Middle Market Deals and how to buy, sell and raise capital from $5 to $500 million

One of the most frequently unasked questions, but one that everyone wants to understand, is what is a fair M&A advisory fee?

To be clear, for a firm that genuinely plays the role of a broker-dealer or investment bank, operating under the requisite legal framework, the answer falls into a fairly narrow band. 

Ignoring the costs of any required fund raising (see my post on fees for raising capital) the fees for advising the buyer or seller in the middle market arena, tend to follow the 5-4-3-2-1 "Lehman Formula."

The Lehman Formula provides that the advisors get 5% of the first million, 4% of the second, 3% of the third, 2% of the fourth and 1% of all the consideration above four million. 

For smaller transactions, under ten million in value, the formula becomes more of a floor in the negotiation between the company and the advisor.  Many advisors receive more.  For large transactions, over $100 million, it becomes a cap--most firms charge less than Lehman on transactions above that scale.   Transactions above the middle market scale would customarily be subject to fees that are a fraction of one percent.

Some firms charge much more than the Lehman Formula, sometimes up to 5% on everything.  Some firms use algorithms like two to three times Lehman.

Note that it is common, especially for the company seeking to make an acquisition, to negotiate a fixed fee up front.  For buyers, this eliminates the risk of giving the advisor an incentive to run the price up.  It also eliminates messy questions about the value of the transaction, such as, whether the assumed debt in the deal gets counted toward transaction value for purposes of determining the fee.

One note for entrepreneurs and executives: it is always wise to alert your counter parties to the role of your advisors in a deal--up front.  If they assume that there is no advisor, you may create problems for yourself down the road.

Appropriate fees for unregistered brokers or finders depends upon the role they play.  If the intermediary merely facilitates an introduction and does not participate in the negotiations, due diligence or documentation of the deal, a much smaller fee is in order.  If, however, intermediary acts in every capacity like an investment bank, the fees would be similar.

Fairness opinions are a key part of the M&A process.  The SEC has recommended but not required that the investment bank that takes a fee for the success of the deal should not be the bank that provides the fairness opinion.