Key Takeaways
- Tiered commission structure for large transactions.
- Original rates: 5% first million, then decreasing.
- Modern variants double fees for middle-market deals.
- Used mainly for M&A and capital raising fees.
What is Lehman Formula?
The Lehman Formula is a tiered commission structure developed by Lehman Brothers in the 1970s to calculate success fees for investment banks and brokers on large transactions, typically exceeding $1 million. It applies decreasing percentage rates to successive million-dollar increments of the transaction value, aligning fees with deal size and complexity.
This formula is widely used in mergers and acquisitions, capital raising, and other financial advisory services, often serving as the basis for negotiating compensation on sell-side engagements.
Key Characteristics
The Lehman Formula features a structured sliding scale designed to reward advisors proportionally for the size of the transaction. Key traits include:
- Tiered percentages: Rates start at 5% on the first million and decrease incrementally, encouraging larger deal facilitation.
- Original and modern versions: The classic formula is often modified into variants like the Double Lehman to reflect inflation and deal complexity.
- Success fee basis: Fees are typically paid upon closing, incentivizing completion of transactions.
- Negotiability: Advisors may adjust percentages based on deal size, complexity, or market conditions, influenced by factors such as the macroeconomics environment.
How It Works
The Lehman Formula calculates fees by applying specific percentages to each successive million dollars of the transaction value. For example, the original formula charges 5% on the first million, 4% on the second, and so forth, which reduces the marginal rate as deal size grows.
Modern adaptations like the Double Lehman increase these percentages to better compensate advisors managing mid-market deals with higher complexity or longer timelines. This tiered approach balances advisor incentives and client cost, with fees typically negotiated alongside retainers or minimums.
Examples and Use Cases
The Lehman Formula is commonly applied in M&A advisory, stock sales, and capital raising scenarios across various industries. Examples include:
- Airlines: Investment banks advising companies like Delta on mergers or stock offerings may use this formula to structure their fees.
- Financial institutions: Firms such as JPMorgan often employ tiered success fees based on transaction value in complex capital market deals.
- Investment tools: When selecting services, comparing fee structures alongside options like those offered by best online brokers can help optimize your overall investment costs.
Important Considerations
While the Lehman Formula offers a clear and historically accepted framework, you should consider its flexibility and context. Inflation and evolving deal structures have led to numerous modifications, so always review the specific terms and negotiate fees that reflect current market realities.
Also, keep in mind that the formula focuses on success fees and may be combined with upfront retainers or flat charges, especially for smaller deals. Understanding related concepts like the par yield curve can further inform your approach to transaction costs and financing.
Final Words
The Lehman Formula remains a key benchmark for structuring success fees in large financial transactions, balancing incentive and fairness. Review your deal size and complexity to determine if the original or a modern variant fits best before negotiating fees.
Frequently Asked Questions
The Lehman Formula is a tiered commission structure developed in the early 1970s to calculate success fees for investment banks and brokers on large transactions, typically over $1 million. It applies decreasing percentage rates to successive million-dollar portions of the deal value.
The original Lehman Formula charges 5% on the first $1 million, 4% on the second, 3% on the third, 2% on the fourth, and 1% on any amount above $4 million. This tiered scale rewards advisors progressively less as deal size increases.
Inflation and larger deal sizes have made the original Lehman Formula less sustainable, leading to variations like the Double Lehman which doubles the commission percentages for middle-market transactions to better reflect the complexity and effort involved.
The Double Lehman Formula doubles the original percentages, charging 10% on the first $1 million, 8% on the second, 6% on the third, 4% on the fourth, and 2% on amounts above $4 million. It is commonly used for middle-market M&A deals.
The Lehman Formula is often used as a success fee structure for sell-side services in mergers and acquisitions, stock sales, capital raises such as IPOs, mergers, or spin-offs, usually paid upon closing the transaction.
Yes, other variations include the Modified Lehman, which might apply a flat rate on the first $10 million, and the Convex Lehman, which rewards exceeding fair market value. Fee structures can also include retainers or minimum fees depending on deal size.
For a $5 million transaction, the fees would be 5% of the first million ($50,000), 4% of the second ($40,000), 3% of the third ($30,000), 2% of the fourth ($20,000), and 1% of the fifth million ($10,000), totaling $150,000.
