Lehman Formula
The Lehman Formula is a tiered commission method developed in the 1960s by Lehman Brothers to calculate investment-banking fees on transactional deals. It applies different percentage rates to portions of a deal’s value, making fees transparent and scalable for transactions ranging from small private placements to large M&A or IPO deals.
How it works
The original Lehman structure applies descending percentages to successive dollar brackets:
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- 5% of the first $1 million
- 4% of the second $1 million
- 3% of the third $1 million
- 2% of the fourth $1 million
- 1% of everything above $4 million
Firms commonly adjust the schedule (for inflation or client negotiation). A popular variant is the “double Lehman,” which doubles each tier (10-8-6-4-2).
Common variations and why they’re used
- Tiered (Million Dollar Amount, MDA): Percentages are applied per bracket. MDA can generate higher fees on smaller transactions and is commonly used in middle-market deals.
- Total Value Amount (TVA): A single negotiated percentage is applied to the entire transaction value. TVA is simpler and provides fee predictability for large deals.
- Pertinent Value Amount (PVA): Combines tiering with a simplified structure—uses one rate up to a threshold and a different rate above it. Useful when deal outcomes are uncertain or when incentivizing crossing a size threshold.
Firms choose among these methods based on deal size, client preferences, competitive dynamics, and the desired incentive alignment.
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Examples
- Original Lehman (MDA) on a $12 million transaction:
- 5% of first $1M = $50,000
- 4% of second $1M = $40,000
- 3% of third $1M = $30,000
- 2% of fourth $1M = $20,000
- 1% of remaining $8M = $80,000
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Total fee = $220,000
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Double Lehman (typical middle-market variant): 10% / 8% / 6% / 4% / 2% on the respective brackets.
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TVA example: If a single 4% rate is negotiated on an $18 million sale, the fee = 4% × $18M = $720,000.
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PVA example: $10 million sale with 2% on the first $4M and 1% on the remaining $6M = $80,000 + $60,000 = $140,000.
Pros and cons
Pros
– Transparent, easy-to-calculate framework for clients and banks.
– Performance-linked, incentivizing bankers to close high-value deals.
– Flexible—percentages and brackets can be negotiated to suit deal complexity or client relationships.
– Widely understood and accepted across transaction types.
Cons
– Can encourage short-term behavior focused on transaction volume rather than long-term client outcomes.
– May create misaligned incentives or conflicts of interest when compensation is not tied to long-term performance.
– Subject to regulatory scrutiny if compensation structures appear to promote excessive risk-taking.
– Can be costly for clients on certain fee schedules, especially with higher negotiated multipliers.
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Brief history note
Lehman Brothers created the formula in the 1960s. The firm later collapsed in 2008 amid the global financial crisis, a reminder that industry practices need continual review for risk and incentive alignment. The Lehman Formula itself, however, remains a common reference point for structuring transaction fees.
FAQs
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Is the Lehman Formula flexible?
Yes. Firms routinely adjust percentages, apply multiples (e.g., double Lehman), or choose TVA/PVA variants to match deal specifics. -
Is it used only in investment banking?
No. Variants of tiered fee structures appear in private placements, M&A, litigation contingency arrangements, and other areas where compensation scales with transaction size. -
Are there regulatory requirements to use it?
No regulation prescribes the Lehman Formula specifically, but regulators monitor compensation practices to limit incentives that promote excessive risk or unethical behavior.
Bottom line
The Lehman Formula is a simple, tiered approach to transaction fees that offers transparency and flexibility. Choosing among MDA, TVA, or PVA (and any negotiated multipliers) depends on deal size, client preferences, and desired incentive alignment. Firms and clients should balance clarity and motivation with long-term outcomes and regulatory considerations when structuring fees.