What it means
When a company hires an investment bank to sell the business, raise money or find a buyer, the bank is usually paid a success fee. The Lehman Formula is a classic way of setting it.
It was developed at Lehman Brothers in the 1960s and became a common starting point for negotiations in mergers and acquisitions. The original version works in steps.
The fee is 5% of the first $1,000,000 of deal value, 4% of the second $1,000,000, 3% of the third, 2% of the fourth, and 1% of everything above $4,000,000. Because each slice is charged at a lower rate, the effective percentage falls as the deal gets bigger.
The logic is that smaller deals require almost as much work as larger ones, so the bank needs a higher percentage to make the effort worthwhile. On a very large deal, the amount of work does not rise in step with the price, so a lower rate on the extra value feels fair to the client.
This is why the fee scales with the deal but not in a straight line. In practice, the original formula is rarely used unchanged today.
Because inflation and the growth of deal sizes have made the original thresholds look tiny, practitioners adopted variants such as the Double Lehman (10-8-6-4-2) for smaller private deals. Fees are also often subject to a minimum, and what counts as deal value, such as whether debt assumed by the buyer is included, is agreed in the engagement letter.
For a business owner, the useful lesson is that fee structures are negotiable and the formula is a starting point. It helps to ask what the effective percentage is on your actual deal size, and whether any retainer paid up front is credited against the success fee.
In practice
Real-world examples.
Example
The owner of a family-run packaging company agrees to sell for $3,000,000. The broker proposes a Lehman-style fee of 5%, 4% and 3% on each of the three million-dollar slices. The total is $50,000 + $40,000 + $30,000 = $120,000, which the owner compares with a flat 4% quote of the same amount.
Example
A software founder raises $4,000,000 in a private placement through a boutique bank. The engagement letter applies the Lehman scale to the capital raised. The founder calculates a fee of $140,000 and negotiates a cap, so that the bank receives less on any funds that come from existing investors.
Example
A hotel group sells a property for $8,000,000 and the sellers' adviser applies the Lehman scale with a minimum fee of $100,000. The adviser's calculation produces $180,000, comfortably above the minimum. The finance director records the fee as a cost of disposal.
Formula
Calculation
Fee = (5% x first $1,000,000) + (4% x second $1,000,000) + (3% x third $1,000,000) + (2% x fourth $1,000,000) + (1% x all value above $4,000,000)
Worked example: a business is sold for $5,000,000.
First $1,000,000 at 5% = $50,000.
Second $1,000,000 at 4% = $40,000.
Third $1,000,000 at 3% = $30,000.
Fourth $1,000,000 at 2% = $20,000.
The remaining $1,000,000 at 1% = $10,000.
The total fee is $50,000 + $40,000 + $30,000 + $20,000 + $10,000 = $150,000. The effective rate is $150,000 / $5,000,000 = 3.0%. Had the sale price been $7,000,000, the extra $2,000,000 would be charged at 1%, adding $20,000 for a total of $170,000, an effective rate of about 2.4%.Case study
Seen in the real world.
Ridgeview Dental Supplies is a fictional business whose owner, Maya, decided to retire and sell. Two advisers pitched for the work. One quoted a flat 5% of the sale price, and the other proposed the Lehman Formula.
With an expected sale price of $5,000,000, the flat fee would be $250,000, while the Lehman scale gave $150,000. Maya also asked whether the adviser would credit a $20,000 retainer against the success fee, and negotiated that it would.
She hired the second adviser, and the sale closed at $5,500,000, producing a fee of $155,000 under the scale. This is an illustrative story, but it shows how understanding the formula lets an owner compare quotes on a like-for-like basis.
Watch out
Common mistakes.
- Applying 5% to the whole deal value. The 5% rate applies only to the first million, and each later slice is charged at a lower rate, so the total is far smaller than 5% of the whole.
- Assuming the formula is fixed by law or regulation. It is a convention only, and advisers can and do offer different scales, percentages and minimum fees.
- Ignoring what counts as deal value. If the fee base includes assumed debt or earn-outs, the fee can be much larger than the cash you actually receive.
Questions
People also ask.
Where does the name come from?
It is named after Lehman Brothers, the bank that popularised the scale in the 1960s. The bank later failed in 2008, but the name lives on in deal-making.
What is the Double Lehman?
It doubles each of the rates, producing 10%, 8%, 6%, 4% and 2% on successive millions. It is sometimes used for smaller deals where a 5% start would not cover the adviser's effort.
Should I ever pay a fee up front?
Many advisers charge a retainer as well as the success fee. It is worth asking whether the retainer is deducted from the success fee so you are not paying twice.
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