Business Brokers: Mistakes to Avoid, Part 2
Two weeks ago, I posted Part 1 of Business Broker: Mistakes to Avoid and promised to follow up with two more lessons to avoid mistakes.
If you recall, it was the story of an experienced broker, busy as he could be, not paying attention to a significant detail of his practice – in that case, the language of his engagement, or listing agreement – only to discover at the worst possible time that the term of that agreement had expired. It was a costly mistake to say the least.
At the end of that post, I stated that paying attention to the details of the listing agreement or engagement letter was not the only lesson our broker learned. Because when he showed us the form he used as his listing agreement, we immediately discovered that this was not the only mistake he made.
We were able to point out two additional issues that, if not addressed, held the potential of him risking many commission fees in the future.
Remember, this business broker had put a lot of work into the deal – one that eventually came to fruition – only to be stiffed on his fee simply because he was “too busy” to focus on some seemingly inconsequential details. But the omission of a couple of other considerations also could have cost our friend a lot of money – and these omissions were not simple oversights as was the first problem.
These were systemic problems.
Extend Your Protection
As I’ve often reminded readers, brokers and particularly clients and potential clients, a reasonable proportion of properly-priced businesses will take somewhere in the range of seven to 12 months to find a buyer – and if the business is even modestly complex, it could take much longer. This is why we counsel brokers to never take on an engagement to sell a business for less that a 12-month engagement or listing term.
It’s not at all unusual for a transaction to take far more than 12 months. It’s also not unusual for a prospective buyer to leave the stage at some point only to return down the road.
This can put the business broker in the position of spending a great deal of time and effort on a prospective buyer that “decides” to pass on the opportunity – only to return to the hunt several months following the expiration of the broker’s engagement term with the seller.
If that happens, we have a broker that 1) “found” the buyer through the broker’s marketing efforts; 2) qualified the buyer; 3) provided the buyer with an abstract of the opportunity; 4) secured a non-disclosure and confidentiality agreement from the buyer; 5) provided the opportunity’s Offering Memorandum to the buyer; 6) fielded and answered innumerable questions over dozens of phone calls and emails; 7) hunted down countless documents and other minutia as the buyer’s due diligence process unfolded; 8) provided outlines of financing structures and contacts of funding sources; 9) arranged and attended meetings of buyers and sellers; and myriad other tasks, small and large, to facilitate the prospective buyer’s due diligence and, ultimately, a successful transition.
If the prospective buyer walks – a not uncommon circumstance – all this work is for naught.
But what happens if, six months after the engagement letter or listing agreement expired, the prospective buyer comes back to the table, contacts the seller and eventually makes a deal to buy. If not properly protected, the business broker may simply be out of luck.
The way our brokers avoid this – to the extent avoidance is possible – is by including a 12-month protection period post expiration in the listing agreement.
Our engagement contracts include a provision that states that, should anyone to whom the broker has introduced the business reenter negotiations to buy that business within 12 months of the expiration of the term of our engagement letter and ultimately does buy that business, we are due our commission or success fee.
This has two benefits.
The first, obviously, is that it protects our position. We know we’ll be paid for all the work we did on behalf of the seller.
Second, if that provision is included in the listing agreement, the seller is likely to call the broker to assist in the negotiation and structure of the deal.
Get It In the Contact
But the are additional ways to protect your commission and we use them all.
For instance, the purchase contract should include two statements or clauses that are meant to protect you, the broker.
First, there should be a “Procuring Cause” clause that reads something like this:
The parties agree that [Broker’s Name], of [name of brokerage company], is the sole procuring cause of this Agreement.
Second, there should be a “Brokerage Commissions” clause that reads something like this:
Seller [or the buyer, if the deal is negotiated as such] shall be responsible for all applicable brokerage commissions in accordance with a listing agreement [or engagement letter] between Broker and Seller dated _______ and made part of this agreement by reference.”
There are several longer versions of these statements – including ones applicable to co-broking deals as well as deals in which the broker is working for the buyer. If you’re interested in such options, let me know.
Commission Due Acknowledgement
If you aren’t involved in drafting the purchase agreement, prepare a simple additional document that you will present to the seller when after all the negotiations have been completed and you’re getting ready to get his or her signature on the purchase agreement.
This is the point when the amount of work you’ve done and value you’ve added to the process is most evident to your seller and when most sellers are at their most amenable. We want them to sign a statement that you’re due your commission.
We use a simple one-page letter that we title “Acknowledgement of Commission Due”.
Such a letter contains the specifics of the deal – seller, buyer, business entity and description, brokerage firm and anything else that the broker deems pertinent – that references the listing agreement (or engagement letter) and clearly states that “X” amount of money is due to the broker for services rendered.
Depending on the deal structure, the commission might be paid over time. If so, such schedule should be included.
The object of this step is to have the seller – your client – confirm in writing that you are owed your fee according to the listing agreement and the purchase contract and to state how and when that fee is to be paid. You’ve done your job and are entitled to be paid.
Again, the optimum time to present this for the seller’s signature is when you present the final negotiated version of the purchase agreement. At that point, your client is likely to be most appreciative of the efforts you’ve expended to get the deal done.
The Bottom Line
The bottom line here is that there were three lessons for our broker to take away from his experience:
- Pay attention to the details. Know when your agreement with your client expires and address extending it no less than 30 days before its expiration.
- Insert language in any purchase agreement that states your role in making it happen and who is responsible for paying your fee.
- When presenting the final negotiated version of the purchase contract, present an Acknowledgement of Commission Due letter for your client’s signature.
In my experience, the vast majority of sellers are honest and ethical. Except for one instance when an unethical lawyer was involved, we’ve never had a seller act dishonestly – and that specific occasion did not a involve a squabble over our fee. In fact, we’ve never had a fee dispute.
We have agreed to negotiate payment plans for deals where there was substantial seller financing involved but we’ve generally handled that with a standard promissory note. Sometimes the fee, particularly if it was large – say, over $100,00 – was paid over time. But we’ve never had to battle for our fee or reduce it in any amount. Paying attention to these three lessons will help you avoid any such unpleasantness, as well.
If you have any questions, comments or feedback on this topic – or any topic related to business – I want to hear from you. Put them in the Comments box below. Start the conversation and 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 safe and profitable week!