Buy a Business: Why Use a Broker

Want to Buy A Business? Use a Business Broker

If you want to buy a business, you might consider using a business broker. Why? Well, there are many reasons but let’s clarify a few things before we get started.

First, if you are looking for a small, Main Street-type business, depending on your level of experience and knowledge of investment returns, hiring a business broker to represent you may or may not be worth the money. However, if your target is a business with sales of more than $1 million, you might do well to consider putting a broker on your team, rather than relying on the seller’s broker.

Second, we’re talking about a broker that works for you, the buyer, and has your interest in mind. You can certainly call a business broker about a business that that broker has listed for sale but you should remember that such a broker is working solely for and in the best interest of the seller, his client.

So, why would you, the buyer, hire a professional business broker to represent you? What kind of broker should you look for? And what would such an arrangement cost? Let’s deep dive…

There are two types of relationships that a buyer can establish with a business broker. The first is to assist in working with other brokers – sellers’ representatives – to find businesses that are for sale and help you in your tactical negotiations to get the right price and terms for the purchase. The second is to hire a broker to find businesses – for sale or, more likely, not – that meet your specific criteria and who will value, negotiate and shepherd the deal through to closing on your behalf. This latter is generally referred to as a mergers and acquisitions (M&A) specialist and there is unlikely to be any other broker involved. (The sellers will generally rely on their board members, attorney and other counselors for guidance and advice.)

Let’s examine both arrangements.

In the first, you hire a business broker to go out into the market place to find out what businesses are for sale that come close to meeting the criteria you’ve laid out; criteria such as general geographic location, industry, net income and sundry other aspects that you are looking for. Your broker begins working with other brokers to see what they have that meets your needs. Depending on how specific your needs are, this could take some time but an experienced business broker will have the contacts and resources to do a search of listed business in FAR greater depth and detail than any search you could do by yourself and will be able to sift through what’s available to find one or more that might meet your needs. In this case, your broker, likely as not, will get paid by the seller insofar as the listing broker – the broker that was hired by the seller – will split the commission with your broker.

In the second, the transaction is likely to be significantly larger and more complex, and you, the buyer, are most likely looking for a strategic acquisition – a business that, for any number of reasons, your existing business is interested in acquiring (i.e., to expand your geographical footprint; expand your offerings with an add-on product or service; gain market share by acquiring a competitor, executing a “roll-up“, etc.). In this case, it doesn’t matter what, if any, businesses are for sale – ‘cuz as the man said, “Everything’s for sale!” – your broker will identify businesses that meet your criteria and, depending on your instructions, approach them confidentially to see if the owners would consider selling. No other broker is likely to be involved.

Strange Concept? Not Really!

In the first instance, the broker that you work with will, as I just mentioned, likely be paid by the seller’s broker who generally will split the commission he receives from the seller with your guy. However, this is not universally true. If you want undying loyalty, you want your broker working for you and to be paid by you. To illustrate the difference we’ll look at a similar relationship in a related industry.

In real estate, the customary client relationship is that the seller lists with one agent or agency but, given the existence of multiple listing services, it is likely that another agent from a different agency will bring the buyer. But  remember that the seller is the party that pays the commission. That is, both agencies/agents get paid by the seller. It is in everyone’s best interest – except the buyer’s, of course – to get the highest price possible for the real estate being sold. Because all the agents are being paid by the seller, their fiduciary duty is to the seller, not the buyer. This is a big deal in real estate law and ethics. Licensing agencies take this concept very seriously.

Well, the same is true in business brokerage. If the seller is paying everyone involved, everyone is working for the seller. It doesn’t take much thought to figure out that, under most scenarios, nobody is representing the buyer.

In a M&A situation – that is, when the buyer hires a broker or M&A specialist to find a business – the broker is paid by the buyer. You can certainly use this approach if you are looking for a general Main Street-type opportunity where your broker is working with other brokers searching through the businesses they have listed to see if he can find something that would suit you. So, how does this work?

In a typical sale of a business, brokers earn fees that generally range between 8% and 12% of the transaction value. By way of example and using those percentages, if a broker sells a business with a purchase price of $875,000, the broker usually earns somewhere between $70,000 and $105,000. If there are two brokers involved, they generally split that fee evenly – each broker would earn between $35,000 and $52,500. However, if you hired a broker and wanted that broker to be loyal to you, you might propose to pay him a percentage of the purchase price (transaction value) yourself and you want to make sure that the percentage you offer would result in a fee that is competitive with what the broker would make by co-brokering with another broker.

