Success Fee

What is a success fee?

Success fee (German: Erfolgshonorar) denotes the part of a transaction adviser's remuneration that is owed only if the mandated transaction is completed. Examples are a funding round, a company sale or a succession arrangement. Transaction advisers are advisers who prepare such projects economically and support them until the contract is signed. The amount of the success fee is, as a rule, measured as a percentage of the transaction volume, that is, of the capital raised or the purchase price, in part supplemented by minimum amounts or tiers. In general, any result-dependent remuneration is called a success fee; for lawyers and tax advisers it is permitted only in narrow exceptions.

The success fee is regulated in the fee agreement (Honorarvereinbarung), which in practice is also called a mandate agreement or engagement letter. The client in a funding round is usually the company itself; in a company sale it is the selling shareholders. The agreement sets out what the fee is owed for, what it is calculated on, when the claim arises and when it falls due. These four points usually determine the actual amount more strongly than the agreed percentage.

Fee models of transaction advisers

In practice, the remuneration of transaction advisers usually consists of several building blocks:

• Fixed fee (retainer): a fixed amount, monthly or in instalments by project phase, that pays for the ongoing work irrespective of the outcome.
• Success fee: the result-dependent part that arises with the transaction.
• Crediting: the rule on whether retainers paid are deducted from the success fee, in full, in part or not at all.
• Minimum success fee: a fixed minimum amount that is due even with a small transaction volume.
• Tiers: different rates for different value ranges, for example a higher rate for the part of the purchase price above an agreed target value.
• Expenses: travel costs, costs for the data room or database access, which are reimbursed separately or as a lump sum.

Pure success-based models without a retainer are possible but often come with higher rates and create an incentive to pursue the fastest rather than the best transaction. A combination of both building blocks distributes the risk between client and adviser. A tier that pays more above a target value additionally aligns the adviser's interest with a higher price.

Basis of calculation of the success fee

The basis of calculation is the amount to which the agreed percentage is applied.

In a funding round

The basis of calculation is, as a rule, the capital that investors bindingly commit in the round. Four cases above all need clarification. If the contribution is paid in tranches tied to milestones, it must be regulated whether the fee arises on the entire committed amount or on each tranche when paid. If existing convertible loans convert into shares in the round, no new capital flows; many agreements exclude such amounts. Capital from existing investors is in part excluded or treated separately. Debt raised in parallel, such as venture debt, a growth loan from specialised lenders, is covered only if the agreement expressly names it.

In a company sale

In a sale, “percent of the purchase price” is not sufficient as a rule. A distinction must be made between the enterprise value, which includes assumed financial liabilities, and the purchase price for the shares (equity value). In addition come components that are paid later or only conditionally: an earn-out, a retention on an escrow account, a vendor loan or a reinvestment of the sellers in the acquirer. Often the fee on such components falls due only when they are actually paid. In an asset deal, that is, the purchase of individual assets instead of the shares, it must be clarified whether assumed liabilities count towards the transaction value.

Arising and falling due of the claim

Two points in time are to be distinguished: when the claim arises and when it is payable. Possible triggers are the signing of the transaction contracts (signing), closing (Vollzug), that is, the actual transfer of the shares against payment, or the receipt of payment. If the claim is tied to signing, the client bears the risk that the transaction fails at closing, for example for lack of a regulatory clearance. If it is tied to receipt of payment, the adviser bears the risk of delays that it cannot influence. Often the claim arises with the binding commitment and falls due with closing or receipt of the funds.

Tail period and termination

The tail period regulates whether a fee is also due if the transaction is completed only after the end of the mandate. The periods are usually twelve to 24 months. Appropriate is a restriction to addressees that were approached during the mandate or with whom talks took place; a list of these addressees is handed over at the end of the mandate. If the client terminates the mandate early, the tail period as a rule also applies.

Some agreements also regulate the case in which a transaction fails after signing and the counterparty pays a termination fee (break-up fee). The adviser is then remunerated with a share of this payment.

Legal and tax framework

The advisory contract is predominantly classified as a service contract with the character of an agency for the management of another's affairs (Sections 611 and 675 of the German Civil Code, Bürgerliches Gesetzbuch, BGB). The success-dependent element resembles a broker's commission but, unlike that under Section 652 BGB, mostly does not depend on the adviser having itself identified or brokered the counterparty. Many agreements clarify that the fee is owed for every transaction within the scope of the mandate, irrespective of who established the contact.

The fee is understood to be plus value added tax. Whether the client can deduct it as input tax depends on its VAT status; private individuals selling shares can generally not do so. In the company's commercial balance sheet, a fee for a funding round is an expense. Expenses for raising equity may not be capitalised, that is, not recognised as an asset (Section 248(1) No. 2 of the German Commercial Code, Handelsgesetzbuch, HGB). If shareholders with a holding of at least 1% sell shares from private assets, the fee reduces the capital gain as disposal costs (Section 17(2) of the German Income Tax Act, EStG). Under the partial income method, however, it is deductible at only 60% (Section 3c(2) EStG).

