Q. So, aside from a recipe for disaster, what is this?
A. It’s a standard fee structure for M&A deals… if you’re buying or selling a business, it’s the market for what you can expect to pay. It was developed by Lehman Brothers back in the 70s, and then became pretty much an industry standard. You hear it all the time around M&A shops.
Q. OK, so how’s it work?
A. The basic rule is 5-4-3-2-1: The broker gets 5% on the first million, 4% on the second, and so on. So what that boils down to is $150,000 on the first $5mm, plus 1% for everything over 6mm. That relatively standard for smaller deals. For bigger ones, you’ll also hear the phrase “double Lehman”, which does not double the percentages; it doubles the brackets: 5% on the first two, 4% on the next two, etc. Inflation affects everything!
Q. Now, is this for M&A deals or money raises?
A. M&A deals. For money raises, you typically see 1-3-5, or something like that: 1% for debt, 3% for sub debt, and 5% for equity. There’s a lot of negotiation that goes on around those numbers, however; sometimes you’ll see the five go up to 6 or even 8.
Q. So I’m seeing a bit of an issue here for smaller VC deals transactions… there’s really no money in it for the brokers… I guess that’s why they’re not really a big factor in the market?
A. Exactly so. Sometimes you do see them, but they’re always taking some sort of equity participation along with the %. This is where you might see something called “warrant coverage, ” which is part of many different kinds of transactions. If the fee is 5%, with 5% warrant coverage, it does *not* mean that the broker gets 5% of the company. It means that if he raises, say, $10mm, he’ll get warrants that allow him to invest $500,000 in the company later, at whatever valuation the company has when the money is raised. So the warrant coverage provides some meaningful upside.
But the fact is that brokers have never been big in the VC market… it sort of violates the culture in some way. Now, of course, with Gust and Angelist and crowdfunding, its even less releva