How do business broker and M&A commissions work? This will be a pretty dry article, but this question comes up a lot so hopefully it will be useful.
There is no law or regulation that sets pricing, but business brokers typically charge a 10% commission (also called a “success fee”) on the value of the business and 6% on any associated real estate. The exceptions are gas stations, grocery stores and hotels which can be less. We have heard of some brokers charging 12% and others readily dropping a few points in order to get a deal, but most hold firm at 10%. If another broker is involved in finding a buyer, the fee is often split between the listing-side broker and the sell-side broker. That is if they agree to work together (cooperate), which not all business brokers do. Some states are better than others (Florida is among the best, California among the worst).
I know 10% seems like an awful lot. I have started and built businesses, and to give up 10% of all that hard work that it took to build the business hurts. I wish it were different, but the reality is that this is what it takes to keep brokers in business and 10% is what the standard in the industry is.
I’ve seen business brokers that don’t normally do larger deals charge 10% total commission for a selling price above a million. They didn’t do that on purpose (I don’t think), they just didn’t know it is standard to use the Double Lehman. Obviously the seller didn’t know that either.
It is standard practice to provide a discount above a $1 million selling price, and many M&A firms will say they use the Lehman Scale although in reality they probably use the Double Lehman Scale. The Double Lehman Scale pays a commission of 10% on the first million, 8% on the second million, 6% on the third million on down to 2% for the remainder.
Investment Bank Commissions
Larger M&A firms and investment banks will skip the 10,8,64,2 Double Lehman scale and will set a scale based on the first five million in value, second five million, etc. However, I’ve compare some examples a few times to the Double Lehman and they have been pretty close. Often they will have a minimum fee of, say, $250,000 which effectively sets the minimum size company that they will work with.
Smaller deals often have a clearly defined value and a success-fee is fairly easy to determine. Not so with larger more complex deals, and it is often up to the seller and the broker to sit down at some point and figure out a fair commission. As an example, we often close deals that have a contingent payment based on the future performance of the company – therefore the full purchase price would not be known for a number of years. This is commonly called an “earnout”. The “expected” purchase price used for commission calculation usually ends up being above the base price but below the maximum price. Yes, the “expected” earnout sometimes is zero and so we’ll charge zero commission on that.
As a general rule, business brokers don’t charge an upfront fee, while M&A advisors do. It makes sense too. A business broker is operating essentially alone much like a real estate agent, while an M&A firm applies a team of writers, analysts and dealmakers on your project and also must pay for a marketing campaign. Some business owners refuse to pay an upfront fee, however a larger firm will pay substantial out of pocket costs for each client for first class mail, telemarketing and advertising and charge an upfront fee to help pay for it.
Investment banks may go a step further and charge a monthly retainer to pay for their costs, and some will even charge a “break up fee” so that a commission is still owed if the seller backs out of a deal at the last minute.
Engagement agreements vary a lot, from real estate type canned agreements for business brokers to custom agreements for M&A firms, but you’ll find a “Tail” on each one. The tail on an agreement means that once the agreement has ended, there is still a clause that says if you sell to anyone within 18 to 24 months that the intermediary introduced to you, you still owe a commission. So don’t let it surprise you, it is standard. What isn’t standard is what “introduced” means. I think a fair way would be to define that as anyone that signed a confidentiality agreement during the time the agreement was in affect.
Well, as you know everything is negotiable, but a quality broker or M&A firm probably isn’t going to move on the fee. However, it is common to change various parts of an agreement depending on the situation.