The Business Broker and Real Estate Agents
Professional business brokers are still a relatively unknown breed. Many business owners, especially the owners of Main Street businesses, have no idea that professional business brokers exist or what they do. This means that if you’re a business broker – or want to become one – you will at some point likely be involved in a transaction that includes a real estate agent.
But before I go any further on this topic, I want to state unequivocally that I believe that most real estate agents know what they’re doing and are good – sometimes excellent – at their chosen profession and I respect them for it. Like most people, however, they are probably not very good at things they don’t do and are not trained to do. You might agree that a real estate agent probably wouldn’t be a good cop, for instance, or an insurance agent without the specific training that those professions require. I imagine that the vast majority of real estate agents would probably agree with that statement, as well. I, for example, though I am a commercial real estate advisor (because such expertise is enormously beneficial in business brokering), am surely not very good at residential real estate.
However, a surprising number of real estate agents have no qualms whatsoever about representing one side or the other in the sale of a business even though they are completely untrained in the profession and cannot possibly advise their client – buyer or seller – on any of the aspects thereof. Given the fiduciary duty required of a real estate agent, which he or she must understand and be tested on in order to be licensed, such agents should automatically suggest to the business seller or buyer that a professional business broker should be consulted. In fact, the National Association of Realtors defines, in part, such duties as follows, taken from the NAR’s website:
Reasonable care and diligenceAn agent is obligated to use reasonable care and diligence in pursuing the principal’s affairs. The standard of care expected of a real estate broker representing a seller or buyer is that of a competent real estate professional. By reason of his license, a real estate broker is deemed to have skill and expertise in real estate matters superior to that of the average person. As an agent representing others in their real estate dealings, a broker or salesperson is under a duty to use his superior skill and knowledge while pursuing his principal’s affairs (italics added). This duty includes an obligation to affirmatively discover facts relating to his principal’s affairs that a reasonable and prudent real estate broker would be expected to investigate. Simply put, this is the same duty any professional, such as a doctor or lawyer, owes to his patient or client.
The NAR Code of Ethics requires real estate agents to be knowledgeable and proficient in their practice. I have been in real estate (albeit commercial real estate) since 1991 and a professional business broker since 2001 and I have NEVER encountered a real estate agent that is either knowledgeable or proficient in the practice of brokering businesses. But that hasn’t stopped many of them from trying to wrangle a portion of the commission.
Let’s look at a couple of real-life examples.
The Business Broker has the Seller
Some years ago, I listed a small mobile home park in a rural area for sale. Because the area was so small and everyone knew everyone else – and everyone else’s business – the owner of another small mobile home park got wind of the fact the park I had listed was available. He was related to a real estate agent.
Rather than contacting me, he called his relative, the real estate agent, presumably so the agent would collect – note that I did not say “earn” – half of the commission. The agent, in turn, wrote a contract to purchase – using a residential purchase form created by the realtor association of the state in which the agent was licensed. The offer contained all the customary residential prerequisites including number of bathrooms, termite inspection, home-owners association language, sexual predator language, etc., none of which was pertinent to this deal, and none of the language that is necessary for a business transfer including allocation of the purchase price, assumption – or non-assumption – of existing liabilities, tax responsibilities, indemnifications, list of assets (all the mobile homes among them!), assurances of certain conditions, etc., etc., etc.
Because the real estate agent wanted to receive a portion of the commission, the agent was, by definition, working for the seller, as was I – because THE SELLER PAYS THE COMMISSION! Though we were both obligated to treat both buyer and seller honestly (the agent, based on the NAR’s Code of Ethics), we both bore a fiduciary and legal responsibility to the SELLER; he was, after all, the one that was paying us.
As soon as I received the offer – on a form intended for the purchase of a house – I knew that, if I was going to protect my client, the seller, I’d have to effectively handle both sides of this deal. This meant I had to draft a purchase agreement for the real estate agent to get the buyer (the agent’s relative) to sign, draft the ancillary documents (bills of sale, indemnification agreements, etc.) required by this transaction and generally do all the work that another business broker would do if a business broker rather than a real estate agent was representing the buyer.
In the event, it was my opinion that, given that my office had to do all the work, the real estate agent was not entitled to half the commission. I treated the transaction as if the real estate agent referred the buyer to me and we subsequently paid a referral fee at closing. This, of course, resulted in a fairly significant and utterly predictable display of drama on the part of the real estate agent but such is life.