How We Handle It

We typically take an assignment for an initial period of 90 or 120 days. Yes, identifying target businesses and negotiating one or more purchase agreements generally takes much longer than that, we limit the original engagement period to give our clients the ability to terminate their agreement with us if they are displeased with our performance; and we want that same flexibility. The initial period can always be extended.

During this initial period and any extension thereof, we are doing a great deal of work on behalf of our client and we want to be paid for that work. As such, we require a retainer to be paid by our client that covers the initial period. The amount of that retainer depends on the scope of the assignment. If we are conducting a worldwide search, that retainer will likely be higher than if our search is limited to a city, state or province or even region.

We include a provision in our engagement agreement that, if the term is extended beyond the initial period, we are paid a monthly fee for as long as our client wants us to continue. We limit all extensions to 30 days but the retainer for the initial period as well as the ongoing monthly retainer fees for any extensions assure that we will get paid for our work should we run into a buyer that is – how should I say? – less than on the up and up.

Assuming that we are successful in identifying a target and are able to negotiate the terms of a purchase and bring the transaction to closing, we are due a success fee at that time. That success fee is also variable (based on the assignment’s scope) but it is NOT based on the transaction value. Why? Because we want our clients to know that we have no interest whatsoever in getting anything but the best possible deal for them. As I mentioned above, if we are working for the buyer, we want them to know that our interest is negotiating the lowest possible price for the acquisition.

So, what do we base our success fee on? We use the previous year’s revenue total. We receive a small percentage of that number as our success fee. More on this in a moment.

How is this approach received by the sellers? Well, consider this. If the business is not actively being marketed by a broker, no commission is involved. This is a great selling point for us because, when we approach a business about selling, the business owners know that we will not be getting a cut of their proceeds; they will net the full purchase price. If a broker IS involved, we explain to that broker that, if we co-broke the deal, their commission will be halved and that reducing the asking price by half the commission will 1) increase the likelihood of the deal closing, 2) not impact the seller’s proceeds and, 3) not impact the other broker’s net commission.

Sounds pretty cool, eh? But you’d be surprised how often we have to explain this to otherwise seemingly intelligent people. Anything that is perceived to be a little unorthodox can be a bit bewildering.

Now, about that success fee…

We do not base it on the value of the deal so that it is clear to our client that we have no incentive to keep the acquisition price any higher than absolutely necessary. We also explain to the client that, using this approach should result in the acquisition price reflecting the fact that the seller either will not have to pay any commission at all or that the commission the seller committed to pay a broker will be cut in half, benefits that accrue to our client.

So, what is the percentage? It varies but will almost never exceed 4% of the previous year’s revenue and, especially for larger businesses, will be lower.

The Benefits

So, what are the benefits of hiring a professional business broker or M&A specialist if you are searching for a business? They include:

• The broker works for and is loyal to you.
• The broker will save you countless hours of research time.
• The broker will be able to advise you as to what the target company is worth.
• The broker will be able to contact the target company’s owners confidentially; no one needs to know your identity, at least initially.
• The broker is experienced in negotiating the purchase and sale of businesses. He generally knows what’s possible and what’s not.
• The broker has contacts with lenders that may make finding the financing easier and less expensive, helping to get the deal closed.
• The broker’s experience will provide invaluable counsel to you as you go through the process of buying.
• The broker will help you structure an offer that covers a field of issues that many buyers simply aren’t aware of.
• The broker will shepherd the deal through closing until all the papers are signed.

The bottom line is that an experienced professional business broker or M&A specialist will provide a deep base of knowledge in a field that you are likely not very experienced in and will likely save you from making one or more costly mistakes in the process of acquiring your business. So, if you want to buy a business, give serious consideration to adding an experienced professional business broker to your team. Look for the “CBI” – Certified Business Intermediary – designation, a sign that the broker has spent a great deal of time and money on his or her trade craft. It will redound to your benefit.

If you have any questions or comments, put them in the Comments box, below. I’ll get back to you with answers or my own comments. If I get enough on one topic, I’ll address them in a future post or podcast.

I’ll be back with you again next Monday. In the meantime, I hope you have a profitable week!

Joe

The author holds a certification from the International Business Brokers Association (IBBA) as a Certified Business Intermediary (CBI) and can be reached at jo*@Wo*******************.com