What Is the Lehman Formula?
Calculating the Cost of Selling Your Business
Are you one of the many entrepreneurs on DealStream who might be thinking about selling your business?
The sale process can be complicated and expensive. While you may know the sale price, how much money you'll walk away with from the deal depends on the various costs involved. But you can at least get a pretty good idea of how much an investment banker or broker might charge for arranging and handling a transaction thanks to a long-standing formula used to calculate the commission.
It's known as the "Lehman Formula."
Lehman Brothers developed the formula in the 1960s to give potential clients a ballpark figure on the cost of their services. Before the formula was adopted as the standard method of compensation in the brokerage industry, the fees varied widely by institutions. Knowing how the Lehman Formula works will help you estimate the commission owed on a sale and get a better estimate of the money you'll take away once the deal is complete.
Today, the Lehman Formula or its variations are widely used to compensate banks for their services. Here's a look at the math behind the original Lehman Formula, sometimes referred to as Lehman Scale, which was widely used from the 1970s to the 1990s:
Generally applied to transactions above $1 million, it followed a 5-4-3-2-1 tiered fee 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
Back in the 1970s, a $5 million transaction was, literally, a big deal. To keep up with inflation and ensure the Lehman Formula was still relevant, several iterations were developed. The one variation that is most commonly used today by "deal finders" — brokers, investment bankers, and mergers and acquisitions (M&A) advisors — in the world of M&As is the Double or "Modern" Lehman. In this case, the scaled fees double the percentages but skip the odd numbers. It looks like this:
- 10% of the first $1 million, plus
- 8% of the second $1 million, plus
- 6% of the third $1 million, plus
- 4% of the fourth $1 million, plus
- 2% of everything above $4 million.
The investment firm Morgan and Westfield uses an example to illustrate how the Double Lehman Formula works: "If a business sells for $5 million, the fee would be: $100k (10% on the first million) + $80k (8% on the second million) + $60k (6% on the third million) + $40k (4% on the fourth million) + $20k (2% thereafter) = $300k."
While the Lehman Formulas are the industry standard, commission rates are still negotiated on a case-by-case basis and there are still other variations on the Lehman Formula such as the Triple Lehman and the Stuttering Lehman (5%, 5%, 4%, 4%, 3%, 3%), notes MidStreet.
There are several online calculators that use the Lehman Formula as well as editable forms.
Holly Magister, CPA and founder of Enterprise Transactions, says that while the Lehman Formulas do offer some degree of transparency in the deal process, sellers should also be cognizant of other additional costs (such as retainer fees) that a broker may charge.
"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," she writes in a blog post. "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.
"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," she adds.
While the Lehman Formula’s scaled fees are part of the M&A vocabulary and the basis for most deals, it's important to talk to your broker about any other fees that might or might not be included in the sale as well as any payment terms that might be part of the Formula.
Find your own formula for success with some of the hundreds of businesses for sale on DealStream in a wide-range of industries here.
Tom Schwendler is a former communications manager for GE Energy with more than 20 years of experience in corporate communications. He recently published two books and works as a freelance communications consultant. He resides in upstate New York.
