When it comes to buying and selling businesses, it’s rare that the buyer and the seller handle the transaction on their own. Nor is it advisable to do so, given the volume of accounting and legal documentation required, the process of negotiating sale terms agreeable to both parties, and knowing steps to take when a deal in progress encounters unforeseen complications. There are many potential pitfalls in the process, and generally buyers and sellers on their own do not have the experience, expertise and time required to recognize and then work through the myriad issues that can arise in the sale process.
This is where a business broker comes in. An experienced business broker is intimately familiar with all of the ins and outs of the business sale process, knows the steps each party will need to take in the sale process, and provides assistance to both parties in the fulfillment of each step.
Business Broker Duties and Requirements
- Pricing the business with a professional valuation.
- Drafting an offering summary, sometimes called a confidential business review. This piece becomes one of the most important marketing tools for the offering, and is provided to prospects only after they have signed a confidentiality agreement and been qualified by the broker.
- Marketing the business to the widest possible audience while maintaining strict confidentiality. This is one of the important distinguishing differences between business brokers and real estate agents. Real estate agents put a sign in front of their properties and typically without the need for confidentiality, advertise widely the specific location. Business brokers are trained to maintain strict confidentiality.
- Introducing prospective buyers to the business after insuring confidentiality agreements have been executed.
- Facilitating meetings between the seller and potential buyers.
- Writing offers to purchase the business.
- Handling negotiations between the parties after an offer has been made.
- Facilitating the due diligence investigation. Offers to purchase are almost always made contingent upon a further due diligence investigation.
- Assisting the buyer in obtaining business acquisition financing.
- Scheduling and facilitating the closing of the transaction.
Business brokers can represent either the buyer or seller in a sale. Historically, the broker has traditionally represented the seller, but buyer representation is becoming more common. The representation of one party in a transaction usually creates a fiduciary duty between the broker and the party represented. Some states allow dual agency representation of both buyer and seller if all parties agree to the arrangement.
In some states, brokers can choose to act as transaction brokers, representing neither party as an agent but working to facilitate the transaction. In this situation, there is no fiduciary duty created and the broker deals with both parties on the same level.
At present, 17 states require business brokers to be licensed by their state’s real estate commission. All states require a real estate license if the business broker is handling real estate along with the sale of the business entity. However, the majority of small to medium size businesses are in leased locations with no real property as part of the sale. (Additional information regarding business broker education and requirements are here and here. California’s requirements are more stringent than others.)
Broker Fees
Just as the seller wants to walk away with a profit, and the buyer expects to profit from the business following the sale, the business broker expects to see a profit from his or her endeavors in the sale process.
While there are no laws or regulations regarding fees and pricing, business brokers typically charge a 10% commission (often referred to as a “success fee”) on the value of the business itself, and 6% on any associated real estate, related to the business up for sale. Some exceptions are businesses such as gas stations, grocery stores and hotels, which can be less. Some brokers will charge as much as 12% while others may be willing to drop a few points to land the deal, but most brokers hold firm at 10%. If another broker is involved in finding a buyer, the fee is split between the listing-side broker and the sell-side broker – provided they are willing and agree to work together (cooperate), which not all business brokers do. Some states are better than others (Florida is among the best, California among the worst).
The 10% fee may seem high to most sellers, especially if a business owner has invested a good deal of sweat equity into the business. To give up 10% of all the hard work it took to build the business can hurt. The reality, however, is that this is what it takes to keep brokers in business, and 10% is considered the industry standard. It may not seem evident at the start of a deal, but by the time the deal is completed, most sellers will realize that the 10% broker fee is fair and justified.
M&A Commissions
It is standard practice to provide a discount above a $1 million selling price, and many M&A firms will say they use the Lehman Scale (https://en.wikipedia.org/wiki/Lehman_Formula) although, in reality, it is more likely they will use the Double Lehman Scale. The Double Lehman Scale pays a commission of 10% on the first million, 8% on the second million, 6% on the third million and 4% on the remainder.
Brokers who don’t normally work on larger deals may charge 10% total commission for a selling price above $1 million. They generally don’t do this on purpose, rather they just don’t know it is standard to use the Double Lehman. (Obviously, the seller in such a deal is also not aware of this.)
Smaller deals often have a clearly defined value, making it easy to derive a success fee. This is not the case with larger or more complex deals – in these cases, it is often up to the seller and the broker to sit down at some point and work out a fair commission. For example: a deal may have a contingent payment based on the future performance of the company. In this case, the full purchase price would not be known for a number of years. This is commonly called an “earnout”. The “expected” purchase price used for commission calculation ended up being above the base price but below the maximum price.
As a general rule, business brokers don’t charge an upfront fee, while M&A advisors do. It makes sense too. A business broker is operating essentially alone much like a real estate agent, while an M&A firm applies a team of writers, analysts and deal makers on your project and also must pay for a marketing campaign – there are substantial out of pocket costs for each client for first class mail, telemarketing and advertising, so the M&A firm will charge an upfront fee to help pay for these costs.
The Tail
Engagement agreements vary a lot, from real estate type canned agreements for business brokers to custom agreements for M&A firms, but you’ll find a “Tail” on each one. The tail on an agreement means that once the agreement has ended, there is still a clause that says if you sell to anyone within 18 to 24 months that the intermediary introduced to you, you still owe a commission. This should not surprise buyers and sellers, it is a standard provision. The part that isn’t standard is what is meant by “introduced”. This is defined as anyone who signed a confidentiality agreement during the time the agreement was in effect.
Legal Assistance and Representation
It should come as no surprise that, given the complexities and contingencies involved in a business sale, both the buyer and seller will have their own legal representation. The lawyers for both parties play a crucial role in ensuring that the terms of the sale do not break any laws and that their respective clients’ interests are represented in the deal.
With the buyer and seller having separate legal representation, the negotiation process can often become a long and drawn out affair. The degree of back and forth on the terms of the deal, and the minutiae involved in said terms, is difficult to avoid in this situation. Good business brokers can try to help mitigate this, but given that lawyers will be lawyers, there’s not much the business broker can really do to change things.
A case can be made that if both the buyer and the seller use the same legal representation, the transaction will run more smoothly and quickly. While this may seem like a good idea in theory, the reality is not as clear cut: having the same legal representation for both buyer and seller can result in a conflict of interest, especially if the lawyer has a pre-existing relationship and/or agreements in place with either the buyer or the seller. If the buyer and seller decide to go down this path, they had both be very sure that the lawyer selected to represent both clients in the negotiation process has no prior relationship to the buyer and seller, or any entity having a pre-existing relationship to the buyer and seller. The difficulty in ensuring this makes having a single legal representative for both the buyer and the seller a rare occurrence.