Success Fees When Selling a Business
The continual upheavals in the market today have forced many business owners to re-evaluate their expenses. In many cases, those expenditures that are not directly related to revenue are decreased such as marketing, training, and hiring budgets.
When it comes to selling a business, it is hard not to get caught into this same mindset. Comparing firms can be confusing when each firm has a similar sales pitch. Yet, the way a firm negotiates success fees with an owner upfront can provide some insights into how they will negotiate the business transaction. Our firm often competes with other firms who provide similar services, and it is clear when a potential seller is more focused on the costs instead of how the firm they hire will drive value.
Below are a few questions to consider when addressing these costs:
Does the firm’s success fee structure incentivize appropriately?
Most M&A firms will provide a standard success fee structure based on a traditional Lehman scale which is a percent fee based on the final purchase price. As the value of the business increases, the effective percentage decreases. In general, if a business sells for $1M then the effective percentage is usually between 8%-11%. If a business sells for $5M then the effective percentage is usually lower between 5-7% and so on. Many firms like ours will also require an upfront advisory fee that is either fully or partially credited back against the success fees at closing. These upfront advisory fees are nominal (usually $10K-$30K) and convey commitment from the owner that they are motivated to sell.
Too often firms will not require this upfront fee or waive it to help the owner feel like they are saving on costs. This begs the question as to what will happen when negotiations start with a potential buyer: does the firm who waives the upfront advisory not see the need for the upfront earnest money to help determine if buyer is motivated? Those owners who are too focused on getting the lowest success fee and not willing to pay an upfront advisory fee may not be choosing the best M&A firm to represent them at the negotiation table.
Does the firm negotiate against itself?
This tends to happen more often than many in our industry would like to admit. While it is expected to negotiate terms and fees, too often a firm will decrease their fee structure upfront with the hope that this will drive an owner to make a quicker decision. This can be a big red flag on how the firm will work with potential buyers when they negotiate on the owner’s behalf.
A firm that understands the value it brings to the selling process will be flexible but will not decrease fees upfront, unless there are good reasons for it. Could a firm who discounts its fees upfront be an indicator they will decrease the value of a business before the negotiations with a buyer have truly begun? Knowing the appropriate time to start negotiations is one of the most important roles of an M&A advisor.
Can the firm provide additional value and perspective that could help offset fees?
In many cases, the way a transaction is negotiated can result in significant difference in net proceeds to seller. This often can be in the form of negotiated working capital or different tax strategies.
For instance, recently our firm represented a client where we negotiated a 5 to 1 return on our fees just on the working capital alone. In another instance, our firm was able to negotiate a buyout structure that more than covered our success fees by working alongside the seller’s accountant to implement a favorable tax strategy.
Wise business owners should focus on the real value an M&A firm brings to the table above the costs.
While there are exceptions, our firm believes that the way one acts initially is most often how one will act in the future. This is why we like to spend more time up front with each potential client to determine if our mutual expectations are in line before entering into a long-term engagement. The majority of our business comes from referrals, and we great appreciate your continued trust in our firm.
Robert W. Amerine
President, CBI, M&AMI