The Lehman Formula is a tiered success-fee structure for business sales that charges 5% on the first $1 million of transaction value, 4% on the second $1 million, 3% on the third, 2% on the fourth, and 1% on every dollar above $4 million. Investment banks and business brokers have used this sliding scale since the 1960s to price advisory work on mergers, acquisitions, and other ownership transfers. It remains a reference point for middle-market fee negotiations today, though most firms now quote a modified version with higher percentages.
The 5-4-3-2-1 Tiers
The classic formula applies a descending percentage to each million-dollar slice of the deal:
- First $1 million: 5%
- Second $1 million: 4%
- Third $1 million: 3%
- Fourth $1 million: 2%
- Everything above $4 million: 1%
The higher rate on early dollars compensates the broker for the fixed work of preparing a company for sale, building marketing materials, identifying buyers, and managing due diligence. That effort is roughly the same whether the business closes at $3 million or $30 million. The declining rate on larger amounts keeps the total fee proportionate to deal size.
How the Math Works on a Real Deal
A $10 million transaction illustrates the arithmetic:
- First $1 million at 5%: $50,000
- Second $1 million at 4%: $40,000
- Third $1 million at 3%: $30,000
- Fourth $1 million at 2%: $20,000
- Remaining $6 million at 1%: $60,000
Total success fee: $200,000. That’s a 2% effective rate on the full $10 million. The distinction between marginal and effective rate matters. A seller who hears “5% commission” might brace for $500,000 on a $10 million deal; the tiered structure cuts it to less than half of that.
The effective rate falls as deals grow. A $2 million sale produces $90,000 in fees, a 4.5% effective rate. A $50 million transaction produces $660,000, roughly 1.32%. The formula naturally compresses the percentage as the price rises.
What Counts as “Transaction Value”
Fee disputes rarely turn on the percentages. They turn on the base those percentages apply to. The engagement letter defines it, and the definitions vary.
Some contracts use equity value, meaning what the buyer pays for the owner’s shares or membership interests. Others use enterprise value, which adds the company’s outstanding debt to the equity price. A business sold for $8 million in equity with $4 million in assumed debt has an enterprise value of $12 million, and the success fee on the second number is noticeably larger.
Contracts can go further and sweep earnouts, seller notes, consulting agreements, and noncompete payments into the calculation base. A seller who signs without scrutinizing that definition can end up paying commission on money they haven’t received yet, or on debt the buyer merely assumed. Reading the “transaction value” definition closely is the single most important step before signing an engagement letter.
Modern Variants You’re More Likely to Be Quoted
The original formula was built when $5 million was a large middle-market deal. Inflation has eroded the brackets, and most firms now quote something other than the straight 5-4-3-2-1.
The Double Lehman
The most common adaptation doubles each tier:
- First $1 million: 10%
- Second $1 million: 8%
- Third $1 million: 6%
- Fourth $1 million: 4%
- Everything above $4 million: 2%
On the same $10 million deal, the Double Lehman produces $400,000, a 4% effective rate. This version is common among business brokers handling transactions under $10 million, where the original percentages don’t generate enough revenue to cover the months of work involved.
Flat Percentages and Minimums
Some advisors skip tiers entirely and charge a flat percentage, typically 3% to 6% on deals under $25 million and 1% to 2% on deals above $100 million. A flat fee is easier to understand but gives up the volume discount built into the Lehman approach.
Roughly three-quarters of middle-market advisory firms also impose a minimum success fee. The floor exists to cover the baseline cost of running a sale process regardless of the final price, and it can bind on smaller or discounted deals.
Accelerators
About 20% of engagement letters include an accelerator that raises the fee if the sale price exceeds a target. The incentive alignment is appealing to sellers: the broker earns more only when the seller does. The risk is agreeing to the accelerator without a cap, which can produce an outsized fee on a strong outcome.
Engagement Letter Terms That Change the Real Cost
The percentage structure is one piece of the economics. Several other provisions can move the total number as much as the tiers themselves.
Tail Periods
A tail clause entitles the broker to a success fee if the business sells within a specified window after the engagement ends, provided the buyer was someone the broker introduced or contacted during the engagement. It prevents sellers from firing the broker right before closing to dodge the fee. Twelve months is generally considered reasonable.1U.S. Securities and Exchange Commission (SEC). Letter Agreement Between Houlihan Lokey Howard and Zukin and Acuity CiMatrix, Inc. A 24-month tail or longer can complicate any future sale effort with a different advisor.
