What is a Success Fee?
In finance, a success fee is a commission paid to an advisor (typically an investment bank) for successfully completing a transaction. The fee is contingent on successfully helping the client achieve their goal, and thus aligns the interests of the client and the advisor.
In a merger and acquisition process, a success fee is typically a percentage of the deal value or the enterprise value of the business being acquired or sold.
Benefits of a success fee structure
There are many reasons for using a contingent success fee structure for a deal or transaction.
The benefits of contingent fee structures include the following:
- Alignment of interests between the client and advisor
- Potential savings, or cost expenditure efficiency, since there is no fee paid if there is no successful outcome
- Incentivizes the advisor to get the best possible deal (since a better, more lucrative deal translates to a bigger commission check)
- The simple fee structure is easy to understand
Drawbacks of a success fee structure
Like everything in business, there are tradeoffs to consider when deciding whether or not to use a success fee structure.
The potential drawbacks of contingent fee arrangements include:
- If the probability of success is low, the advisor may make little effort toward working on the deal since they doubt they will be able to earn a commission.
- If the fee structure is for a flat fee, a fee that is the same regardless of the value of the deal, then the advisor may be incentivized to close the deal as quickly as possible rather than spend time trying to get a better deal that will not make them any additional money. In such a circumstance, the best interests of the client and the advisor may not be sufficiently aligned.
- The advisor is exposed to a lot of risk if they are working on a deal with the possibility that – if they are unable to put a deal together – they may earn nothing at all for their efforts. (Because of this possibility, many contingent fee arrangements provide for the advisor to receive some nominal compensation for their time and efforts even if they are ultimately unsuccessful in helping the client set up a deal.)
- A potential drawback for the client is that a success fee may be more expensive than a work fee or fixed charge.
Example Fee Structure on a Deal
Imagine a client approaches an investment bank to sell their company for the highest possible price. The following fee structure is negotiated: 2% of the transaction value up to $500 million and 5% of any excess value over $500 million. With the large percentage differential for any revenue over $500 million, the advisor is strongly incentivized to work hardget the highest possible sales price for the client.
In this example, assume the bank finds a buyer for the business willing to pay $650 million. The total success fee would be $10 million on the first portion of the transaction cost and $7.5 million on the additional value above $500 million, for a total fee of $17.5 million.
Ranges of success fees
There is a wide range of fees charged on the sale of a business in investment banking. Below is a very rough guideline of ranges that can typically be seen in the industry:
- $0-10 million: >10%
- $10-100 million: 3-10%
- $100 million-$1 billion: 1-3%
- >$1 billion: 0.5-1%
Thank you for reading CFI’s guide to a success fee in the investment banking advisory business. To continue learning and advancing your career, these additional CFI resources will be helpful: