Business Brokers’ Commissions

Questions constantly arise about Brokers’ Commissions:  What are they and why are they frequently higher than the rate charged by Residential and Commercial Real Estate Brokerages?

The levels of Commission Rates are negotiated between the Seller and the Broker.  Although those fees may be similar in various regions, and even to a large degree, across the Country, there is no specific percentage that is designated by any particular governmental or association authority.  In fact, to do so may be illegal.

It may be that some Brokers will state a specific rate and refuse to negotiate; but that is their prerogative, not because there is some law or organization that stipulates such a decision.

Some Sellers may ask, “My business is so small; can you discount the fee?”  Again, some Brokers will, but others will specifically refuse to discount smaller deals, for several reasons.  First, because if the rate is quoted on a percentage basis, the Broker’s own fee is reduced, simply because a percentage of a smaller sale obviously represents a smaller dollar return to the Broker.  And second, because smaller deals are frequently more difficult, time consuming and expensive for the Broker, than a larger deal.  Many larger companies have better books, more detailed accounting systems, more documentation, better advertising…all things that help in making the pricing and presentation to prospective Buyers easier on the Broker.  When a smaller business is asking for a discounted commission rate, he/she is asking for the Broker to accept a smaller percentage of a smaller price – so in effect, the Broker’s dollar amount is reduced twice – in exchange for the privilege of working twice as hard, in some cases.

Some Brokers will, some will not.  And sometimes, it will depend on the business itself:  How much is that business in demand?  How good are the records?  How cooperative is the Seller?  In the vast majority of cases, if Real Estate is involved, the Broker will offer a reduced rate, without being asked.  But again, it depends on the Broker – it is all subject to negotiation.

Moreover, some Brokers charge for Inventory, while others do not.  Some Brokers that charge their fee to include the Inventory may charge a lesser percentage than those that do not figure Inventory into their fees.  But not always.

You, as the Seller, have to know what you are being charged, BEFORE you get to the settlement table.  BEFORE you sign that Listing Agreement.

Frequently, we are asked why our Commission percentages are higher than Residential Agents’ charges.  The answer is relatively simple.  When a Residential Agent lists a property, the Agent puts a sign on your lawn, puts it into a Multiple Listing system, puts a lock on your door that allows all Agents in the area the opportunity to show your home, without the Listing Agent being present.  That Listing Agent may not even know your home was shown until the next day, when he/she gets a report from an appointment company that handles the showing schedules.

When your business is up for sale, obviously we do not put a sign in the window!  In fact, the advertising – whether on our Web Site, some multiple listed database, or in other media – is always done in an abstract and confidential way, so that the casual reader cannot identify your business.  The promotion (by any responsible Broker) should give enough information to make it attractive and interesting, but not enough to allow your employees, landlord, vendors and customers to know that your business is for sale, and become alarmed.

That means that each and every business is, by necessity going to require much, much more personal attention, personal communication and personal TIME, for every potential Buyer.  The responsible Broker goes through several stages of qualifying every single Buyer, and giving those individual Buyers information ABOUT the business, BEFORE he/she ever gets the identity of the business, itself.

This means that Brokers do not necessarily earn more than Residential Real Estate Agents; they frequently earn less, because they cannot do the volume of sales transactions their Real Estate compatriots do, and each deal normally takes far longer than the average Residential sale.  This DOES NOT mean that Residential Agents do not work for their commissions – far from it!  It is simply a different business, with different responsibilities and requisite skill sets.

We only accept about 30% of the businesses we are asked to list.  And one of the big reasons is that we feel that we cannot list too many businesses at any one time, and still do justice to each.

Some Brokerages brag that they have 400 or 500 listings!  We are uncertain why some sellers thing that is such a good thing.  Unless they have more than 50 Agents, how can such a Brokerage promote any of those businesses, competently?  (And by the way, the same can be said for Commercial Real Estate.  We have tried to relocate several of our Clients, and found that the major Commercial Real Estate Brokers do not always know their own listing portfolio, because of the volumes they carry!)

In fact, what happens is that those kinds of Brokerages typically specialize in something like Convenience Stores or Liquor Stores – something that is high in demand and volume of potential sales.  Some go so far as to post their listings on an erasable board, in their offices.  On the basis of the claim that they have that number of listings, they invariably get Buyers simply walking in to their doors.  The Buyer says he is looking for a Convenience Store, and the Broker points to the listing board and invites the Buyer to pick one out!

That is great for the Buyer – but it does NOTHING to promote your individual business!

If you have a Liquor Store or a Convenience Store to sell, that may work for you.  There is nothing wrong with that approach, legally or ethically.  It is a matter of style, and whether that fits into your need.

If you are a Buyer, the real danger with that scenario, is that many of those listings are not real listings, at all.  We are familiar with one Brokerage that boasts about that kind of listing volume, except we have been told by both Buyers and Sellers alike that most of those are not real listings.  They are a function of a Business Owner telling the Broker, “If you find a Buyer willing to pay a quadrillion dollars for my business, call me.”

That means that the Broker really has no idea about the true value of the business…because he/she has no idea of the Cash Flow of the business…because he/she has never actually seen any written documentation on the business!

When you are looking to buy or sell, actually talk to the Broker, before you do anything.  It should not take you long to determine whether he/she knows what he/she is talking about.  If they are just throwing stuff against the wall to see what sticks, regardless of which side of the deal you are on, your interests will not be well served.

(The BAF Group LLC is a full service Business Brokerage, with a history of more than a decade of service. Its Principal Broker possesses 25+ years of Business Sales and Divestiture. Although most of our work is involved in the Mid-Atlantic States, we have represented Sellers and Buyers throughout the Continental USA, and a number of overseas Buyers, as well. Some of our listings and additional information about us can be viewed at www.bafgroup.com. Or, you may contact us at combroker@bafgroup.com. Thank you for your interest.)

Business Sellers Need to Understand “Cash Flow”

A vital issue to the sale of any small business is the Seller understanding his/her own Cash Flow position, as it applies to a potential sale.

It is amazing how few Business Owners understand this issue.  Many operate out of their check books, feeling that if they have money left at the end of the month, that is good enough for them!

Keep in mind that we are not Accountants, we do not pretend to be Accountants and we do not even play Accountants on TV!  The discussion provided here must be viewed in that light; however, the term “Cash Flow” is quoted in any number of documents and reports as a “non-GAAP” financial measurement, anyway.  (GAAP itself is defined as the Generally Accepted Accounting Principles by which Accountants operate.)  Cash Flow is utilized as a term most frequently by non-Accountants, as well.  You see it in the vast majority of advertisements and other promotional materials, when Sellers and Brokers offer businesses for sale, but also in more technically oriented documents such as quarterly and annual reports from some of the Country’s largest companies.  However, in those latter documents, Cash Flow is normally, specifically labeled as a “non-GAAP” measurement of financial health.

That’s not to say it is an invalid measurement; but what it does mean is that it is something that has a wide variety of definitions and you, as a potential business Seller, need to understand what each individual Buyer or Broker is using to measure his/her definition of Cash Flow.  The absolute only way to do that is to disclose your own definitions, whenever information about your business is presented.

We are really going to discuss what Cash Flow means to the average Business Owner and Broker, (contrasted with what might be meant in a public company’s Annual Report,) with the emphasis that even here, there are broad variations in definitions.  The Seller or Broker should be able to explain him/herself in great detail.  If you provide vague answers, it is an invitation to the Buyer to back off of the deal.  The perception will be that you are playing games, or that you do not know what you are doing!  You or your Broker should be able to tell the Buyer – in writing – what methodology has been employed in a Cash Flow report, and why.

Cash Flow is not even a universal term.  Brokers will frequently label terms like “Sellers Discretionary Cash” (SDC).  EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortization) which is a more descriptive term than any of the others.  But it is not necessarily as all-encompassing as what is normally thrown into either Cash Flow or SDC.  There are many, many other terms used by many, many individuals, particularly in small businesses.  So again, you absolutely need to provide documentation, or ask your Broker to do so, in writing.

(We are currently involved in a C-Store negotiation, and the Broker admitted in advance that she was a novice.  She kept saying that the Seller was “making about $13k a month…”  The term “making” was vague, but in fact meaningless to us:  Was that Gross?  Net?  Adjusted Net or Cash Flow?  She was terrific in answering all questions in what she meant in great detail, and certainly was not hiding anything.  But the example demonstrates that lots of people use lots of different terms, none of which are standardized and demand clarification.)