Scope matters as much as length. Some engagement letters define the protected buyer list broadly enough to cover anyone who received marketing materials or had indirect contact with the broker’s firm, plus their affiliates and employees.1U.S. Securities and Exchange Commission (SEC). Letter Agreement Between Houlihan Lokey Howard and Zukin and Acuity CiMatrix, Inc. A narrower list limited to buyers the broker actually introduced preserves your ability to run a fresh process later.
Retainer Offsets
Most M&A engagements require monthly retainers during the sale process, ranging from a few thousand to tens of thousands of dollars depending on firm and deal size. Whether those retainers are credited against the success fee at closing varies by firm. Some deduct the full amount, some deduct part, and some keep the retainer as a separate charge. Negotiate this explicitly. If the engagement letter is silent, assume the retainer is non-refundable and additive.
Exclusivity
Many engagement letters grant the broker exclusive rights to market the business for a defined period. Under an exclusive, the success fee is owed on any sale that closes during the engagement, regardless of who found the buyer. If you already have a buyer in mind or want the option to sell directly, negotiate a carve-out for named parties before signing.
Who Can Legally Collect the Fee
Not everyone is entitled to earn a Lehman-based success fee. The rules depend on what’s being sold and who is doing the selling.
The M&A Broker Exemption
Federal securities law generally requires anyone who facilitates the sale of securities, including shares of a private company, to register as a broker-dealer with the SEC. An exemption under Section 15(b)(13) of the Securities Exchange Act allows unregistered “M&A brokers” to collect success fees on the sale of an eligible privately held company without full broker-dealer registration.2Office of the Law Revision Counsel. 15 U.S. Code 78o – Registration and Regulation of Brokers and Dealers
To qualify, the target must have EBITDA below $25 million or gross revenues below $250 million in the year before engagement. The buyer must end up with control and be actively involved in management. The broker cannot hold or transmit funds, provide deal financing, represent both sides without written disclosure and consent, or facilitate a sale to passive buyers.2Office of the Law Revision Counsel. 15 U.S. Code 78o – Registration and Regulation of Brokers and Dealers The exemption covers federal registration only. State broker-dealer requirements still apply and vary.
Real Estate in the Deal
If the business sale includes owned real property, licensing rules add a layer. A majority of states require anyone collecting a commission on the transfer of real estate to hold a real estate license, even when the property is one piece of a larger business sale. A minority of states hold that the broker doesn’t need a real estate license if the dominant purpose is the sale of a going concern. Confirm your broker is properly licensed in your state, or the commission on the real estate portion could be unenforceable.
Splitting Fees With Unregistered Finders
FINRA Rule 2040 prohibits registered broker-dealers from sharing transaction-based compensation with anyone who isn’t registered but would be required to register based on their activities. A registered investment bank generally cannot split a Lehman-based fee with an unregistered finder or consultant who helped source the deal.3FINRA. 2040. Payments to Unregistered Persons
Tax Treatment of the Fee You Pay
Success fees paid in connection with a business acquisition are generally treated as transaction costs that must be capitalized rather than deducted in the year paid. The IRS presumes that a fee contingent on closing facilitates the transaction, which triggers capitalization.4eCFR. 26 CFR 1.263(a)-5 – Amounts Paid or Incurred to Facilitate an Acquisition
Revenue Procedure 2011-29 offers a safe harbor: elect to deduct 70% of the success fee immediately and capitalize the remaining 30%. The election requires attaching a statement to the original federal income tax return for the year the fee is paid, identifying the transaction and specifying the amounts deducted and capitalized. The election is irrevocable and applies only to that transaction.5Internal Revenue Service. Revenue Procedure 2011-29 Miss the filing and the entire fee defaults to capitalized treatment. On a $400,000 fee, the difference between deducting 70% now and capitalizing all of it can be worth six figures in present-value tax savings, so raise the election with your accountant well before the return is due.
Negotiating Points
Whatever the broker proposes, every component is negotiable. The most impactful lever is the definition of transaction value. Narrowing the base to equity value instead of enterprise value, or excluding earnouts and seller notes that haven’t been paid, can reduce the fee substantially without changing a single percentage.
Other provisions worth pushing on: crediting retainers against the success fee, capping reimbursable expenses, holding the tail to 12 months, and narrowing the protected buyer list to parties the broker actually introduced. If the letter includes an accelerator, pair it with a fee cap. A bonus on the upside without any ceiling looks small at signing and can turn expensive at closing.
The strongest leverage comes from a competitive process. Proposals from two or three firms reveal the real market rate for your deal size and let you compare the whole package, not just the headline percentages.