Inherently, you can probably already guess what a success fee is by the name.
However, you may have a few questions about it, with the primary one being “How is a success fee calculated?”
This is a great question and the answer can vary depending on what broker you ask.
At MidStreet, we clearly explain how our success fee is structured on our website and when speaking to business owners. We use a Double Lehman scale to calculate our success fee.
Knowing what you are going to pay is important, especially when it comes to selling your business. To give you a better understanding of how success fees work, we will cover what they are, how they are calculated, if they can be negotiated, and much more.
Let’s get started.
What is a Success Fee?
A “success fee” is what a business owner pays their intermediary for selling their business. This fee is usually paid upon the successful completion of a sale.
Some brokers or merger and acquisition advisors may also call a “success fee” a “commission.” This should not be confused with retainers or upfront fees, since those are additional fees that brokers may charge.
The terms, structure, and contingencies of the fee will differ depending on how your merger & acquisition (M&A) advisor structures their fees and how their listing agreement is written.
How is a Success Fee Structured?
A success fee can be structured in multiple ways and will usually depend on the size of your business and your broker. Brokers can structure their fees in the following ways:
- Fixed success fee
- Flat percentage success fee
- Scaled success fee
- Reverse scaled success fee
The first three methods are most commonly used in lower middle market sales. The last method, the reverse scaled success fee is primarily reserved for upper middle-market deals.
1. Fixed Success Fee
A fixed success fee is a fee for select services. For instance, you may agree upon a fixed success rate if you already have a buyer for your business and you just need your M&A advisor to execute the deal for you. In some cases, this will include a minimum hourly fee throughout the sale to cover the M&A advisor’s costs.
These rates will usually be lower if they are for a proprietary deal since proprietary deals do not require the same amount of buyer vetting or marketing efforts. On the flip side, the success fee for an auction sale (one with multiple buyers) will typically be higher since it will require extensive buyer vetting and marketing.
2. Flat Percentage Success Fee
If your business is small or valued under $10 million, your broker may propose a flat percentage fee. This structure helps protect the amount the M&A advisor receives for managing your deal.
3. Scaled Success Fee
A scaled success fee means that the broker’s fee decreases in percentage in relation to the amount they get you for your business. If they are able to get buyers to pay a higher price for your business, they will get a larger commission overall. However, the percentage they receive for each additional million will be lower.
If you are using the Double Lehman Scale (illustrated above), the broker’s success fee would be:
- 10% of the first million - $100,000
- 8% of the second million - $80,000
- 6% of the third million - $60,000
- 4% of the fourth million - $40,000
- 2% of the fifth million - $20,000
- 2% of the sixth million - $20,000
If you are using the Modern Lehman Scale (illustrated above) it would be:
- 10% of the first million - $100,000
- 9% of the second million - $90,000
- 8% of the third million - $80,000
- 7% of the fourth million - $70,000
- 6% of the fifth million - $60,000
- 5% of the sixth million - $50,000
4. Reverse Scaled Success Fee
A reverse scaled success fee is usually reserved for larger businesses, in excess of $40 million in sale price. Instead of starting with a large percentage upfront, the reverse scale starts small on the first few million and increases as the sales price goes up.
This can create a unique incentive for M&A advisors to get their clients the most competitive price for their business.
Do I Owe a Success Fee if My Business Doesn’t Sell?
Depending on your broker’s policy and the language in your listing agreement, you may or may not need to pay them the success fee if don’t end up selling your business.
There are a variety of scenarios to consider and the terms may only require you to pay the success fee if certain factors were fulfilled.
For example, if you signed a listing agreement with a broker, they performed all the services they promised, presented you with qualified buyers, got you an offer at your stated price, and you ultimately decided not to sell, then you may owe them a success fee.
However, it will all come down to what is written in the listing agreement. Even if they bring you several unqualified buyers and you do not sell, they may still have it written into the contract that you owe them the success fee.
As usual, we advise you to review listing agreements with your attorney so you know what you are signing up for. They will be able to understand the legal language of the document to determine whether you will owe the fee whether you sell or not.
Another thing to note is that your broker may or may not subject you to paying them the success fee if you do not sell, even if it is written into their contract that you must. The reason they may refrain from charging you the fee is because they want to preserve the relationship with you or they may use it as a way to structure a future listing agreement with you.
Say the reason you didn't sell was because you decided that you were not ready to sell after all. In that instance, they may create an agreement that states you will use them when you decide to sell in the future and waive the success fee of the terminated sale.
Can Success Fees be Negotiated?
Success fees can be negotiated upfront to a certain extent. However, some brokers will be more willing to negotiate their fee, while others may not be willing to negotiate it all.
Some factors brokers will take into account are the size of your business and the complexity of your deal. If your company is fairly large, then the success fee can seem steep - some M&A advisors will sympathize with this and are open to negotiating their success fee.
If you are going to negotiate the success fee, it is best to do it before you sign a listing agreement. It is bad practice to sign with a broker who helps you find an amazing buyer, only to try to negotiate their success fee lower at the closing table.
Understand The Success Fee You Will Owe Your Broker
It is important to know how success fees work so that you know what to expect to pay. By knowing this ahead of time, you can better understand your broker’s fee, how it is structured, and when you are and are not responsible for paying it.
Your M&A advisor’s success fee is just one part of the costs associated with selling your business. Learn more about the costs by reading “How Much Does a Business Valuation Cost?”
Determining how much you are going to pay and how much you will receive for the sale of your business is difficult. If you are thinking about selling your business, give us a call today and we can walk you through the costs.