The Role of the Business Broker in a Sale

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.

The Acquisition Exit Strategy - Making It Work

As a business owner, you know the importance not only of keeping your business going and growing, but also of knowing what to do when you decide you are done.  Of the many exit plans you may be considering (such as transferring ownership to relatives or friends, liquidation, or simply running down the clock), a common exit strategy which can both maintain the success of the business and generate the maximum profit for yourself is finding another business or investment group to acquire and perpetuate your business: the Acquisition Exit Strategy.
 
Here are some things to keep in mind, to help make this strategy a success for you:
 

• Choose the Right Acquirer For Your Business

Finding an acquirer with the right strategic fit and alignment with your business will increase the acquirer’s chances for success in keeping your business thriving after the transfer of the business is completed.
 

• Make Your Business Attractive to an Acquirer

Pinpointing and emphasizing the aspects of your business that offer the greatest potential for profit and growth will go a long way toward attracting potential acquirers.  If a bidding war ensures, the possibility of a higher acquisition price can increase exponentially.
 

• Avoid the Temptation of Targeting a Specific Acquirer

If you have a specific business or group in mind to which you would most like to sell your business, tailoring your attractiveness to the business/group may make your business less attractive to others.  There is also no guarantee that your preferred acquirer is genuinely interested in buying your business in the first place.
 

• Pay Attention to the Business Culture of the Acquirer

Your business brings with an associated cultural operating inclination (fast and loose, straight shooters, cautious, aggressive, conservative or liberal minded etc.).  If the business culture of a potential acquirer is at odds with yours, there is a greater likelihood of the culture clash getting in the way of – and potentially preventing – the success of the business going forward.  An acquirer with a culture more closely aligned with yours will have a greater chance of succeeding after the transfer of the business.
 

• Carefully Evaluate the Terms of the Agreement

If you’ve landed an acquirer and are set to make the deal, go over the terms of the agreement and make sure they won’t cause you grief after the transaction is completed.  For example, a non-compete clause might make things difficult for you if your plan is to start a new business along similar lines as the one you sold.
 
If proper care is taken in the process of executing the steps of a well thought out acquisition exit strategy, the result can be profit and success greatly exceeding alternative strategies.  Of course, we here at CPI are more than happy to help you with this.
 

Sources:

https://www.entrepreneur.com/article/78512
http://articles.bplans.com/types-of-exit-strategies/

Selling A Business When It’s In Trouble

Not all businesses succeed.  For every success story, there are many more stories of failures, and the failure can happen for almost any reason.  There are also stories of businesses that found success, only to encounter difficulties later on.  Businesses like these may find themselves in a position where they would rather sell than stand by while the ship sinks.

Can distressed businesses be sold?  Is there a market for distressed businesses?  Provided the business is viable and can remain a going concern through the sale process, the answer is yes – as long as the business owner is willing to either accept the fact that the value the business based on its current condition may not be as high as they’d like it to be, or alternatively, is willing to take the necessary steps to improve the business and thus increase its sale value.

Accurately pricing a distressed business is the domain of an experienced professional business broker, one that knows how to use the tools and techniques at their disposal to identify both the weak and strong points of the business in order to arrive at a valuation that closely conforms to market conditions and expectations.

If the business owner is open to the idea, a professional business broker will also be in the best position to suggest steps the business can take to minimize its weak points and shore up its good points, which can go a long way towards increasing the value of the business to prospective buyers.

While the manager or owner/managers of a troubled company may be in the position of decision-maker in the sale, this is not always the case.  The business broker will need to become acquainted with all parties involved in the business in order to determine which party is the real decision-maker in the sale process.  The business broker will then ensure they are the primary party involved in the sale process.

If the business is on the cusp of bankruptcy, a sale usually proceeds faster, cheaper and more privately – although there is less protection for the parties concerned.  If the business has already fallen into bankruptcy, the sale will proceed more slowly, be more expensive, and it will also be public – but there are benefits in the form of greater protection for the concerned parties, an automatic stay, and there is a forum for addressing related issues.

