It’s once again time to look at the latest trends in M&A fees. It’s been a few years since I wrote about M&A fees, and it’s time for an update!
Once again, Axial and Firmex teamed up to provide the M&A Fee Guide for 2023-2024, focusing on middle-market advisors. I’m summarizing the highlights and takeaways from both the report and my personal experience over the last couple of years. Keep in mind, this survey was done across multiple industries with technology advisors representing only 23% of the respondents.
Unpredictability in the economy and geopolitical environment has caused many to change their approaches to fees. With higher interest rates becoming a new normal, some saw the volume of deals decrease, while others remained steady or even saw an increase. Regardless, overall trends show deals are taking longer to put together and more are falling apart before closing.
This doesn’t mean that it’s a bad time to sell; like others, I’ve had plenty of deals of all sizes successfully close in the last couple years. But it does mean many bankers and advisors are adjusting their fee structure to ensure they get paid fairly for their work, regardless of whether a deal successfully closes or not. This includes engagement fees like hourly/monthly retainers or fixed upfront work fees. In addition, 38% of advisors surveyed increased their fee levels to respond to rising costs and challenges in dealmaking.
M&A Success Fees by Deal Size
Half of the advisors surveyed use some version of the Lehman Formula* for success fees, where the fee rate decreases as deal size increases. About a third use a flat percentage regardless of the deal size.
The survey asked advisors what their typical success fee looked like for different deal sizes. There was a lot of variation in responses for each deal size, but to summarize:
- For a $5M deal, the average fee was 6.3%, but answers ranged from about 4.7% – 8%.
- For a $20M deal, the average fee was 3.8%, but answers ranged from about 2.3% – 5%.
- For a $100M deal, the average fee was 2.1%, but answers ranged from about 1% – 2.8%.
Smaller deals often require just as much work or time as large deals, especially when there may be a lack of sophistication on the part of the buyer or seller, leading to more “hand-holding” by the advisor. Therefore, larger fee percentages for smaller deals make sense to ensure that advisors get paid fairly for their time.
While the survey wasn’t able to directly compare these results to previous years due to a change in methodology, about 16% of survey respondents said they increased their success fees this year.
The biggest factors for advisors when setting their success fee were:
- Engagement size
- Riskiness associated with closing
- Complexity associated with transaction
Risk rose up as a much more prominent factor than previous years, showing that advisors are more sensitive to risk in the current dealmaking environment.
All of this comes back to the resounding sense that deals are having more difficulty getting over the finish line. Therefore, that sense of risk is playing a bigger role in setting fee levels, and some advisors have increased fees to match the increased work associated with successfully closing deals of all sizes.
Engagement Fees
Engagement fees, also known as work fees or commitment fees, are the fees advisors charge for their efforts to sell a company. These fees are paid by the seller whether the deal closes or not.
Of those surveyed, 76% said they charge some kind of engagement fee. 35% charge a fixed fee that is paid upfront and 30% charge a monthly fee.
The amount that advisors reported charging for a fixed upfront fee varied quite a bit by firm size. Smaller firms (20 employees or less) typically charge $15k or less, and larger firms (more than 20 employees) typically charge $25k or more.
For those that charge monthly fees, 65% said they charge between $5k and $10k per month.
Ongoing engagement fees, like monthly and hourly fees, have become more common compared to fixed fees, as many deals are taking longer to complete or never closing. Many respondents mentioned that these ongoing fees help mitigate risk if deals fall apart and keep sellers engaged in the process and its outcome. After all, if a seller backs out of a deal at the last moment, the engagement fee is the only payment their advisor receives for their work on the transaction.
Minimum Success Fees
Minimum success fees have remained standard in the middle market and lower middle market, with 72% of advisors charging them. As its name suggests, this defines the minimum dollar amount that an advisor will charge if the deal closes. These fee amounts are usually based on company valuation, setting an expectation between the advisor and client for what is acceptable. According to the survey, many respondents have been increasing their minimum fee, likely following the changes in success fees.
How Do Fees Work with Earn-Outs?
As earn-outs have become more and more common (meaning sellers have to wait a year or two to receive a portion of the purchase price), many owners wonder how that may affect the timing of advisor success fee payments. Do advisors get paid in full at closing, or do they get paid as the seller gets paid?
The survey shows that it is still standard for advisors to be paid in full at closing. Two-thirds (67%) of advisors require this, regardless of whether there is an earn-out or other delay in a portion of the purchase price (e.g., seller note). This is up from 59% last year. One third (33%) allow clients to pay them as they receive the components of the purchase price. Some survey respondents wrote that their standard contracts require payment in full, but that they are willing to negotiate it with clients if requested.
Conclusion
These results demonstrate that, regardless of the challenges facing M&A, the industry is strong. 77% of advisors saw their revenue increase or remain consistent, signaling that there is no lack of opportunity in the M&A space and deals are still getting done.
My word of wisdom to sellers, which I also mentioned in my fees article a couple years ago, is to be cautious of any advisor who is willing to only work for a success fee. While a lesser payment from your purchase price may be enticing, these advisors are only rewarded when your deal is sold, regardless of the quality of the deal. This means they are not necessarily incentivized to get you multiple offers to ensure you are getting the highest price and best terms that you can; they likely will stop at the first offer that looks feasible.
Your advisor should be just as committed to your deal as you are: seeking the best possible outcome for you and your company. The current trends in fee structures, especially the rising focus on engagement fees, reinforce this commitment. After all, the sale of your company is likely the biggest financial decision you will make. You want to make sure that whoever you choose to guide you isn’t just looking for the easiest or quickest solution, but the best solution.
And keep in mind that, with the increase in deals that are not closing or taking much longer to close, advisors may become more selective with who they take on as a client. They will want to know their client is motivated and prepared for a transaction: both their company and themselves personally.
If you’re not sure how prepared you are for the sale of your company, take my short quiz that will help you understand where you’re at.
If you know you want to sell in the next 1-5 years but don’t know where to start, join the waitlist for Ready…Set…SELL, my online course for business owners to better understand, plan, and prepare their company for their ideal M&A transaction.
*The Lehman Formula (also known as the Lehman Fee or Lehman Scale) is a commonly used method for defining compensation owed to an investment bank or deal broker for arranging a transaction. In the 70s and 80s, it was commonly used for fundraising and private placement transactions. Today, it is much more common in lower middle market acquisitions.
The original formula applied to transactions above $1 million and followed a 5-4-3-2-1 tiered structure:
- 5% of the first $1 million
- 4% of the second $1 million
- 3% of the third $1 million
Today, the Double Lehman formula is also popular, which doubles the rates for each transaction tier:
- 10% of the first $1 million
- 8% of the second $1 million
- 6% of the third $1 million
- and so on…
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