There’s a difference between the accountant in your office referring you to one of his clients and you securing a VC for a multi-million tranche to a startup. Mind you, there are situations of every type in between that casual introduction in a bar and a well-thought out strategic alliance with follow-up and a working relationship.
I felt giddy a few years ago when I received a surprise check in the mail for $300. It took me a few moments before I realized it was from a small business owner I barely knew. I had casually mentioned his name at a networking event and had shared his number with someone. Networking events are always fun and I am always keeping an eye open for a new connection I can share with someone I know. I never really expect anything from a future transaction between them.
I read the note that came with the check. It read, “thanks for the referral, Gary, I only work by word of mouth and like to make sure you know I appreciated the gesture – attached is a 15% thank you.” It’s not the size of the check that matters, it’s the thought that counts. Sage words but, who takes the time to offer compensation for a simple referral over a glass of wine at a cocktail party? Small business thrives on connections and networking.
Enter the big time! Big time meaning higher stakes. The years of developing a reputation for honesty, hard work and people knowing that your word is your bond. Big time meaning that the introductions you are making are not between people, necessarily, but between corporations, and the stakes can be very high.
You want credit for the introduction. Your reputation has gotten you to this point and you want to make sure honor is observed. With your relationships in the mix, you want a successful meeting of the minds. Are your relationships that important to the deal? Would the deal have ever been possible without your connections? How do you get compensated? Heady questions and often they’re not relevant because, most times, those monster deals don’t happen. But when the due diligence is done and people start working feverishly towards a successful end-game completion there are a lot of people with their hands out. What should you expect?
Believe it or not there is a formula. The Lehman Scale/Formula developed by the Lehman Brothers in New York in the 1960s, was used when they were raising capital for clients. It was widely accepted as the way commissions were paid to traders, intermediaries or people who introduced the parties. Lehman was once one of the leading global investment bankers before they were caught in the sub-prime catastrophe of 2008 and went bankrupt.
They developed the formula to make things easier for intermediaries to bring deals to the house. It caught on because it was fair and a good place to start negotiations. Here it is:
- 5% of the first million dollars involved in the transaction
- 4% of the second million
- 3% of the third million
- 2% of the fourth million
- 1% of everything thereafter (above $4 million)
So if someone brought $10M to a startup he would get a comfortable commission of $200,000. Not bad for an introduction! Mind you the more work involved the more the intermediary would supposedly get from the transaction.
In the 1990s the Lehman Scale adopted some changes. Specifically, the percentages paid to the deal finders increased substantially and many more people started polling their resources to put deals and people together. By the 2000s the Scale looked like this:
- 10% of the first million: $100,000; plus
- 8% of the second million: $80,0000; plus
- 6% of the third million: $60,000; plus
- 4% of the fourth million: $40,000; plus
- 2% of the fifth million: $20,000.
Total commission fee paid to the lead generator: $300,000 based on $5MM brought to the table.
If you add in extra work like being more involved in the negotiations that’s where the ‘plus’ of the formula enters the picture. Incentives, a ‘kick’ from the other side as well, equity or options and the money can be considerable. That’s the value of the digital Rolodex! Fees will vary depending on whom the finder is like a registered professional intermediary, a trader, vs. the average guy making the introduction only.
There are a certain amount of variables to finder’s fees and restrictions that go along with this practice. Considering the complexities of Security Law, one can’t afford to run afoul of them. It’s often wise to keep the person who made the introduction at arms length because of the limited range of activities he can do unless he is an approved source.
The average finder with no credentials is not allowed (under Canadian Securities Law) to:
- Provide an Offering or Placement Memorandum to the investor
- Nor can he provide the Subscription Agreement or investor presentations
- He can’t discuss the financials of the company with the investor or distribute shares.
For small deals, perhaps startups, fees are usually negotiable between 2-7% and sometimes in a situation with gray areas, the finder fee will be classed as a ‘consulting fee’. For legitimate finders a good fee is between 7-10% of all tranches for the life of the deal. Ongoing deals can be very lucrative!
For the finder who thinks it’s a good idea to get a piece from ‘both’ sides it’s not a great idea to ask the investor for money. Investors usually don’t pay finder’s fees unless they are looking for a referral agent to find startups in which to consider an investment. Think of the recruiting fees paid to headhunters and you get the idea.
If you are fortunate to be the finder, good fortunes await you but don’t be greedy. By all means feel free to negotiate but do it in good faith. Chances are if you feel empowered to introduce two parties in the first place in a business deal that has risk and high stakes you must feel they are both honest and trustworthy or the deal just won’t get past due diligence. Don’t let the deal fail because you, as the intermediary, became too demanding. If cash is an issue maybe you can take stock as a payment. Make the deal work!
The same, of course, goes for the company looking for the investment. If you need money consider the costs of finding that money in your negotiations with the investor and not at the expense of the Finder.
Finding money is always a dance back and forth with each part of the negotiations taking different twists and turns. Those involved will tell you the ‘art of the deal’ is exciting and the rewards to everyone can be generous.