Should You Use an Investment Banker or Business Broker?
You’ve worked hard to build your business, investing significant time and resources into growing your company into the thriving and successful business that it is today. Selling your company is an exciting prospect, and for many, it’s the dream. The reality of selling involves many details such as understanding how to reach the largest possible base of buyers and presenting your company in the best light. You want to secure the maximum value, get the best terms and also ensure that the buyer will help your company continue to thrive in the future.
Many business owners turn to investment bankers or business brokers to handle the transaction details. But there is often confusion surrounding this option, including understanding what investment bankers and business brokers do, how much they charge and how these types of deals work. If you’re considering this option, understanding a few details can help determine which path is best for your situation.
Why entrepreneurs don’t like investment bankers or business brokers.
According to our 2019 Entrepreneur Selling a Company Survey, the Net Promoter Score (NPS) for using an Investment Banker or Business Broker, which measures how likely a person is to recommend this type of service, was -42 NPS.
A big reason why entrepreneurs aren’t using investment bankers or business brokers is they consider them to be too costly and aren’t always clear on the value they bring. So how much do these types of firms really cost? If an entrepreneur uses a business broker, which handles smaller-sized transactions, they can expect to pay a couple of different fees, including the following.
Fixed success fees. Business brokers charge a success fee, which is typically a percentage of the deal value. The percentage value can be fixed, or it can be adjustable. For example, with a fixed rate, the business broker earns a flat percentage of the sale amount. Success fees can vary based on many different factors, but it’s helpful to have a general idea of what to expect. Here is a general guide based on the value of your business.
- Less than $1 million: 8%;
- Between $1 million and $5 million: 6 – 8%;
- Between $5 million and $10 million: 4 – 6%;
- Between $10 million and $25 million: 4 – 5%;
- Between $25 million and $50 million: 2.5 – 4%;
- Between $50 million and $100 million: 2 – 3%;
- Between $100 million and $250 million: 1.5 – 2.5%;
- Between $250 million and $500 million: 1 – 2%; and
- Above $500 million: 0.5% – 1.5%.
Scaled success fees. In contrast, with a scaled success rate, the rate paid varies based on the sale price. The structure of these deals can take many forms, but let’s look at an example. Let’s say that a business sells for $15 million, and based on the deal, the firm gets paid 4 percent. But let’s say that instead, the business gets a sale price of $30 million. In this instance, the firm might get paid 5 percent. The scale is finalized ahead of time, but generally, the higher the sale price, the higher the percentage the firm earns. The benefit of this arrangement is that entrepreneurs can avoid situations where a business broker closes a deal quickly without securing the best possible purchase price.
Retainer fee. A business broker may also require a retainer fee. For example, a retainer fee might range from $50,000 to $100,000 in a middle-market transaction. But it’s important to note that a retainer shouldn’t be large enough that it reduces motivation for the broker to earn the success fee and close the transaction. In general, the upfront fee shouldn’t be greater than 15 percent of the overall fee. And some firms deduct this retainer fee from the success fees.
Fee tail clause. The deal might also include a “fee tail” period that remains in effect for a specific period of time, such as 12 months after a terminated engagement. For instance, if an agreement terminates before a deal closing, and you close the deal on your own a few months after, you still owe the success fee to the first broker.
A Word of Caution on Fees. The fee structure you ultimately pick determines how aligned you are with your business broker. Also know that a broker makes most of their money when the transaction is completed. So they have a strong incentive to encourage a deal to get done, even if it may not represent the top value you would like to get.
Does using an Investment Banker benefit the sale of your business?
When first starting your research about using an investment banker or business broker, you might find general information explaining what they do. For instance, they help structure the transaction, negotiate the deal, add credibility to the sale and identify the right buyer. And this is all true, but there is more they do for the sale of the business, including the following.
Assistance with the planning process. They can help you prepare the business exit prior to the event. While It’s possible to exit within a matter of months, brokers often recommend 1-3 years planning to yield the best results. They can also help with a “sell now vs. sell later” comparison to determine the ideal timing.
Additionally, these professionals should help you understand the valuation of the company. They are motivated to ensure the valuation is high and that the deal will close. This allows you to focus on running your company and let the professional that you hire oversee the sales process.
Create a reverse auction. They can help you run a “reverse auction” and create a market to sell your business. For instance, unless a seller decides to negotiate a sale with a single buyer, some form of auction is often the best way to secure multiple bids and negotiate the highest possible sales price. A good business broker should communicate to likely buyers and help find other potential buyers who participate in the consideration to purchase your business.
Drive greater competition and a higher sales price. A good investment banker or business broker can also give the illusion of a second offer, which creates a critical element for the deal: competition. Sometimes there is a second or more interested parties, but often, one offer stands out amongst the others. However, having this illusion can move the first party into making their best possible offer, including a certainty of closing on the deal when terms are agreed upon.
