Sunday, January 31, 2010

Selecting a Business Broker - Look Out for these Red Flags

Selecting a business broker or an M&A firm to represent your company for sale can be a confusing and difficult process. This post exposes some of the red flags to watch for as you select the firm to represent you in your business sale.

Last week I got a call from a business owner who had decided to sell his business. He and his partners were beginning the beauty contest phase of selecting a firm to represent them in the sale. His partners had begun discussions with a merger and acquisition advisory firm. He had followed up with this firm prior to calling us and had questioned them on several issues. He shared his findings with me and asked my opinion. Generally I subscribe to my old IBM training and will not disparage a competitor, however, some of the answers were alarming to me so I elected not to withhold my opinions.

The first red flag was that this competitor required a large up-front engagement fee. I certainly have no problem with Merrill Lynch or Goldman Sachs charging their up front fees to their fortune 1000 clients. These firms are a proven commodity with a proven process. Their clients feel confident that a liquidity event will result from their work. A monthly fee is a more accommodating approach for smaller clients whose cash flow would be strained by a large up-front payment.

We have had many prospective clients approach us after unfortunate experiences with these big up-front fees. In one recent case, we were brought into a holding company who had acquired one of our sell side clients. Another division had engaged an M&A firm to sell one of their subsidiaries. After a $40,000 up-front payment and over four months, not one prospect had been contacted. Another common result for clients of these up-front fee firms is a beautiful, bound, 40-page book of boilerplate compiled by a junior level analyst. Unless this is accompanied by a concerted sales and marketing effort, this book will become a very expensive coffee table book.

Think of evaluating the performance of your M&A firm like you were evaluating a salesman selling your company's product. If you are not getting status update reports or pipeline reports indicating who has been contacted and what progress was made, you are not managing your business sales process.

Another red flag we see with these up-front fee firms is a 4 or 5-year exclusivity period. Our firm will not take an engagement unless it is exclusive, however, locking a seller in for 5 years is unconscionable. Here's what that says to me. Some of the less honorable firms are marketing machines who target business owners with their 6 letters per year mailing campaigns. These campaigns are designed to get the business owners to their beautifully orchestrated seminars for potential business sellers. The presenters are very polished speakers. I doubt that these wonderful presenters have actually closed a business sale.

Their objective is to lock up 3 or 4 businesses per seminar with a $40,000 book and to put them into their growing inventory of 5-year exclusive engagements. These businesses are not actively sold, but are passively presented in mass mailers and on Internet sites. I can't tell you the number of times we have been contacted by firms that are unfortunately the victims of this approach.

I am just getting warmed up. Let me expose, forgive my French, the biggest load of crap presented at these seminars. “We have foreign buyers.” Some unscrupulous moron in our industry discovered that this phrase was particularly alluring to unsuspecting business sellers. If your business selling price is less than $30 million, you will not be a candidate for foreign buyers.

Ask any law firm that does transactions. Check with BV Resources, the number one database of completed transactions. You will find it a rare occurrence to have foreign buyers at the small end of the market. The transaction costs are just too high to make a small purchase economically viable. The buyer will have to fly teams of people with potential language barriers, new sets of laws, new accountants and attorneys, etc.

What is the allure of these alleged foreign buyers? Are they going to pay you a huge premium over a U.S. buyer? Are they going to be duped into a poor investment decision for your benefit? Pleasssssse! If you are a smaller business, you are not a target for a foreign buyer. If you are presented with this line, run for the exits.

Another classic red flag is when a potential business seller asks to talk to references and the business broker tells his prospective client, “That's going to be tough. They are sitting on a tropical island drinking umbrella drinks.” Come on. Our firm is in regular contact with the majority of our sellers. They are very valuable to us as references in our business development efforts.

We absolutely protect them from frivolous contact, however. Our firm is contacted by over fifty potential sellers annually. We have to go pretty far down the mutual discovery process before we connect a potential client with our references. If we have not pre-qualified a prospect, we are not going to waste our references' time. However, if the major issues on fees, qualifications, approach and chemistry have been satisfied, do not hire an M&A firm without talking to two references.

The final issue I would like to discuss, I would not call an official red flag, but maybe a “nice to have.” Have you sold any companies in my industry? Sometimes, your business is unique and there has not been much M&A activity and you will have to weigh other factors more heavily. The advantages in using business broker or merger and acquisition firm that has industry experience are that it both speeds up the sale process and it increases the likelihood of a completed transaction.

An M&A firm that has your industry experience will already have their database of potential buyers established. They know the right contact person and these prospects know them and actually take their calls. This alone can reduce the sales cycle by as much as 90 days. Another big advantage of industry experience is your advisor will understand valuation multiples and deal structures unique to your industry. That can be invaluable when the buyer is attempting to grind down your selling price. Industry credibility is very important when your advisor gets the CEO of a targeted buyer on the phone and has exactly 30 seconds to establish buyer interest. It really helps if you speak his language. Our clients in information technology and healthcare have found industry specialization to be of significant value.

Our industry is misunderstood at the lower end of the market. The fortune 1000 companies would not consider a capital event without engaging an investment banking firm. Smaller companies seeking a sale need the same kind of services, but with a fee structure that is more size appropriate.

When I see a couple of firms with a powerful marketing reach engaging in practices that hurt our industry, it ticks me off. Most of the firms that service the lower end of the market are hardworking, honorable people seeking to provide excellent value. Many of these firms are members of the International Business Brokers Association, IBBA. This organization sets standards for business practices and ethical behavior. They also have established an industry certification, the CBI, Certified Business Intermediary.

So as you consider the company you want to engage to sell your business, he is what you look for:

1. No big up-front fees, but monthly fees.
2. No promises of foreign buyers for companies under $30 million.
3. A period of exclusivity from 12 to 24 months, not 5 years.
4. A firm that actively sells your company using direct calling into targeted buyers, and not simply posting on business for sale Web Sites and mass mailings.
5. A firm that tracks and reports their sales progress to you bi-weekly with a status or pipeline report.
6. A firm that is a member of a professional association like IBBA or M&A Source or a local or regional business broker network like MBBI.
7. A firm that at the appropriate time will introduce you telephonically to two of their reference clients whose business they successfully sold.
8. A firm that has a principal that has passed their industry testing and has been issued a CBI designation.
9. An Advisory firm that has experience selling companies in your industry and understands who the targeted buyers are, the right contact, and the industry nomenclature. Finally they should understand your industry's unique valuation metrics and deal structures.

This is the most important contractor or vendor you will ever hire for your business. Your economic future depends on the success of this engagement. Think of other major purchase decisions you have made for your company. Be every bit as rigorous in making your selection of an M&A advisor.

Dave Kauppi is a Merger and Acquisition Advisor and President of MidMarket Capital, providing business broker and investment banking services to owners in the sale of lower middle market companies. For more information about exit planning and selling a business, click to subscribe to our free newsletter The Exit Strategist

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