Above all else, the main hurdles to overcome in the sale process of a distressed business are twofold.  One is to make clear headed decisions and not let emotions get the best of the parties involved.  The other is dealing with time constraints, which can further exacerbate feelings of panic.  A good business broker will be able to keep these challenges in mind throughout the process, properly dividing up the steps each party needs to take based on their role in the process and effectively managing the activities of each party as needed.

With a steady hand, attention to detail, hard work and a clear-headed approach, a good business broker can meet the challenges of selling a distressed business, and the business can be sold for a value which is satisfactory to all parties involved.

Sources:

http://www.krbrokers.com/site/wp-content/themes/krbrokers/articles/sellingyourbusiness/Selling%20a%20Troubled%20Business.pdf

http://ml-sf.com/publications/docs/TPL0804-Litteneker_McNutt.pdf

Managing Expectations of Seller Valuation

I love the following quote by Warren Buffett as it sums up my feelings on business value in a nutshell:

Price is what you pay, value is what you get.

One of the biggest struggles with selling in the middle to lower middle market is business valuation expectations. Sellers almost always feel their business is worth far more than what the market will bear. Here are some reasons why this has been the case:

• The owner is valuing assets and not cash-flows. In most cases, a buyer is only willing to buy the business based on the cash the company is kicking out month-over-month and quarter-over-quarter. The true value–especially in today’s businesses–is not typically in the hard assets, but said assets are able to produce in a cash-on-cash return for investors.
• One of the biggest problems with valuations is the "Facebook" effect. Just because Facebook paid a multiple outside the range of anything reasonable in the real world, doesn’t mean your company is also worth 100X Revenues or $40/user. In fact, unless the business has some form of intellectual property combined with the ability to scale in a network-based format, forget about it. You’re a traditional business.
• Valuation multiples don’t increase if your bottom-line increases, rather if the company becomes more sell-able. Ie: the company is set up for large scaling, progressive technology, expansion strategies in place etc.  Sure, the business will be worth more if you put more cash flow to the bottom line, it doesn’t mean your multiple moves from 4x to 6x.
• The owner/operator is reverse-engineering a valuation based on wants/needs, not on fair market value. There are many instances when selling a business is not the right move at all. If you’re <50 years old, the business is kicking-off cash and you’re looking to retire, but realize you’ll need a 7X or more multiple to get there, forget it. Keep operating the company for a few more years.

There could be a host of other reasons, but these are the most common incident to the clients with whom we’ve recently worked. There are certainly ways to help boost the valuation multiple of the business of up to 40%  above the FMV (that’s what our process helps to do), but the exception to the fair value should not be considered the rule. It is tough for sellers and buyers to walk in one another’s shoes. Unfortunately for the seller, the buyer is also usually right about what the value of the business truly is. Because buyers typically acquire businesses many times and sellers only sell maybe once or twice, it usually means the buyer is much more sophisticated and knows more about what the market will bear in terms of price. Hence, as an advisor, it’s always frustrating when sellers fail to listen to both retained advisory and acquiring firms when they tell them their business isn’t worth 12x EBITDA.

A Note on Earnouts

Some owners are diabolically opposed to earnouts as part of the deal structure. Earnouts can increase the risk of not getting paid what is expected and can ultimately be a source of frustration, but in some instances they work really well. In the case when an owner has an unrealistic valuation expectation on the business an earnout may be just the thing to keep expectations in check and provide the right incentives to maintain, manage and grow the business post-acquisition. Earnouts of up to 30% of the total deal value are often applied in situations where the seller wants more and is confident the coming 12, 18 to 24 months will see a boost in the bottom-line.

When it comes time for owners to prepare to sell, the company will certainly sell much faster if management has keen and realistic expectations on what the company is worth. From our experience, the larger the deal gets, the less this particular problem becomes an issue. That’s a topic for another day.

The above was written in part by Nate Nead in M&A Advisory and updated by Devon Fleming.