Handles the tough issues. Tough issues can come up during the sale, including retention packages and escrow, and tensions can run high. If you’re dealing with the other side directly, you might be too close to the business to handle everything without emotional attachment. This isn’t the best situation if you end up staying on with the company for a period of time after the sale. A business broker can handle these details and help distance you from the conflict to avoid uncomfortable future situations.
Own your Story. Entrepreneurs need to be the ones who drive the story and communicate the value of your business. The area I’ve seen entrepreneurs miss when using a Business Broker is over-relying on them to build the deck to communicate with potential buyers.
Should you look for an Investment Banker or a Business Broker?
How large is your business? This is the most important question to ask when understanding the differences between using an investment banker and broker. Business brokers typically handle smaller transactions – generally up to $5 million in enterprise value. For instance, imagine that you’re selling your home. You might decide to use a real estate broker. The broker lists your house, advertises it to potential buyers and negotiates potential deals. This is a simplified version of what a business broker does for your business.
An investment banker handles the bigger deals, typically $50 million or higher. Additionally, investment bankers deal in securities and may need specialized licenses issued by the SEC. Both investment bankers and business brokers can assist with the sale of your company, but if your company is valued at less than $10 million, it typically makes more sense to use a business broker.
Understanding the different types of firms
If you’re looking into using an investment banker or broker, you’ll quickly discover that not all firms are structured in the same way. There are a variety of firm types, each engaging their clients a little differently. Understanding the differences will help you select the right one.
Boutique investment firms. This type of firm specializes in a specific type of investment, such as capital raising, mergers or acquisitions. These firms might have a few locations in a specific geographical area and may specialize in specific industries. Boutique firms may have lower fees when compared to larger investment banks. Also, the dealmaker is more involved in the sale when compared to a larger investment bank, where an analyst or associate may do the majority of the work.
Regional investment banks. A regional firm focuses on a specific geographical area. The typical deal size for these banks is larger than that of a boutique firm, generally $100 million and up. The benefit of using this type of firm is they have a deep industry knowledge similar to that of a larger investment bank. However, fees are typically higher than those of a boutique firm due to the higher overall cost associated with running a large firm.
Bulge bracket investment banks. This type of investment firm typically handles only large deals that exceed $1 billion, but they may also execute mid-market deals. One of the pros of using this type of firm is that it can get more attention and exposure for a business sale. One of the cons, however, is the high premium paid in fees.
Business brokerage firm. This type of firm handles smaller transactions, typically those less than $5 million. Business brokers assist with setting a sales price, conducting buyer searches and handling negotiations. They typically make the business available to a broad base of buyers and charge a success fee.
A word of caution on industry-focused brokers: While someone who has a deep knowledge of your industry may be of great value, often they are in a place where they will do deals with a small group of people. There is an element where they have an incentive to keep the buyers happy, knowing they will have repeat business with them versus being 100% in your corner. Ultimately they are often going to do more transactions with the buyer of your firm and as such want to make sure they’re viewed favorably by bringing the buyer a good deal.
Why should entrepreneurs rely on investment bankers and business brokers?
Let’s go back to the -42 NPS score. Why do people end up using investment bankers and business brokers, even though so many entrepreneurs have a negative view of them?
Research has found that the most difficult part of the transaction is finding the deal, which is likely why so many business owners who set out to sell don’t end up closing the transaction. In fact, research shows that only 20 to 30 percent of businesses that go to market actually end up selling.
The second most difficult part of the transaction is the valuation, according to our survey participants. Oftentimes when selling on your own, as discussed previously, a potential buyer will treat your business as a distressed asset, which isn’t the reality of most situations.
In our survey, business brokers hit on two of the most difficult parts of the transaction: 1) finding a deal and 2) getting the valuation you want.
Since the most difficult parts of the transaction are finding that deal and getting the valuation that you want, this is precisely why most people end up hiring help. In fact, in our survey, despite a low NPS, 37.61 percent of respondents said they did or would rely on an investment banker or business broker to get a deal done. These professionals can help entrepreneurs solve their largest pain points when working to successfully sell their businesses.
Bottom Line for Entrepreneurs
The realities of selling a business in today’s market is that this process is still a bit opaque and therefore often justifies using a professional to navigate this process. The stakes are high when you sell your company with what often is the largest financial transaction an entrepreneur will have in their life. When used properly, an investment banker or business broker should help with securing a higher valuation for your company and getting the deal closed. But it’s important to understand a couple of key pieces of information. First, understand what the investment broker is compensated for, and second, know who the investment broker works for. They are primarily compensated when the deal closes, but it’s critical that the professional is aligned with your objectives in selling. Design a deal structure that is created with this in mind and motivates the professional to secure the highest price possible, while ensuring the deal is the best fit for you and your business.
Want to learn more about exiting big? Check out current Platform Strategy and learn if this could be the right exit strategy for your business.