The Business Broker has the Buyer
But let’s flip this around and suppose that you have a buyer for a business listed by a real estate agent. Being trained as a business broker, you know what a buyer needs in order to analyze the opportunity and decide whether or not to make an offer. As such, you reasonably request tax returns, income and expense statements, inventory figures and all the other data required by any reasonably knowledgeable business buyer. You are likely to get blank stares in return.
You also – again quite reasonably – ask how the asking price was arrived at. The answer? It will usually be, “That’s what the owner wants”, an answer that essentially states that neither the seller nor the real estate agent has any clue what the business is worth nor any intention of figuring it out. This task will be left to you – and, given my experience over the past nearly 20 years, I can pretty much guarantee that the asking price will not bear the slightest resemblance to value.
I have found that, as challenging and difficult as working with a real estate agent that is representing a buyer is, trying to help a buyer acquire a business that is represented by a real estate agent is one of the most frustrating aspects of being a business broker. They – the agent and, in most case, the seller they “represent” – almost never grasp the concept of value or due diligence; and the agent is generally unable to advise or assist their client in any meaningful way.
What Matters? VALUE!
In the acquisition of a business, value is objective and can be determined fairly easily. In residential real estate, value is subjective; it is in the eyes of the beholder. In a business acquisition, the value lies in the earning capacity of the business; how much discretionary earnings does the business generate? In residential real estate, the value can be completely different to different people; “I love this view!” “I hate this color!” “This is a crummy neighborhood.” “The schools stink.” “The front porch isn’t big enough.” None of this stuff matters when someone is buying a business. What matters is the earning power of the business; what can the owner put in his or her pocket. Real estate agents who understand this and prepare for the sale accordingly are as plentiful as are conservative-thinking faculty in a typical American university these days.
How We Handle This: A True Story
When we represent the seller, we will work with real estate agents only on a referral basis; that is, if they purport to have a buyer, we will work with them only if they turn the buyer over to us and get out of the way. That may sound cruel but our experience has shown us that, if we want the deal to close, we have to operate this way. If the buyer they refer to us buys the business, we pay the real estate agent a referral fee. Yes, this pisses some of them off but we know that to protect our client and to give the deal the best chance of closing, we have to do all the work. The fee that we pay is usually 10% of the commission we receive, an amount that generally far exceeds what they make on the everyday sale of a house, as you will see from the quick true story, below.
We have developed some excellent professional relationships with a number of real estate agents who always and gladly refer anyone that wants to buy or sell a business to us. How we did this is instructive, as you will see from this story about one of the first referrals I received.
Eight months after receiving a referral from a real estate agent – in this case the referral of a seller – we sold the seller’s business, a healthcare provider. A week or two later, my wife and I took the agent and her husband out to dinner. I did not disclose the reason for this dinner but over dessert I handed the agent a check for $8,700, her referral fee. You might imagine her reaction when she saw the amount; and you might imagine that she refers sellers and buyers to us whenever she has the opportunity.
My experience working with real estate agents suggests that, in order to represent my client efficiently and professionally, and in order to give the deal the maximum opportunity to close, I work with agents only on a referral basis. Sometimes this is tough to explain to sellers, as some of them want me to bring any potential buyer to the table regardless of the potential buyer’s capabilities. I use the two true stories related above to explain why working with agents on anything other than a referral basis is a bad idea.
A business owner asking a real estate agent to sell his or her business is like asking a chiropractor to do your kidney transplant. Granted, they are both healthcare professionals but with vastly different training and professions. It is the same with “brokers”. No one who is licensed as a real estate broker can do the work of a stock broker, a currency broker, a visa broker or any other broker, including a business broker. (And asking a business broker to sell your house is just as dumb!)
I suggest that, if you are beginning your career as a professional business broker – or if you are in the early stages of that career – you think long and hard about working with a real estate agent on anything other than a referral basis. I realize that, early on, you will look at every opportunity to get a deal done but the potential for problems is great and the fallout of a deal that goes south because of an inexperienced agent will redound to your detriment. It is a reputational risk that is hard to justify.
If you have questions or comments, put them in the Comments box, below. I’ll get back to you with answers or my own comments. If I get enough on one topic, I’ll address them in a future post or podcast.
I’ll be back with you again next Monday.