Signing a Business Broker’s Contract? Read This First.
Selling your business? It’s not like anything else you’ve ever sold. What are you signing? Another fabulous article here from Barbara Taylor as she steps you through the “must know” items to consider before signing on with a business broker. Original article here.
Selling a business is the antithesis of a cookie-cutter affair. While there are several commonalities, every deal truly is different.
Many business owners embark on the process of selling their business thinking that it will be similar to selling a piece of real estate. No matter where you live, the experience of selling (or buying) a house is almost identical. The commission is 6% of the sale price. There will be one agent for the buyer and one for the seller, and they will split the commission equally. The documents — including the listing agreement — will be form documents prepared by the state’s real estate commission.
You can see where I’m going with this: Real estate follows a highly standardized, cookie-cutter process. Not so when it comes to business brokerage.
Once you’ve found a business broker or M&A advisor to help you sell your business, you’ll be asked to sign their contract. Here are a few things to keep in mind as you look over the document and consider moving forward:
What does the business broker’s contract look like?
While this isn’t a beauty contest, you can glean a few things right off the bat by how the contract looks.
First, how many pages is the contract? Watch for a document that seems either too long or too short (most run about three pages).
A 10-page contract may be an indicator that the broker has run into trouble in the past and thinks a contract with “teeth” is required to protect their interests. Nobody enjoys signing a big ugly contract, and your attorney will likely advise you not to. The underlying issue behind a big ugly contract is often that the broker either has poor judgement when it comes to choosing clients, and/or a bad process. Both are operational issues that no contract will fix.
If the broker’s contract seems too short, it’s probably not adequate. There’s a certain amount of stuff that needs to be in there (plenty more about that, below).
Does the broker’s contract look professional, like it was drafted by an attorney? If it looks like a form document, or a real estate contract, beware.
Most seasoned business brokers have put a ton of thought into their client engagement agreement, and it should show.
Commission or “success fee”: Rate
Most business brokers and M&A advisors earn a percentage of the final sale price of the business. The going rate for a business broker is 10%, although some charge as little as 8% and as much as 12%. Again, there’s no hard and fast rule on this; it’s up to the business broker.
With larger businesses that sell for $2M or more, the Double Lehman scale is often used. The Double Lehman is also based on the final sales price and follows a graduated formula:
- 10% of the first million
- 8% of the second million
- 6% of the third million
- 4% of the fourth million
- 2% of the fifth million, and any amounts thereafter
Commission or “success fee”: What’s included
The final sales price of the business is often referred to as “transaction value.” Transaction value can include:
- Total value of all cash, securities, or other assets or property
- Accounts receivable
- Noncompete agreements
- Licensing agreements
- Employment or consulting agreements
- Capital stock or equity of the company
- Assumption of debt
Make sure you understand what the selling price or “transaction value” includes before agreeing to pay the broker a commission on it. You do not want to be arguing with a business broker about their commission later, when you’re working together to get a deal closed. Talk about bad timing!
When the business broker gets paid
Business brokers typically get paid at closing. Look for language about when they expect to be paid on any contingent or future payments that you’ll be receiving from the buyer, like promissory notes, indemnity holdbacks and performance-based earnouts.
The business broker’s contract should state whether or not they charge an upfront fee (retainer), or any milestone (progress) payments. Again, this varies from broker to broker. What should be clearly stated is: The amount(s), when payment is due, and what the payments are for. Upfront fees are typically non-refundable, although some business brokers will credit the amount against any commission earned.
Duration and termination of contract
Some business brokers will ask you to sign a one-year agreement. Others will ask for six months, or allow the contract to be terminated at any time by either party with 30-days’ written notice. Whatever the length, the contract should state how long the agreement is for, and what happens if either party wants out.
Another thing to look for is whether the business broker charges a fee to cancel their agreement before the term is up. We once worked with a client who paid $25,000 to get out of their contract with another business broker before they found us. Ouch!
Most business brokers have what is called a “tail” on their contract. This means you will owe them a commission for some time period after the contract has expired if you sell to a buyer that they introduced. A typical “tail” is 24 months.
Like in a real estate contract, most business brokers will ask for an exclusive right to sell your business. This means you won’t engage any other professional to sell your business, and you will owe the broker a commission regardless of who finds the buyer (including you). If you have some potential buyers you’ve already worked with that you want excluded from the agreement, discuss that with the business broker before signing.
Other things addressed in the business broker’s contract include venue, a description of what services they’ll be performing, confidentiality, indemnification and a disclaimer that they cannot guarantee any particular outcome.
If there are things in the contract that you’d like to negotiate with the business broker, they should be more than happy to have that discussion. In fact, this is a good time to get a sense of the broker’s negotiation and work styles.
When you ask them questions about their contract are they civil, patient and transparent? Or, do they become irritable, pushy and defensive? Take this as a sign of things to come when the hard negotiating starts with buyers.
Lastly, you may or may not want your attorney to look over the business broker’s contract before signing it. This seems obvious, I know. The reason it’s worth mentioning is that If the broker says anything even remotely along the lines of “oh, you don’t need your attorney to look at this,” run the other way. Fast!
There are times when I wish the business brokerage industry were a bit more standardized, like real estate, but that’s simply not the case. And maybe that’s a good thing. The problem with a commoditized industry is that it can be hard to tell the good from the bad; everyone looks the same.
Business brokers come in many different flavors, and you can actually tell a lot about them by the contract they ask you to sign. Give it a close read and make sure you understand what you’re agreeing to. That contract should be the start of a good relationship, and a great outcome for you and your business.
Check out our comprehensive guide: Business Broker or M&A Advisor: How To Find The Right Pro To Help You Sell Your Business.
Barbara is co-founder of Allan Taylor & Co. and a former New York Times blogger. She has been a small-business owner since 2003. Barbara lives with her husband, Chris, and their two sons in Northwest Arkansas.