What is a Finder’s Fee?
If you are in the business world, we are sure you have come across the term private equity finder’s fee agreement.
But what’s a finder’s fee?
A finder’s fee refers to a commission paid to an intermediary or a facilitator who makes a referral or introduction that leads to an M&A transaction between a buyer and a seller. The finder’s fee is paid to the intermediary as a way of compensation for deal origination service and linking the two interested parties. It’s derived from the assumption that, without the intermediary who facilitates the M&A transaction, the buyer and the seller would not have discovered the deal. As an intermediary, we want to sign the finder’s fee agreement before any introduction is undertaken.
From our point of view, it’s good practice to inform the buyers in advance so that they can clearly understand the governing terms of the finder’s fee agreement. The agreement will stipulate the percentage of commission that we will receive as an intermediary and which party will pay for it. Finder’s fee is usually paid by the buyer once the M&A transaction deal was sealed. Finder’s fees are also known as “Success Fees” since are paid after a successful M&A transaction.
Finder’s fees in a small-cap M&A transaction
The deal process starts when we identify an M&A opportunity. We would then approach the buy-side party who gets introduced to the sell-side party. In case of Aqcon.co, these are usually the sell-side advisors of the business owners, normally boutique M&A advisory firms with up to ten front office employees. Before a deal introduction is done, the buyer agrees to compensate Aqcon.co accordingly as per the laid out finder’s fee agreement.
Elements of a finder’s fee agreement
There are two main elements of a finder’s fee agreement. They include:
- Fee structure
- Definition of transaction value
Below is a detailed explanation of what they stand for.
Fee structure
A fee structure that is based on a Lehman Fee is what is used as the golden standard in private equity finder’s fee agreement. This type of fee structure was invented by the Lehman Brothers and it’s one of the formulas that is widely used in small companies’ mergers and acquisitions. To understand the fee structure, we need to look at how a Lehman fee is calculated. The formula is outlined as follows:
- 5% of 1st Million of transaction Value
- 4% of the 2nd Million
- 3% of the 3rd Million
- 2% of the 4th Million
- 1% of the remaining transaction value
A Lehman Fee structure is easy to calculate and therefore, is one of the most common fee structures that are widely used in a Finder’s Fee Agreement.
Other less frequent forms of fee agreements that are used to calculate finder’s fee in a small business M&A transactions include:
- Flat fee - Charged as a percentage of the transaction value
- Double Lehman - Where all the percentages of single Lehman are doubled
- Flat monthly retainer fee - Also known as Retained Fee Agreement
At Aqcon.co we typically use Single Lehman scale.
Definition of transaction value
As you can see from the fee structure, the amount of the finder’s fee depends on the increment of M&A transaction value. Therefore, it’s very important to define what constitutes transaction value. Apart from the cash value, there are other forms of value that are included in M&A transactions that the buyer pays for.
A short explanation of Transaction Value is that it equals Enterprise Value of the acquired business. This typically includes the following elements:
- Cash paid at closing
- Seller notes - Vendor loans or other forms of vendor notes issued to the buyer by the seller to help finance a transaction
- Net debt position - The buyer assumes the debts of the seller. Since the buyer is the one who carries the debt liabilities and the seller has received something of value, this amount is included in the calculation of transaction value.
- Retained equity - If the deal is done in a way that the seller retains equity in the company, the estimated value of retained ownership is also included in the transaction value.
- Consulting / employment, lease agreements, and other payment forms - If there are any of such elements in an M&A transaction, they should also be included in the transaction value.
The form and timing of finder’s fee payments
If the transaction involves cash buying, the finder’s fee is also paid in cash during the closing process. In the event that there are some contingent payments in the transaction proceeds, the buyer may hold a small portion of the finder’s fee and clear them only when the seller earns the pending contingent payments.
Is the finder’s fee agreement important?
Yes, it is indeed very important for Aqcon.co to have a written agreement with the buyer before any introduction is made. A well-structured finder’s fee agreement defines the nature of the partnership between the finder and the buyer. It will also outline clearly the fee structure and definition of transaction value elements.
Finder’s fee agreement gives us a protection from being kicked out of M&A transaction deal brokerage after linking both the buyer and the seller. An agreement also gives us a courage to hunt for lucrative acquisition opportunities.
At the same time, the finder’s fee agreement protects the buyer as it clearly outlines that the fee becomes payable only after (and if) the closing of the transaction has happened.
Wrapping up
There are many small businesses out there that are ripe for M&A transactions looking for an intermediary who can link them up with potential buyers. The problem of small cap world is that maintaining a wide network of sell-side advisors and investors is hard – there are simply too many players on the market that generate too few deals per relationship. On the other hand, having such network is crucial to getting sufficient deal flow for small cap investors.
Finder’s fee agreement that Aqcon.co signs is transparent and should be agreed upon by both parties before any introduction is done. When we introduce the buyer to the seller to carry out an M&A deal, we expect to get a success-based fee as a form of compensation for managing this search process.