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What Is the Fair Market Value for a Finder’s Fee?

Written By: Carol Roth | Comments Off on What Is the Fair Market Value for a Finder’s Fee?

One of the areas that is most opaque for those doing business is how to value finder’s fees.  Having been involved in more than $2 billion worth of transactions in my career, I receive a lot of questions asking about insight into how to value a finder’s fee.

I wrote a piece on finder’s fees here for some preliminary information. Here are some additional best practices around how to approach finder’s fee valuation.

Clarify it Upfront

Most of the issues I encounter regarding finder’s fees are parties who agree to a finder’s fee upfront in concept, but don’t actually spell out the obligation or the fee upfront. Not surprisingly, usually the party who is the finder believes they should get a much higher amount than the party paying the fee.

Set a fee or range of fees based on the work that is to be done by the finder, the size or value of the deal  and the type of deal structure, as discussed in more detail below, clearly in any agreement to avoid issues.

An Art and a Science

As with any valuation methodology, there is an art and a science to valuing finder’s fees. When I do an expert opinion on finder’s fees, I always look at how involved the finder is and the impact on the business of the counterparty. Key questions that I ask of both parties doing an after the fact valuation analysis include, but are not limited to, the following:

  • Experience and risk: How well did the finder know the counterparty and was there a reputational risk in making the introduction (i.e., the finder is putting their reputation on the line and/or their reputation helped secure the agreement of the business to talk to the counter party)?
  • Transaction type: Is this a new client? Is it purchasing a business? What type of transaction is contemplated and how complex is the transaction?
  • Transaction value: What value is the transaction or arrangement on a one-time basis and on an ongoing basis? What percentage of the target business was impacted (for example, was it a minority or majority purchase)?
  • Business impact: How meaningful is the transaction to counterparty’s business?
  • Finder involvement: How involved was the finder? Was it a phone or email introduction only? Did they help prepare materials? Did they attend meetings? Did they help structure the ultimate transaction or business arrangement? Did the counterparty know the target business or did the finder bring the business to that party’s attention? How many additional parties did the finder introduce over time that didn’t result in a transaction?

For an upfront arrangement, you should consider the above and spell out the obligations of the finder related to different scenarios. For example, denote how the value is considered in a minority transaction (which is typically valued at the actual value of the investment) vs. a majority transaction (which is typically valued as if 100% of the company had been bought, even if it is just a 51% investment).

Once you have the qualitative information, you can evaluate it against a range of “comparables”, as is done with other valuation methodologies.  As it can be time consuming, expensive and difficult to find a list of comparable finder’s fees paid, you can use investment banking and brokerage deal fees for similar deal sizes and types as your starting point. For example, if you use a range of investment banking fees for a majority transaction and the finder did a lot of work, such as preparing materials and deal structuring, they would have a smaller discount to the comparables range than if the finder just made a few calls, for example. As there are a number of inputs to compare (deal size, type of transaction, etc.) the range will be different for different types of transactions.

This can lead to a variety of outcomes.  For a smaller transaction, like a referral leading to a company carrying a new product line, there are benchmarks from 5 percent to 35 percent and higher, depending on whether you are looking at net revenue (revenue minus any direct costs) or other metrics, and whether you are looking at a fee on a one-time or ongoing basis.  And, if it is a multi-million dollar majority acquisition transaction where an investment banker might get paid 3% of the transaction value, 0.5% or 1% of total transaction value may be a market fee.   Note that there is never one right amount or answer. As with any valuation, there is a suggested range of reasonable outcomes, based on the quantitative and qualitative inputs surrounding the transaction.

Use a Professional

To achieve a fair outcome for both sides, it makes sense to use a professional to either structure the deal or determine fair value. Be sure to use someone with a specialty in finder’s fee structuring and valuation, specifically. Most standard valuation opinion shops are used to deal valuation and their usual methodologies (discounted cash flow, etc.) won’t apply well here.

Professionals can have a range of compensation structures, as well. For example, I often offer a flat rate or a percentage of the finder’s fees when I work on structuring and/or valuation. Also, note that unlike a fairness opinion for a M&A deal, you shouldn’t expect the valuation expert to take on any legal liability associated with their work.

Finders can be valuable in helping to consummate partnerships, transactions and more for businesses and should be compensated fairly, in keeping with the role they perform and the value they are bringing to the counterparty.

 

Author’s note: If you would like to hire me related to finder’s fees, please use the contact form on this site.

Article written by
Carol Roth is a former investment banker, entrepreneur and author of the new book, The War on Small Business and the New York Times bestselling book, The Entrepreneur Equation. Twitter: @CarolJSRoth