Managing Expectations

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 ( 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 Other Side Of The Coin

Our previous posts have focused on the small business – approaches to growing the business, seeking out investors, and the issues involved in formulating exit strategies.  In this post we turn things around and focus on the investment side of the equation: the factors involved in evaluating a business investment and the factors involved in taking it over once it has been acquired.

There are 28 million small businesses in the U.S., but research services are few and far between.  What makes one company more worthwhile as an investment target than another?  Certainly there are great opportunities for above-market returns but to take advantage of this opportunity, investors must have an approach for determining which companies are worth focusing on.

Here is an initial list of factors to consider at the start, when evaluating a company as a potential investment opportunity.


  • Gross Margin

Gross margin is the percentage difference between what a product sells for in the market (revenue) and what it costs to produce that product (cost of goods sold, or COGS).   This ratio is critical because it is what allows a company to invest in all the other areas needed to get the product to market such as marketing and distribution.

Gross margins can vary by industry, and even by categories within an industry, but razor-thin gross margins leave no room for error.  In private equity, I focused on investing in categories that had higher gross margins and thus could sustain increased costs more easily.  Examples of higher gross margin categories include personal care, premium pet food, and natural and organic products.

It’s very important to keep in mind that gross margin expansion is very difficult. Focusing on creating products with better margins, automating production or getting lower prices for ingredients can help, but the instances where gross margin improvement drives outsized investment returns are rare.

  • Brand Strength

This is often the toughest thing to assess in a small company, but an investor needs to ask herself, "Does this brand offer something unique?" A great example of this is Method, the eco-friendly cleaning products. The world did not need another green cleaner, yet Method created a special brand by packaging a quality product with beautiful design and distinctive packaging.

Customer and consumer surveys, "earned" media presence, and third-party data are good ways to start evaluating brand strength. In the consumer packaged goods (CPG) world, there are countless energy drinks and cleaning products. But there's a reason why Red Bull and Method have been huge successes while other products with similar recipes and formulas have failed: formulas can be copied, brands cannot.  A tech entrepreneur will not put her idea for a startup on a crowdfunding site (unless all other investors pass), because any engineer can copy it. But a consumer products company with $3 million in revenue would be comfortable talking about not just the idea, but the actual performance of the business. Why? Because you can back into the recipe for Cherry Garcia from Ben and Jerry’s.  It doesn’t matter. You can’t copy the brand.

  • The CEO

In a small business, you are investing as much in the leadership as you are in the product or company. As a result, you need to invest behind a CEO in whom you believe.  As part of your initial diligence, reference checks and third-party background checks are a must.  Beyond that, there isn’t a formula for evaluating leadership talent but you should do what every investor does–spend time asking questions. Get on a conference call and probe on issues you think are important. Does this person understand their business, have a passion for the product, and have what it takes to persevere?

  • Exit Prospects

Many people think that if they build a great company there will always be a home for it, but in certain industries that's not the case.  If the company has visions of selling to a strategic acquirer, it should be able to (a) identify who these likely “strategics” are, (b) determine what their acquisition strategies have been, and (c) be able to explain why that business should be attractive to a strategic acquirer.

  • Recurring Revenue

Recurring revenue is the portion of the revenue that is going to continue in the future.  It provides a nice base (ideally a growing base) of revenue on which management can rely while focusing on ways to grow the business.  It’s especially valuable because the cost of acquiring a new customer is typically about six times the cost of keeping an existing customer.

In consumer products, recurring revenue comes from repeat purchase. Maybe you bought the product once because you liked the packaging. You buy it again because the product performed.  It’s not enough, of course, to look to recurring revenue; the question is how frequently that revenue will recur.  At a prior firm, we invested in a shampoo company with a beautifully designed bottle (it won multiple awards) that dispensed shampoo in the exact proportions the average woman needed. The problem was that the average person usually uses a lot more shampoo than is needed.  As a result, consumers took 12-18 months longer than normal to use up our shampoo. Sounds great for the consumer, but it was problematic for the company because it delayed the repeat purchase cycle.


Once you have purchased a business, the real work begins.  To ensure a smooth ownership transition, here are seven steps you will need to take which will help lay a strong foundation for your new business to grow and prosper.


  • Have the previous owner stay on throughout the transition period.

Make the best out of the pre-determined transition period. Prepare a comprehensive list of things you want the seller to cover like processes, USPs and flaws of the business etc. Work with the owner to learn the business plan and the ins and outs of day to day operations.  In particular, you need to understand the future strategies that current owner has in mind.  Some business owners may have a hard time letting go of control after the sale, so you will need to take extra care in understanding the reasons for this and to take whatever steps are necessary to ensure the owner that the business can carry on and thrive after the transition period has passed.

  • Observe, ask questions, and make notes.

Observe the daily activities of the owner, the flow of communication with customers, employees and vendors. Make notes, get to know every bit of the business, continually ask questions and get answers from the owner.

  • Do not make any substantial changes out of the gate.

In general, people are resistant to changes (the ‘who moved my cheese’ phenomenon).  As such, it pays to go slow and avoid making changes that disrupt current business operations, or that can result in dissatisfaction on the part of employees and/or customers. You will have the chance to make changes and grow your business after you know it well enough to identify the kind of changes to avoid in this regard.

  • Meet your employees.

Take the time to get to know the employees and their roles in the business.  Convey to them that they will be an integral part of your business, and that you have no plans to make staff changes in the short term.  Get their thoughts and perceptions on the current business operations and how things can be improved to make their jobs more efficient and effective.  This kind of feedback from your new staff is crucial to formulating your business plans and strategies going forward.

  • Make your customers aware of the new ownership.

Get to know your customers, and review the customer service policies and the procedures. Let your customers know that you are the new owner, that you are committed to providing them the service they have come to expect, and that you intend to improve on this as you move forward. Gestures such as special offers or a giveaway, something that you think your customers will appreciate, can go a long way toward maintaining good will with your customers.

  • Don’t forget the vendors!

Just as you will rely on your customers and employees to maintain the business, the suppliers for your business are equally important. Schedule meetings to get to know the major suppliers of your business, and make contacts with the others as well. If possible, avoid making any long term commitments to them which can hinder your new strategies. Later, when you feel comfortable, look out for other suppliers to get better pricing and terms for future deals.

  • Give your premises a makeover.

Once you have settled in, make some changes to the office: get the walls painted, re-arrange the settings, and get rid of unproductive assets. This will help to make the business look new and different, and it will help convey your commitment to making a go of your new business. This will also have a psychological effect on yourself, reinforcing for you that the business is now yours, to take in the direction you see fit.


Work out your action plan around these seven steps to get things going in the right direction. Use the transition period wisely and build a thorough understanding of all the relevant facets of the business. Effective implementation of the ownership transition process will go a long way towards making your new business a success.


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.