How do Business Broker and M&A Commissions Work?

How do business broker and M&A commissions work?  This will be a pretty dry blog post, but this question comes up a lot so hopefully it will be useful.

Business Brokerage
There is no law or regulation that sets pricing, but business brokers typically charge a 10% commission (also called a "success fee") on the value of the business and 6% on any associated real estate.  The exceptions are gas stations, grocery stores and hotels which can be less.  We have heard of some brokers charging 12% and others readily dropping a few points in order to get a deal, but most hold firm at 10%.  If another broker is involved in finding a buyer, the fee is split between the listing-side broker and the sell-side broker.  That is if they agree to work together (cooperate), which not all business brokers do.  Some states are better than others (Florida is among the best, California among the worst).

I know 10% seems like an awful lot.  I have started and built businesses, and to give up 10% of all that hard work that it took to build the business hurts.  I wish it were different, but the reality is that this is what it takes to keep brokers in business and 10%  is what the standard in the industry is.  Indeed, it is a lot of work, and often the seller will comment on that towards the end of the deal.  I just wish that they could see that at the front end when the 10% seems so steep. 

M&A Commissions
It is standard practice to provide a discount above a $1 million selling price, and many M&A firms will say they use the Lehman Scale although in reality they probably use the Double Lehman Scale.   The Double Lehman Scale pays a commission of 10% on the first million, 8% on the second million, 6% on the third million on down to 4% for the remainder. 

I’ve seen business brokers that don’t normally do larger deals charge 10% total commission for a selling price above a million.  They didn’t do that on purpose (I don’t think), they just didn’t know it is standard to use the Double Lehman.   Obviously the seller didn’t know that either.

Smaller deals often have a clearly defined value and a success-fee is fairly easy to determine.  Not so with larger more complex deals, and it is often up to the seller and the broker to sit down at some point and figure out a fair commission.  As an example, a recent deal we closed had a contingent payment based on the future performance of the company – therefore the full purchase price would not be known for a number of years.  This is commonly called an “earnout”. The “expected” purchase price used for commission calculation ended up being above the base price but below the maximum price.

As a general rule, business brokers don’t charge an upfront fee, while M&A advisors do.  It makes sense too.  A business broker is operating essentially alone much like a real estate agent, while an M&A firm applies a team of writers, analysts and dealmakers on your project and also must pay for a marketing campaign.  At Woodbridge, we pay substantial out of pocket costs for each client for first class mail, telemarketing and advertising and we charge an upfront fee to help pay for it.

The Tail
Engagement agreements vary a lot, from real estate type canned agreements for business brokers to custom agreements for M&A firms, but you'll find a "Tail" on each one.  The tail on an agreement means that once the agreement has ended, there is still a clause that says if you sell to anyone within 18 to 24 months that the intermediary introduced to you, you still owe a commission.  So don't let it surprise you, it is standard.  What isn't standard is what "introduced" means.  We define that as anyone that signed a confidentiality agreement during the time our agreement was in affect.

Negotiable?
Well, as you know everything is negotiable, but a quality broker or M&A firm probably isn't going to move on the fee.  However, it is common to change various parts of an agreement depending on the situation.