Lehman formula is also known as the Lehman scale and it defines the rate of compensation that a bank or a finder should receive for brokering services. The formula was initially used by investment banks, individual or corporate finders to raise the capital for a business. It was applied in public offerings or private placements. The commission was paid by the vendor of the business once the funds have been cleared. The Lehman scale is used with the amounts greater than one million dollars. Below one million dollars mark, investment banks and brokers offered set fees. (A. R. Lajoux, J. F.Weston 1999)
The original version of the Lehman Scale
- 5% applied to the first million of purchase price
- 4% of the second million of purchase price
- 3% of the third million of purchase price
- 2% of the fourth million purchase price
- 1% of the purchase price thereafter
The above scale was commonly used in the 1970s, 1980s and 1990s; usually when a large stock investment transaction was made with an investment bank or institutional broker as well as for private asset transactions. However, it has stopped to be the standard due to inflation. In 1990s some banks developed different variants of the formula by replacing 1 million to 10 million dollars, 4% of the next 10 million dollars etc., which was considered to be extremely greedy. Nowadays, the formula is only used under few circumstances, mostly by individuals, not companies, who declare the relationship, however they do not have any other role in the execution of the deal, like distribution, legal, analytics or administrative. (R. De Haas & N. Van Horen 2012, p. 231-237)
Lehman Brothers was a global financial services firm that in the early 1970s developed the formula with the commissions applied for underwriting and capital raising. Before the scale was introduced, the rate varied from institution to institution, in some cases reaching even more than 15%. The formula was applied to the dollars as a total capital of a transaction, rather than a larger share of equity dollars. (A. S. Kaplan 1985)
In September 2008, Lehman Brothers announced the bankruptcy which was the result of exodus of most of their clients, massive losses in their stock and due to devaluation of assets by credit rating agencies. This bankruptcy was the largest in the US history and it had a huge impact on the late 2000s global financial crisis; global markets immediately plummeted. (M. Williams 2010).
The report from 2010, which was examined by the court, proved that Lehman executives were using cosmetic accounting tricks so that at the end of each quarter their finances looked less unstable than they really were. This practice was described by Lehman as the outright sale of securities and created "a materially misleading picture of the firm’s financial condition in late 2007 and 2008”. (M.Trumbull 2010).
Current commissions vary, some banks seek higher rates (even Triple Lehman) while other push for lower rates, for example in case of $100 million and higher transactions. It is also a common practice to run transactions in-house. Such example was the Google IPO, they performed the analytics, execution and structure requirements while a Dutch Auction was used for pricing and banks were used for distribution network. Retainers and ongoing fees are typical for big transactions. Usually underwriters try to get the company that is collecting the capital dedicated to pay the underwriter's legal fees which are significant. (A. R. Lajoux, J. F. Weston 1999)
- De Haas, R., & Van Horen, N. (2012). International shock transmission after the Lehman Brothers collapse: Evidence from syndicated lending. American Economic Review, 102(3), 231-37.
- Kaplan A. S. (1985) Lehman Brothers: 1850-1984: a chronicle. New York: Lehman Brothers
- Lajoux A. R. Weston J. F. (1999) The art of M&A financing and refinancing: a guide to sources and instruments for external growth. McGraw-Hill Professional, New York, London.
- Trumbull M. (2010). Lehman Bros. used accounting trick amid financial crisis – and earlier. The Christian Science Monitor.
- United States Congress U.S. (2002) The Watchdogs Didn't Bark: Enron and the Wall Street analysts.
- Williams M. (2010). Uncontrolled Risk. McGraw-Hill Education.
Author: Katarzyna Mamak