If you are a business owner who is planning to sell your business, you may have heard of the Lehman Formula. This is a common method of calculating the brokerage fees or commissions that you will pay to an investment bank or a business intermediary who helps you with the transaction. In this article, I will explain what the Lehman Formula is, how it works, and what are some of the variations and alternatives that you may encounter.
The Lehman Formula was developed by Lehman Brothers, a former global investment bank, in the 1960s. It was originally used to determine the fees for raising capital for corporate clients, either in public offerings or private placements. The formula is based on a sliding scale of percentages applied to different tiers of the transaction value, as follows:
- 5% of the first $1 million
- 4% of the second $1 million
- 3% of the third $1 million
- 2% of the fourth $1 million
- 1% of everything above $4 million
For example, if the transaction value is $10 million, the fee would be:
- 5% x $1 million = $50,000
- 4% x $1 million = $40,000
- 3% x $1 million = $30,000
- 2% x $1 million = $20,000
- 1% x $6 million = $60,000
- Total fee = $200,000
Advantages of The Lehman Formula
The advantage of the Lehman Formula is that
- it is easy to understand
- it is easy for the client to estimate the fees
- it also provides an incentive for the investment bank or the business intermediary to maximize the transaction value, as they will earn a higher percentage of the higher tiers.
Variations and Alternatives of the Lehman Formula
Despite the eminent advantages, the Lehman Formula also has some drawbacks. One of them is that it may not reflect the complexity and difficulty of the transaction, as some deals may require more work and expertise than others. Another drawback is that it may not account for the inflation and the changes in the market conditions over time. For instance, $1 million in 1960 is equivalent to about $8.8 million in 2020, according to the Bureau of Labor Statistics. Therefore, the original Lehman Formula may not be appropriate for today’s transactions.
To address these issues, some variations and alternatives of the Lehman Formula have been developed over the years. Some of them are:
Double Lehman
This is a modified version of the Lehman Formula that doubles the percentages for each tier. For example, 10% of the first $1 million, 8% of the second $1 million, and so on.
For example, if the transaction value is $10 million, the fee would be:
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- 10% x $1 million = $100,000
- 8% x $1 million = $80,000
- 6% x $1 million = $60,000
- 4% x $1 million = $40,000
- 2% x $6 million = $120,000
- Total fee = $400,000
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This is usually used for smaller transactions that are below $10 million, as they may involve more risk and effort for the broker.
Million Dollar Amount (MDA)
This is another modified version of the Lehman Formula that uses $10 million increments instead of $1 million. For example, 5% of the first $10 million, 4% of the next $10 million, and so on. This is usually used for larger transactions that are above $100 million, as they may involve less risk and effort for the broker.
Flat Fee
This is a simple method of charging a fixed amount for the transaction, regardless of the value. For example, $250,000 for any transaction. This is usually used for transactions that are very complex or difficult, or that have a high degree of uncertainty.
Hybrid Fee
This is a combination of the Lehman Formula and the flat fee, where the broker charges a lower percentage of the transaction value plus a fixed amount. For example, 3% of the transaction value plus $100,000. This is usually used for transactions that have a moderate level of complexity and difficulty.
“If you think it’s expensive to hire a professional, wait until you hire an amateur.”
As you can see, there is no one-size-fits-all formula for determining the brokerage fees for your business sale. The best method depends on the size, nature, and circumstances of your transaction, as well as the market conditions and the negotiation skills of the parties involved.
- Therefore, it is important to consult with a professional and experienced business brokerage advisor who can advise you on the most suitable and fair fee structure for your deal.
- A business brokerage advisor is a experienced expert who has the knowledge, skills, and ethics to assist you with the entire process of selling your business, from valuation to closing.
- By hiring a business brokerage advisor, you can ensure that you will get the best possible outcome for your business sale.