Selling Your Company? Watch Out for that First Step -- Hiring the Broker
Like a vignette from Groundhog Day, we find time and again with new clients that they regret the very first step they took in the business sale process – the way they selected and hired their business brokers or investment bankers.
The decision to sell a business often is made privately and kept as a careful secret lest the word leak out to employees, customers or the general market. Many business owners think the first advisor they should engage is the broker, and they will engage mergers and acquisitions (M&A) counsel only if and when there is an actual deal to document and close.
The problem is that first step, signing the agreement with the broker. Unlike attorneys or accountants who charge hourly and can be terminated at will, a broker or investment banker typically uses a percentage fee agreement that is not easily understood and cannot be easily terminated.
Brokers and investment bankers can play an essential role in the sale of a business. Typically, a “broker” is engaged to find buyers for a smaller business, and an “investment banker,” with more staff and expertise, provides strategic and financial services to owners for the sale of a larger business (usually over $10 million expected sale price). Respected and effective brokers and investment bankers rightfully want their transaction fees and commissions to be protected by a strong contract. The truly good ones also are willing to negotiate their engagement agreements to make sure that their clients are protected as well.
For starters, the engagement agreement should affirmatively obligate the broker to identify potential purchasers and energetically conduct a sale process. It also should list specific responsibilities, such as collaborating with the client to create a prospect list, creating and sending teaser information, controlling confidentiality, preparing the memorandum giving detailed company information to approved prospects who have signed confidentiality agreements, coordinating due diligence requests, and providing strategic and negotiating advice as the prospects submit their letters of interest, letters of intent, and best and final offers.
Compensation provisions, including any non-contingent monthly or milestone fees, minimum commission amount, and the commission rate structure itself should be analyzed carefully and then negotiated. Is the minimum commission based on an overly optimistic forecasted sale price, making the percentage commission for a disappointing sale effort much higher than anticipated? The commission’s percentage rate usually is applied to total transaction “consideration.” Many business owners are surprised to find this definition means the owner must pay a commission on assets that are not being sold, on salary the owner might work to earn after the closing and on the value of equity interests in the buyer (“rollover equity”) that the seller is required to accept—instead of cash—as part of closing the deal.
“Tail provisions” can protect the broker from being terminated just before an earned commission becomes due by assuring payment of the commission for a period of time after termination. But these provisions often are written too broadly, and for too long a period, in a way that effectively prevents the business owner from replacing the broker. An appropriate tail provision assures the broker of a commission if a sale is concluded within six months or so after termination with a specific prospect that the broker included in a “contacted prospect” list delivered to the owner at time of termination. By contrast, it is not uncommon for proposed tail provisions to cover sales to anyone for 18 months after termination, so that an owner who hires a new broker during that period risks having to pay two commissions instead of one.
If you intend to sell your business with a broker or investment banker, you should start with a thoughtful process to select the most effective and knowledgeable one for your industry. Once you have done so, the provisions above and other terms of your engagement agreement with
the broker will have a big impact on the risks posed to your company during the sale effort, the ultimate success or failure of the effort, and the net dollars you receive at closing.
Ray Sherbill is a corporate attorney at Lerch, Early & Brewer in Bethesda, Maryland who represents businesses and business owners in the structuring and implementation of mergers and acquisitions. For more information about selecting a broker, contact Ray at (301) 347-1275 or email@example.com.