Business Brokers: Transaction Costs
As you recall from a recent post, seller preparation includes determining what they will need to fund their retirement -or whatever else they plan to do – post closing and then determining what their business is worth to make sure the value is there to realize those funding needs.
But if transaction costs are not identified, calculated and factored into the overall calculations, the seller will very likely be surprised by what is subtracted from the gross sale proceeds.
Now, I’m not talking about debt, of course. That’s not a “transaction cost”.
But there are some significant costs that many times are overlooked if the business broker isn’t fully versed on the business being sold
The big one, of course, is the broker’s commission, which I’ll get to in a future post, but there are lots of smaller transaction costs that a business broker must warn the seller to consider when calculating the net proceeds at sale.
Let’s look at a few of them.
Almost all except the smallest transactions will involve the seller’s attorney.
As I’ve stated previously, it is in the broker’s best interest to involve the attorney only in the review process – after the deal terms have been negotiated. Getting the attorney involved at the review stage removes much of any legal liability from the broker.
In most jurisdictions, it’s illegal for anyone who is not an attorney to give legal advice. Yes, we have a good grasp of the legal issues involved in the transfer of a business and can negotiate the purchase agreement to address them, but we want the seller’s attorney to review and sign off on the contract language. It covers our butts.
Limiting the attorney’s involvement to review and sign-off also limits the legal costs. If an attorney is involved in the negotiation process, it will absolutely increase the costs. It will also decrease the likelihood of the deal getting done.
I know there are some attorneys that read this blog and I mean no personal disrespect. But we’ve been doing this for more than 20 years and I can tell you that, based on that experience, if an attorney – especially one that is not specifically a “transaction attorney” – is involved in the negotiations, the chances of completing a successful transaction drop dramatically.
Get the deal negotiated pending attorney review and have the seller give the agreement to the attorney with the comment that the price and terms have been agreed to and that they cannot be changed. Have the seller ask for a legal review only. This is a transaction cost but one that can be controlled.
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Our course, The Basic “How-To” of Becoming a Business Broker”, teaches how to market and sell businesses.
Become a Professional Business Broker…
Assignment FeeMost businesses lease the premises they occupy. If the business is sold, the seller will naturally want to assign the lease to the new owner. Many leases include a fee that is paid to the landlord if the lease is assigned. This fee is purportedly to cover the costs the landlord will incur for its vetting of the new owner and the preparation of the necessary documents.
However, we’ve seen assignment fees in amounts that have made us think they were established to deter assignments; almost as a punishment, if you will.
If the landlord is a major property owner – mall owners and national commercial landlords, for example – an assignment fee could be quite high. Read the lease section that pertains to assignment.
Transfer Fees
If the business being sold is a franchise or licensed business, there will almost always be a transfer fee.
Transfer fees were established to cover the costs the franchisor will incur for the process of vetting and approving (or denying) the buyer of the franchised business.
Most franchisors are very particular about who they approve as a franchisee and the process of vetting the applicant is very detailed and arduous. Check the franchise agreement for the section on “Fees” and find the one that deals with transferring the franchise or license rights.
Sale of Business FeeSome rapacious landlords now include a clause in their leases that states that the landlord is entitled to a fee – sometimes even a percentage of the sale proceeds – if the tenant is sold during the term of the lease.
Now, one would think that a reasonable assignment fee would be adequate to cover the costs of the landlord when a sale happens, but there are instances when landlords feel that the an excellent business owner selling to a newcomer to the business might detract from the value of their property.
If the business is indebted to any extent – loans for equipment or software, for instance, or mortgages for real estate – the lender may be entitled to a penalty payment if the loan is paid off early. When you’re gathering information from the seller, ask if there are any loans outstanding. If there are, mention the possibility that such loans may include a clause providing for a pre-payment penalty. Suggest that the owner review the loan documentation and let you know.
Real Estate-Related Fees
If real estate is involved in the transfer, there will be, at minimum, transfer fees paid to local government as well as closing and settlement fees. But there could also be additional fees.
A survey and real estate appraisal might be required and, increasingly, we’re seeing costs for environmental surveys. Though these costs can often be negotiated between the buyer and seller, they should be identified upfront as possible fees that could impact the seller’s net proceeds.
Other Professional FeesAs I’ve written previously, the seller’s preparation for a sale will often involve their accountant as well as an estate or financial planner. These professionals will be able to help the seller determine what amount of money the seller will need to fund his or her life after closing.
If the seller has not already consulted with this talent, the intermediary – the business broker or M&A advisor – would be remiss not to urge them to do so. All will involve fees.
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Our course, The Basic “How-To” of Becoming a Business Broker”, teaches how to become a professional business broker.
Become a Professional Business Broker…
The Bottom Line
Transaction costs can make up a larger-than-expected percentage of the gross sale proceeds, reducing the net to the buyer by an amount the buyer did not anticipate. Surprises like this have killed more than one transaction at the closing table, a situation that can, in many cases, result in a lawsuit.
And if the anyone involved starts calling attorneys, you can be sure that the broker or M&A advisor is going to be on the receiving end of a demand that they appear in court or the office of the attorney for the plaintiff to answer questions. And in that case, you need to have your own hired gun.
Don’t leave yourself vulnerable to such an outcome. Help your seller identify as many of the possible transaction costs as you can. And, if you are asked to estimate what the seller’s net proceeds are likely to be, always include the appropriate disclaimers.
If you have any questions, comments or feedback on this topic – or any topic related to business – I want to hear from you. Put them in the Comments box below. Start the conversation and 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. In the meantime, I hope you have a profitable week!
Joe
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