Transaction Costs: The Commission
Last week’s post focused on some of the costs a seller will incur as a result of a successful transaction and the need for the seller’s broker to be able to outline these costs to their client. But one of those costs that was not discussed is the largest one: the broker’s commission or “success fee”.
Brokers that successfully guide a deal to conclusion do a lot of work, spend a great deal of time – and no small amount of money – on everything from preparing the marketing materials and the marketing campaign to meeting with potential buyers, negotiating offers and shepherding the transaction through to the closing table.
We do the heavy lifting and we earn our fee.
But that fee is, with the exception of any existing note payoff, by far the largest line item on any closing accounting statement and, early in the process, the seller needs to be made aware of how it will impact their net proceeds. Reminding the seller when the deal is about to close risks the seller being taken by surprise – which can happen even when the broker’s fee is clearly stated in the listing agreement.
What’s the Fee?
There is no standard fee. What a broker charges for his or her services can depend on the size of the transaction, the complexity of the deal, the location of the practice, the amount of competition it faces among other factors and – most significantly – the depth of experience and reputation of the broker.
But as a general rule, in the Main Street Market, we and many other brokers generally earn fees of between 8% and 12%.
For bigger deals, we use a “laddering” fee structure. That is, at certain dollar levels of the transaction, we’ll reduce the percentage. For us, those dollar levels are usually in increments of $1 million.
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That said, I’ve heard of commission fees as high as 15%.
Hopefully, it’s not a surprise to learn that, as counter-intuitive as it may seem, the smallest businesses generally incur the steepest fee percentage. Why is that? Well, the reason our brokers give is that it takes as much – if not more – work to sell a $100,000 business as it does to sell a $1 million business.
So, think about the impact of a 10% fee on a sale of a $100,000 business versus the sale of a $1 million business. In the smaller deal, the broker earns $10,000. In the larger deal, it’s $100,000. Even with a 12% fee, the smaller deal generates a fee of only $12,000. If the transaction takes the customary “average” time of seven to 12 months to close, which deal would you prefer to work on?
Some brokers that have been in the business for a while are less than thrilled to take on the smaller deals for the simple reason that, assuming they have other deals to work on, they know they’ll be able to spend their time on something that is going to generate a larger payday.
But this fact means that there are plenty of smaller opportunities for beginning brokers to work on and that’s where the experience is gained!
This, of course, is tantamount to saying you didn’t earn your fee because you were too successful; that you sold the seller’s business too quickly! It’s hard to imagine a dumber statement but it does happen.
It also completely ignores what is sometimes many years of experience that the broker brings to the deal as well as classes and study that the broker undertook to gain his or her professional knowledge.
Such a position by a seller is, fortunately, not often encountered – but it will happen.
This problem has a two-part solution.
First, assuming that all discussion during the process of the broker-client relationship that addressed the net proceeds at sale included a reminder to the seller that transaction costs must be considered, as soon as any offer is submitted, before presenting it to the seller, prepare a draft closing statement – to the extent that you the necessary information – and present it to the seller when you present the offer to show the seller what the approximate net proceeds will be once all the known transaction costs are deducted.
Do this with every offer and, as an offer is negotiated, with every new version of every offer. This way, there is no “surprise” to the seller; he or she will have repeatedly seen all the fees – most importantly, the largest one; the broker’s – during the negotiation process.
The second part of the solution is to prepare a commission statement at the point that the negotiations are completed and a deal is being signed. Have the seller sign it acknowledging what the broker’s fee is and that it is due at closing.
As a rule, you’ll be hard-pressed to find the seller in a better mood than when he or she is putting his signature or initials on what is the final iteration of the agreement. This is the time to get the seller to acknowledge that the broker has earned the commission.
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The Bottom Line
It’s important that brokers remember that, if they succeed in finding a buyer for a business they were hired to sell, they’ve earned their fee and deserve to get paid. But it’s the broker’s responsibility to make sure that the seller is always aware of their responsibility in this regard and isn’t able to feign surprise at the last minute.
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 profitable week!