Generally speaking, Cash Flow is comprised of, Net Profit, ideally as claimed in the Seller’s Tax Returns, plus Adjusted Expenses such as:

• One-time items purchased by the Seller, which either would never to be replaced, or would not need to be replaced within the next number of years.
• Expenses that the new Owner will not inherit, like the loan the Seller is paying off for when he/she bought the business; the Buyer will have his own loan, but the Seller’s own loan will be retired with the settlement, as will his payments.
• Non-cash expenses, such as depreciation and amortization.
• Some Tax Expenses.  (This is where your Accountant is invaluable!)
• Any payments the Seller has made that are absolutely not part of the business expenses. (We once saw three salaries in a business, but no employees; I asked the Seller about it and he said those were he three grandchildren, all of whom were in kindergarten, first and second grades.)

This last issue is where arguments usually start. There are some adjustments that should not be legitimate business Expenses, but extracting them and proving they are not germane to the operation is difficult, if not impossible. The Seller that argues that issue is not very wise, in many instances.  For one thing, these individual items are frequently not terribly large, and pushing the Buyer to accept them will frequently create more of an air of suspicion or negativity than they are worth.

Even if those Expenses are not part of the business, Buyers will not be able to get any lender to agree to honor those adjustments, when the bank is using the Cash Flow for the purpose of granting a loan.  Moreover, if the Seller puts this in writing, he/she is opening him/herself to scrutiny from the IRS, which could very well then see such comments as a confession to Tax Fraud; the Broker that cooperates could have some liability in this area, as well.

Some Sellers/Brokers put the Seller’s entire Salary into the adjustments. This is not wrong, but the Seller/Broker should disclose this in advance, and the Buyer should know that this needs to be adjusted again for him/herself, when applying for a loan to fund the acquisition.

The Seller’s Fringe Benefits are another area that need to be understood.  As a general rule, if the Seller has an established IRA or other Retirement programs for himself and for which the Company is paying, these are added to the Cash Flow.

Health Insurance is commonly added back in, as well.  If it is not specifically required to continue the daily operations of the business, the Seller/Broker is completely justified in adjusting such an Expense and adding it to the Cash Flow total.  BUT YOU NEED TO BE ABLE TO DISCLOSE AND EXPLAIN YOUR METHODOLOGY!

Also, be very careful to understand that all Cash Flow and the resulting recast P&Ls you create in using such information, is based on historical data; it is the result of your (the Seller’s) own activity and methods of operation.  Cash Flow is used as the basis for pricing the sale of many small businesses.  IT IS VITAL THAT NEITHER YOU NOR YOUR BROKER DOES ANYTHING THAT WOULD SEEM TO EVEN HINT THAT THESE FIGURES CONSTITUTE ANY KIND OF A GUARANTEE THAT THE BUSINESS WILL CONTINUE TO EARN AT THIS LEVEL!!!!  Any assumptions should be solely made by the Buyer, him/herself.  This is the area where most lawsuits occur.

Cash Flow issues are the most crucial areas of the transaction.  It is the basis for attracting Buyers, and their understanding and faith in your disclosures is vital to whether the deal will be adversarial in nature from the beginning, or whether they will decide to move forward, at all.  And it provides you with an idea of whether your Buyer pool will be able to get financing, once the two of you agree to terms.  It sets the pattern for everything that follows!

(The BAF Group LLC is a full service Business Brokerage, with a history of more than a decade of service. Its Principal Broker possesses 25+ years of Business Sales and Divestiture. Although most of our work is involved in the Mid-Atlantic States, we have represented Sellers and Buyers throughout the Continental USA, and a number of overseas Buyers, as well. Some of our listings and additional information about us can be viewed at www.bafgroup.com. Or, you may contact us at combroker@bafgroup.com. Thank you for your interest.)

Business Owners’ Exit Strategy: Are You Ready to Sell?

We do not mean, are you sick and tired of the Business?

What we mean is, are you and your business positioned for the maximum sale price, offering the best view of a prospective Buyer coming in for a look-see, and can you turn it over with confidence that you are giving the Buyer the best shot at succeeding?  That does not mean you are guaranteeing him/her success; but it does mean that you are providing the Buyer with a positive environment, both inside and outside your doors, and a workable foundation for him/her to take over.

