- Explanation
- How to Calculate the Success Fee?
- Example
- Who Pays?
- Success Fee Ranges
- Benefits
- Drawback
- Recommended Articles
- A success fee is a type of contingent agreement that specifies a fee will be paid if the outcome of an event or deal is positive. If the outcome is unfavorable, there is typically no obligation to pay the fee.
- Success fees are commonly used in investment banking, where teams may work on a performance-based or success-fee basis.
- Success fees can allow organizations to avoid paying a fixed fee in case of an unsuccessful deal. This structure allows organizations to align the success probability with the payment of fees, potentially reducing financial risk and incentivizing performance.
Explanation
Investment banks act as a middleman when a company plans to raise public funds, try to take over another company, plan for a merger, or try to sell a segment. So companies enter into a Success Fee structure with the Investment bank so that the Investment banking team tries their best for the event to be successful. It is quite a common procedure as it relieves the company from paying a fixed fee, and the interests of both parties are now aligned. Investment banks make a lot of money when they complete a project. The fee acts as a gift for the hard work that the team performs.
How to Calculate the Success Fee?
This fee depends on the outcome. Say a company is planning to raise money from the public via FPO (Follow-on Public Offering). The company is planning to raise a minimum of $500M. They hired Goldman Sachs to be their investment banker and put forward a success fee agreement. The agreement was that if the capital raised is below $500M, then the fee will be 2%, and if it is above $500M, then the fee will be 6% of the excess capital. So the Investment Banking Team will have to perform thorough research of the demand for the company's shares in public and do mock trading of the shares to determine the price and the total number of shares to be issued.
Once all the decisions are made, and shares are listed, the Success Fee will depend on the outcome. Say the total money raised is $650.
The money raised has crossed the $500M mark, so the team is eligible for a success fee.
Calculation:
- Normal Fee = 2% of $500M = $10M
- Success fee = 6% of the excess of $500M
- That is 6% off ($650M - $500M) = $9M
- Total Fee = $10M + $9M = $19M
Example
Company XYZ is planning to sell its Tourism Segment. The company plans to start a new segment from the money and estimates that it will require $500M for the new segment formation. Company XYZ reaches JP Morgan to help them with the process. They plan to set up the fee structure on a successful basis so that the interests of both parties are aligned.
Terms: If the sale amount is less than $400M, then a flat fee of $200,000.
If the sale amount crosses $400M, then a 6% Success Fee to be given on the excess amount.
The investment banking team researched and found a potential buyer who will strategically gain from this transaction. The team calculated a superb synergy value for the buyer, and they agreed to pay $800M for the acquisition.
The deal was closed, and the company XYZ received $800M. So the project is an extraordinary success.
The investment will receive a fee of:
- Flat Fee = $200,000
- Success Fee = ($800M - $400M) * 6% = $24M
- Total Fee = $24,200,000
Who Pays?
Any organization that plans to execute a deal through an investment bank can pay the success fee. This fee structure relieves the organizations to pay a fixed fee even if the deal is unsuccessful. So many organizations opt for this structure to increase the probability of success.
Success Fee Ranges
There is no fixed range. It mostly varies from deal to deal basis. A typical structure could be:
- Deal Ranging from $5M to $15M can have a fee of 5% to 7% with a fixed fee of $250,000.
- Deals Ranging from $15M to $50M can have a fee of 3% to 5%.
- Deals ranging from $50M to $500M can have a fee of 2%.
- Deals above $500M can have a 1% or less fee.
Benefits
- It helps to align the interests of both parties. As the fee depends on the outcome of the deal, the investment bank will give its full effort to complete the deal.
- As the fees are contingent on the outcome. So the organization is not burdened with paying unnecessary fees in case of negative results.
- The fee structure is not fixed, so it gives the potential to the investment bank to earn big.
Drawback
- The investment banks do not accept risky deals where a negative outcome is great. So it gets difficult for the client to get an investment bank for the deal.
- As the fee structure is not flat. So the client may end up paying a lot of fees once the event is successful.
- Suppose the fee is designed so that a fixed fee will be received as a success fee if a hurdle is reached. Then the investment banking team will put effort into reaching the hurdle and will not try to do more. Say if it is said that if the capital generation is above $500M, then a fixed fee of $200,000 will be paid. Then the investment bank will not try to push it beyond $500M as they will not be paid more.
Frequently Asked Questions (FAQs)
1. Are success fees recoverable?Success fees are typically contingent fees that are earned by service providers, such as investment bankers or business brokers, upon completing a transaction, such as a merger or acquisition. These fees are generally negotiated as a percentage of the deal value and are typically not recoverable if the transaction does not close.
2. What is success fee vs. contingency fees?Success and contingency fees are similar in that they depend on a transaction's successful outcome. However, the key difference is in their application. For example, success fees, such as mergers and acquisitions, are often used in financial transactions. In contrast, contingency fees are commonly used in legal cases where the attorney's fee is contingent upon winning the case or obtaining a settlement.
3. What are seller success fees?Seller success fees, also known as seller's premiums or success-based fees, are fees paid to a seller in addition to the purchase price of a company or asset upon the successful completion of a sale transaction. These fees are typically negotiated as a percentage of the transaction value and are intended to incentivize the seller to achieve a successful outcome in the sale process.
Recommended Articles
This article has been a guide to Success Fee and its definition. Here we discuss examples, how to calculate, who will pay the success fee, and benefits and drawbacks. You may learn more about financing from the following articles –
- Prime Brokerage
- Investment Banking Function
- Initial Public Offering (IPO)
