How Does Business Brokerage Work?
This article on Business Brokerage is part of the Business Brokerage Resource Library Series.
Business brokerage, despite some misconceptions, is not extremely complicated. It does, however, require knowledge, persistence, hard work, and a lot of patience. The purpose of this article is to demystify how business brokerage is conducted so that even a non-business person can understand it.
At its core, business brokerage is about helping people to achieve their goals and desires. The two main groups that business brokers work with are business owners and those who wish to become business owners. In addition to these two main groups of people, business brokers work with a subset of professionals that work with them to help transactions to conclude successfully. Some of the types of professionals that business brokers worth with include attorneys, bankers, landlords, commercial real estate agents, accountants, financial planners, and others. To use a circus analogy, business brokers have to act as ringmasters making sure that each performer is carrying out their role at the designated time and place to ensure that the performance concludes successfully and right on cue.
Business Brokerage Marketing
Business brokerage begins with business brokers establishing meaningful relationships with business owners and other professionals in his or her community. You can’t serve people who don’t know you exist. This means that business brokers have to be good at marketing. There are many ways that business brokers go about marketing their services to business owners in their communities. Here are just a few examples of these methods:
Drop letters – If you are a business owner, chances are you may have come to work on Monday morning and seen a letter taped to your door with a little painters tape. This letter is called a drop letter. The purpose of this letter is to let you know that there is a business broker in your area and that he or she is ready, willing, and able to help you if you have thought about selling your business. There is also information on how to call or email them if you would like to learn more information.
Industry letters – Some business brokers chose to send out “snail mail” to local business owners in the form of an industry letter. This kind of letter targets certain segments of the business community such as construction, service companies, or transportation, and logistics. These letters will typically have some data relevant to the sector of the recipient and then encourage them to contact the broker if they have considered selling their business.
Telemarketing – It is not uncommon for business brokers to pay employees or other professionals to call business owners and discuss the possibility of selling their business. These calls are usually done in conjunction with drop letters and or industry letters. The idea is that when a business broker or designee calls it’s better to have connected with the business owner some other way first to avoid the call being a completely “cold call”.
Social Media – One of the fastest growing methods of business brokerage marketing is through social media. Of the many different social media outlets, the two most widely used for marketing are LinkedIn and Facebook. The broker can choose to connect with business owners organically or through paid ads.
Networking Events – Brokers also have the option of attending local networking groups such as BNI, Chamber of Commerce, the Rotary Club, etc. These are great ways for a broker to get connected with other professionals in his or her community. Its always easier to serve someone with whom you have already established a connection.
Business Brokerage Client Assessment
Once a business broker has established himself in the community and has begun to buildup a pipeline of potential clients, then the focus of the business brokerage is on client assessment and valuations. A reputable business broker will want to assess the business owners situation to see if listing their business for sale is a wise option.
In many cases a business may not be in a good position to sell. They could have had internal or external complications that resulted in loss of revenue, or it could be that the market for their goods or services are saturated. In any case, an ethical broker will advise such an owner to wait to list their business after there has been time for conditions to improve. Provided that there are no good reasons for not pursuing a sale, a broker will begin the next phase of the brokerage process.
Business Brokerage Valuations
Once a broker has determined that a seller is a good candidate for a successful sale, then its time to perform a professional business valuation. This process involves the business owner releasing to the broker certain financial documents such as filed tax forms, profit and loss reports, balance sheets, and inventory reports where applicable. A broker will then comb through these reports and condense the information into what is called a recast report. This recast report will show a couple of pieces of crucial data that are needed to formulate a value range for the business. The report will either show the EBITDA or earnings before interest, taxes, depreciation and amortization or it will show the SDE or sellers discretionary earnings. With that data, a broker can plug numbers into a formula and provide the business owner with a range of what their business is likely to sell for on the market.
When the valuation is complete, a broker will meet with the business owner to discuss the potential listing price for the business. Most brokers don’t give a specific price to a seller but rather a range of value. The higher the listing price the longer it is likely to take to sell the business and, of course, the reverse of this is also true. Ultimately the listing price decision is up to the business owner but they should wisely consider the research, expertise, and wisdom of the broker with whom they have chosen to consult.
Business Brokerage Listing and Marketing
Once a business owner has decided on a list price, then its time to discuss the listing agreement. The three most important numbers on any business brokerage listing agreement are the list price, the length of the agreement, and the amount of the commission. Since the list price should have been decided on at this point, the only two numbers to focus on should be the term and the commission.
Most brokerage contracts require a 12-month term. That means a business owner will be agreeing to have their business on the market for a period of no less than 12 months. Some business owners get really alarmed when they see that 12 but really there is a reason for that number. Business brokerage firms have done extensive research to understand the life cycle of a business listing. What the studies found was that listings experience two strong waves of interest with a slight lull between waves. If graphed, it would look something like this:
On this graph, the first peak of interest is at around the 3 month mark. The cycle peaks again at around 9 months. Good brokers have used this research to structure their listing agreements to capture both waves of interest thereby giving a business owner the greatest opportunity to sell their business. Any shorter and the owner will miss out on potential selling opportunities.
The last big number that needs to be explained is the commission. Most brokers will have a flat commission that they charge and in many cases they will also have a minimum commission. They may also adjust their commission rates for listings over a certain number such as a million dollars.
It is important to know that while there are no set in stone rules for what a broker may charge in commission, there is usually a reason why a reputable broker charges what they do. For instance, a good broker knows their track record of getting deals done, they know their work ethic, and they know what other brokers charge for their services. They don’t want to be the most expensive, unless their services can rightfully demand a premium, and they don’t want to race to the bottom either. A smart broker will look you in the eye and tell you why they deserve the commission that they quote and if they deliver on what they promise, then they have rightfully earned what you pay them.