For example, who is the face of the business?  If you are a micromanager, (or is you are simply a solo operator,) and every sale is due to your sole efforts, every problem is handled solely by you, and the Customers only know your name, when dealing with the company, you could be in trouble.  This could mean that anyone coming in behind you could fail before he/she starts, because the company really means very little to the Customers; it is YOU they feel that they deal with, not the ABC Corporation.

It is like when football start John Unitas left the BALTIMORE Colts, (yes, we are still bitter about the move to Indianapolis…)  No matter who the next quarterback was to be, no matter how good his prospects, Unitas was so beloved in Baltimore that the fans were ready to hate the next guy.  (You younger people can replace Favre with Unitas, andGreen Bay with Baltimore…)

Business can be exactly like that.  In some businesses, customers can get a comfort zone with one person, and when he/she leaves, they feel a personal sense of loss, perhaps even a betrayal.  This is particularly true when long term, repeat transactions are characteristic of the daily business routine.  People will frequently wait for the same person to cut their hair, whether the customer is a male or female; people will ask for the same auto mechanic; the same doctor.  When going to a Walmart or similar retail operation, the brand is the issue – you do not necessarily ask for the same cashier.  But if you are a Home Builder, you might ask for the same guy at the local Lumber Yard, because that guy knows your traditional needs and the transaction is viewed as more efficient and secure.

Similarly, populating the business with family members or people that are so, personally close to you that when you leave, so will they, is a huge mistake.  Ask yourself:  What will happen to the business when I walk out the door?  If the business fails after the sale because of the actions (or inaction) of the Buyer, that is not your problem.  But if your business is organized so the company cannot keep going without you, it is unsalable, or at least salable only at a very discounted Price.

Financial issues need to be addressed, before you can sell, as well.  One of the biggest things to bring to order is how expenses are expressed, in order to reduce Taxes.  The more you attempt to legitimately obscure or camouflage your Profits, the less the Bank or the Buyer is going to be willing to accept that Cash Flow as a function of the Price you demand.

And for those of you who just plain hide money – like the guy to accepts cash in his Retail store and simply does not report it to the IRS – God bless you!  But do not try to then use that as a part of the Cash Flow that will translate into a selling Price.  You profited from the fact that you cheated the IRS; do not think that you will get that same money reflected in the Price.  A Bank will simply not honor that kind of thinking, when considering a loan for your Buyer.

And speaking of Taxes, what terms will you need to employ in selling the business, or how should you structure the proceeds for the best tax advantage?  Making these decisions at the settlement table is a radical mistake.

Long term planning is best in other areas – sometimes, LOONNGG term planning means years in advance.  Making certain that your Clients are not too heavily concentrated takes enormous effort and time, to accomplish.  Having one Client that represents more than 20% of your business can heavily reduce interest in your business, or at least be used against you in negotiating Price.  (The 20% number is not engraved in stone, since some Buyers become alarmed when the number goes above 10%, while others will say it is not a problem until the number approaches 40%.)  The issue is that the sale of any business has the potential of a loss of some Clients; if there is a concentration of business in one Client, the threat of losing that one Customer can be catastrophic, and that will weigh heavily on the Buyer, one way or another.

Finally, most small Business Owners do not have a written Business Plan, or if they ever did, they forgot all about them once they got the loan to start or buy their businesses.  When selling a business, having an updated Business Plan can be an extraordinary plus, for the Seller.  It can be the most powerful tool with which to impress the Buyer about the business’ history, and its prospects for the future.  If you have one, use it.  If you do not, consider creating one.

There are many other issues that should be considered.  But these are the most vital, in our view.  As stated, these can make the difference between getting a maximum from your business, or being able to effectively sell it, at all.

(The BAF Group LLC is a full service Business Brokerage, with a history of more than a decade of service. Its Principal Broker possesses 25+ years of Business Sales and Divesture. Although most of our work is involved in the Mid-Atlantic States, we have represented Sellers and Buyers throughout the Continental USA, and a number of overseas Buyers, as well. Some of our listings and additional information about us can be viewed at http://www.bafgroup.com. Thank you for your interest.)