If the company bears advisory costs that economically concern the selling shareholders, this can be treated for tax purposes as a hidden profit distribution (verdeckte Gewinnausschüttung), that is, a benefit to shareholders that is taxed like a profit distribution. At the same time it can touch on the capital maintenance rules of the German Limited Liability Companies Act (GmbHG). Who the client is and who pays is therefore set out unambiguously in the agreement and agreed in advance with the tax adviser.

Worked example: calculating the success fee in a company sale

The shareholders of a software company sell all their shares. The enterprise value is EUR 24 million, and financial liabilities less cash and cash equivalents are EUR 4 million. The purchase price for the shares is EUR 20 million. Of this, EUR 15 million is paid at closing, EUR 2 million is retained for 18 months on an escrow account and up to EUR 3 million is an earn-out. For illustration, a fee rate of 2% is assumed; the example shows how strongly the fee varies with the basis of calculation alone.

• Basis enterprise value: 2% of EUR 24 million = EUR 480,000
• Basis purchase price for the shares with all components (15 + 2 + 3 = EUR 20 million): 2% = EUR 400,000
• Basis only the amount paid at closing: 2% of EUR 15 million = EUR 300,000
• Rule “fee follows the money”, if the retention is released in full and EUR 1 million of the earn-out is reached: basis 15 + 2 + 1 = EUR 18 million, fee 2% = EUR 360,000, paid in three parts (EUR 300,000 at closing, EUR 40,000 on release of the retention, EUR 20,000 on payment of the earn-out)
• Range between highest and lowest basis: 480,000 minus 300,000 = EUR 180,000

With an unchanged rate, the fee varies by EUR 180,000 through the choice of basis alone. On the closing basis of EUR 15 million, this would correspond to raising the rate from 2% to 3.2%. The basis of calculation therefore belongs in the same negotiation as the rate itself.

Distinctions: success fee, fixed fee and broker's commission

• Fixed fee: remuneration of the ongoing work irrespective of the outcome. It covers the adviser's effort, while the success fee remunerates the result.
• Broker's commission: statutorily regulated pay for identifying or brokering a contract. The success fee of a transaction adviser, by contrast, remunerates support through the entire process.

Common mistakes

• Negotiating only the rate. Basis of calculation, trigger and crediting often move more money than a percentage point in the rate.
• Conditional purchase price components not regulated. Without a rule on earn-out, retention and vendor loan, a fee can fall due on amounts that are never paid.
• Unlimited tail period. A tail period that is not restricted to addressees approached also captures transactions to which the adviser contributed nothing.
• Unclear client. If the company pays a fee that the shareholders owe, tax disadvantages and conflicts with fellow shareholders threaten.
• Agreed too late. If the remuneration is negotiated only after the term sheet, the question ties up attention in the phase in which the negotiation with the counterparty needs it.

Frequently asked questions

Who pays the success fee?

The client under the fee agreement. In a funding round this is, as a rule, the company that receives the capital; in a company sale it is the selling shareholders, whose proceeds are reduced by the fee.

Is a success fee due if the transaction fails after signing?

That depends on the agreed trigger. If the fee falls due only at closing or receipt of payment, it lapses if closing does not happen. If the agreement is tied to signing alone, it can nevertheless be owed; the question therefore belongs expressly in the contract.

Is the fixed fee credited against the success fee?

Only if the agreement provides for it. Full crediting, crediting up to a ceiling and models without crediting are all common. For a comparison of offers, the total remuneration at the expected transaction size is therefore decisive.

May lawyers and tax advisers agree a success fee?

Only exceptionally. For lawyers, a success fee is inadmissible unless the German Lawyers' Remuneration Act (Rechtsanwaltsvergütungsgesetz, RVG) provides otherwise (Section 49b(2) of the German Federal Lawyers' Act). Under Section 4a RVG it is permitted only in narrow cases, for example for monetary claims up to EUR 2,000 or where the client would otherwise, for economic reasons, forgo pursuing the claim. For tax advisers, a comparable prohibition applies with an exception for this individual case (Section 9a of the German Tax Advisers Act, StBerG). Transaction advisers without a lawyer's or tax adviser's licence are not subject to these limits.

How do investors and buyers take adviser fees into account?

They have them disclosed and factor them in. In a funding round, fees appear in the use of proceeds, the statement of what the capital raised is used for, and reduce the capital available for growth. In a sale, acquirers often treat fees that the target company owes and that are triggered by the transaction as debt-like items that reduce the purchase price for the shares.

The Roemer Capital view

At Roemer Capital, a fee agreement regulates the success fee. In a funding round, it is signed before the investment agreement is signed. This settles before the negotiation with the counterparty what the fee is owed for, on what basis and from when. In the talks with investors, only the terms of the transaction are then at issue, not the remuneration of the advice.

We advise in the transaction exclusively on the client's side. The success fee ties our remuneration to the outcome the client is aiming for. The tax treatment of the fee, for example for input tax deduction or as disposal costs, is clarified by the client's tax adviser.