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Investment Bank Fees

Investment bankers charge significant fees to provide their services on a deal.  Fee structures are typically customized to each deal, so there is no standard fee for a deal.  Fee structures generally include retainers, success fees, minimum transaction fees, breakup fees, and expense reimbursements.  Fee agreements also usually define exclusions, exclusivity, tails and indemnification clauses.

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To some extent, the size of the transaction and the possible fees to be earned from it determine the type of type of firm that is likely to accept the engagement.

Size of fees to be earned

Optimal deal size

Type of firm

$1,000,000 or more

$100 million or more

Large national and international firms (dozens or hundreds of professionals in the firm)

$500,000 to $1,000,000

$20 million to $75 million

Regional, mid-market and boutique firms (three to 25 professionals in the firm)

$500,000 or less

$10 million or less

Individual practitioners and business brokers (one or two professionals in the firm)

 

Retainer Fees

Investment banks will almost always seek to obtain a retainer fee for a transaction.  A retainer fee is a fixed amount of money that a client agrees to pay, in advance, to secure the services of an investment bank or other professional.  Retainer fees are paid whether the transaction is successful or not.  A retainer is often paid in a single, lump sum, or on an ongoing basis (typically monthly or quarterly).  The higher the investment bank’s confidence in the success of the transaction, the less likely they are to require a retainer.  Conversely, the riskier the deal (in terms of whether it will close or not), the higher the likelihood that a retainer will be required.

Retainer fees are often credited back to the client if a transaction is successful, but this must be negotiated with the investment bank.  It is also common for to require the bank to return the retainer if the bank terminates the engagement.

For large, complex deals that are likely to take a year or more to close, or which are have a substantial risk of failure, it is not uncommon for the investment bank to structure its fees such that the retainer (sometimes augmented by hourly fees) make up the bulk of the money they expect to earn on the deal.

 

Upfront Fees

In addition to monthly retainer fees, investment banks sometimes seek upfront fees that are paid at the time of engagement, before work has started.  This is really just a form of retainer and is purely a matter of negotiation between the bank and the client.

 

Success Fees

In a successful transaction, success fees (also known as “transaction fees”) are the largest part of the investment banker’s compensation.  A success fee is an amount of money paid to an investment bank or other professional for the successful completion of a transaction.  Success fees are typically a percentage of the total deal value.

The best-known guideline for determining success fees is the Lehman Formula, develop by Lehman Brothers in the 1970s:  5% commission for the first million dollars of a transaction, 4% for the second million, 3% for the third million, 2% for the fourth million, and, finally, a 1% commission for everything above $4 million.  Under this formula, an acquisition made for $10 million would give the investment bank a success fee of $200,000 (5% of $1M + 4% of $1M + 3% of $1M + 2% of $1M + 1% of $6M = $50,000 + $40,000 + $30,000 + $20,000 + $60,000).  As inflation reduced the absolute value of these dollar figures, the Double Lehman was employed:  10% commission for the first million dollars of a transaction, 8% for the second million, 6% for the third million, 4% for the fourth million, and, finally, a 2% commission for everything above $4 million.  The Modified Lehman Formula charges 2% of the first $10 million and some lesser percentage for everything thereafter.

In practice, these formulas are rarely used:  almost all success fee structures are highly customized to the individual transaction and highly subject to negotiation.  Although opinions vary and the facts are often hard to verify, the following ranges for success fees are sometimes mentioned:

Transaction value

Fees as % of transaction value

Fees as dollar amount

$10 million or less

8% to 12%

$150,000 to $750,000

$10 million to $25 million

4% to 6%

$600,000 to $1,000,000

$25 million to $100 million

2% to 3%

$750,000 to $2,000,000

$100 million to $1 billion

0.5% to 2%

$2,000,000 to $5,000,000

$1 billion or more

0.5% or less

$5,000,000 or more

 

Minimum Fees

Investment banks will usually require a minimum fee as part of their engagement.   A minimum fee is the smallest sum of money the investment bank will accept to undertake the engagement.  For instance, a large investment bank might stipulate a minimum fee of $500,000, meaning the client must pay at least that sum of money to the bank no matter what the outcome of the transaction.

 

Consideration To Be Used In The Fee Base

Defining the consideration to be used in calculating success fees is often difficult.  Shares and cash exchanged at the time of closing are easily defined and measured, but transactions are often structured such that less liquid assets are exchanged (e.g. above-market employment contracts, selective non-compete agreements, below-market supply contracts) or liquid assets are to be exchanged at and undefined time in the future (e.g. as part of an earn-out or true-up).

Investment banks frequently seek to use enterprise value as the basis of the fee calculation.  Enterprise value is a measure of a company's value, often used as an alternative to market capitalization.  The concept is the theoretical cash that would have to be paid to buy a firm and settle its outstanding debt and preferred shares.  Enterprise value is calculated as market cap plus debt, minority interest and preferred shares, minus total cash and cash equivalents.

 

Expense Reimbursement

Investment banks, as with most other professionals in the US, will seek to have their expenses reimbursed.  While this is accepted business practice in the US, investors should be careful to limit these expenses by establishing reasonability standards, requiring preapproval and documentation, and placing a cap on overall expenses.  Without these safeguards, clients often find themselves required to pay for first class airfares, luxury hotels and expensive restaurants.  As expenses are virtually always incurred in connection with a doing something the client requested, it is usually impossible to limit payment for these expenses after they have been incurred.

 

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