.S. Securities and Exchange Commission about M&A Success Fees for Privately Held Companies.
I realize you didn’t ask for all of that… I just want you to be fully informed.
Now, to answer your question. Given the size of the deal and the amount an M&A Advisor or Intermediary would be paid to represent the buyer or seller, you should consider how much your part as the introducing party is worth relative to the other duties and responsibilities. Kevin (above) asked a similar question…
All the best…
Hi Holly,
I introduced a deal worth $180-$200M when it’s all said and done. First capital amount the business owner is raising is $20M.
I looked at the Lehman Scale, but seems that is for more technical and as you say “a lot of hard work”.
What kind of fee/s should I expect/ask for now and/or ongoing as the introducer?
Very much appreciate your thoughts and counsel!
Best Regards,
Kevin
Hi Kevin,
If you are introducing acquisition targets to potential M&A firms, it is not unusual to be paid 10 to 20% by the M&A firm.
I can’t tell from your question if the introduction was directly made to the buyer or if it was to an M&A firm.
All the best…
“Thanks Holly,
The seller owns a product he wishes to develop and a business idea he wants to build, I’ll call him Mr. A. He has had this “dream” or idea for 10+ years.
The buyer (I’ll call them Group B) is a joint venture group who has the money to invest in something they see as valuable. They will put up the money for his idea and join him in it for the long term (sounds like at 7 to 10 years). But he remains in control and leadership on the idea and keeps production here in the US at least initially (first couple years).
I introduced Mr. A to Mr. C who is the connection to Group B.
I know Mr. A and Mr. C and put them together.
There is now a Memorandum of Understanding between Mr. A and Group B.
As I mentioned the total funding for this project is likely going to be $180-$200 million.
Please just share what I should ask for as a “finders fee” or “introducers fee.”
It was a few emails back and forth and a conference call and some phone calls.
No office space was used, no posters or overhead costs.
And that doesn’t minimize the connection – just makes it simpler I think.
Thank you!”
Hi Kevin,
Well, it sounds like you’ve got a few great relationships!
Because you’ve already made the introduction to the investor group and did not ask to participate by way of a finder’s fee, going to this group at this point to request payment may be very difficult to do.
That said, you may want to consider asking both parties what they feel to be a fair finder’s fee/compensation for your part in the transaction. If they value what you did and would like to be considered for future deals you may be privy to, they just may be pleased to write you a check!
As for the amount, it’s not unusual for the introducing party to receive roughly 10% of the fee paid to a transaction’s Intermediary. Using the Lehman Formula, it’s easy enough to calculate a reasonable fee range to start the conversation.
All the best…
Looking to broker a large deal. Asking price is in the mid 8 digit range. Since the Lehman scale was developed back in the 70’s. Should I set the 5% at the asking price and go 4%, 3% and so forth down the scale.
Hi Richard,
If your brokering a M&A transaction in the mid 8 figure range, using 5/4/3/2/1/ would be way above the market rates.
2% on the first $10 million and something less above $10 million is what I see being used in this deal size.
A deal this size usually takes a licensed Intermediary with a team of people to negotiate and close the deal. That’s why they are paid so handsomely. It’s a lot of hard work!
All the best Richard…
Holly,
So what do you see as “market” for a mid 8 figure institutional capital raise?
Thanks,
Hi Jesse,
What I’ve observed in terms of a rate for a capital raise is approximately two percent (2%). Given the size of the capital raise you are seeking, you may have room to negotiate.
All the best…
Afternoon!
I’m in the process of introducing an innovative organisation who is looking for an initial investment of $1.5 million to a VC and possibly Business Angels and or Institutional investors. I’ve now been advised that the overall investment required could reach $20 million. (They have a ‘VERY UNIQUE PRODUCT’) My question is: How would I structure the commission? I wanted to use the Lehman formula, (5,4,3,2,1) then using some of the commissions gain from the transaction, to inject that back into the company for an equity share. They want FICCI and the British Chamber of Commerce to be the arbitrators should there be a disagreement, but I want the whole contract to be governed by UK jurisdiction and law. The VC’s have no involvement in the commission structure. I’m a UK resident, the company is in Asia and the VC’s are in the US. Can you advice me how best to structure this.
Kind Regards; D.F.A
Hi Dennis,
To my knowledge, I don’t believe the Lehman Scale was intended to be used to compute a commission when someone is raising business capital from Investors, whether the investors are Venture Capital or Angels. Instead, the Lehman Scale was developed and in practice is used by Business M&A Intermediaries and Investment Bankers who are properly licensed to sell businesses.
As for UK Jurisdiction laws, rules and practices related to Venture Capital and Angel investing in start ups, I am sorry to say I unable to help you. My experience is based in the U.S.
In my work in the United States, I don’t normally see successful Startups paying a commission to someone who sources Venture Capital or an Angel Investment. Instead, I see the Startup founders exploring their own networks to source startup capital. That’s after they’ve depleted their own savings accounts and have approached their friends and family.
All the best…
Thank you for the information Holly.
Very much appreciate
Kind Regards
D.F.A
Good explanation of this method Holly. M&A Advisors often expect a retainer to cover their out of pocket expenses, which also serves as skin in the game on the Owner’s part.
Hi Paul,
Thank you and I agree with you! I’ve found some business owners reluctant to advance expenses in the form of a retainer… I don’t think they like the term ‘retainer’. It feels like something they pay Attorneys… at least that’s what I’ve observed.
One of the biggest hurdles for business owner selling his or her business is the notion of letting go. For so many, their business serves as their identity. Asking them to put up some cash in this form may shine a big bright light on the issue.
Thanks for your thoughts Paul!
Holly