Whether you are a first-time seller or an old hand at M&A, it may be wise to retain a financial “tour guide” to help you through the process. The proper role of a financial intermediary is to connect two parties who haven’t figured out that they need each other yet, and to help craft a better deal than those parties could have made on their own. But who do you choose? An investment banker or a business broker?
If financial markets were textbook perfect, you wouldn’t need any help figuring out what your business is worth or finding the optimal buyer for it. Unfortunately, real markets do not act like your college Econ 101 models. Sellers struggle to find the right buyers. Buyers struggle to find the right price. Nobody has perfect information or foolproof judgment.
If you want to sell your business, you have to start the process by figuring out how to sell it and to whom. Since you don’t have perfect information or foolproof judgment, the business sale faces a lot of uncertainty and risk. Realistically, you have three forward paths to choose from:
The first option is a bad one. The second option is possible, and is probably the correct choice for some, but the odds are against most first-time sellers. The reality is that most sellers (and a lot of buyers) are best served by working with an M&A intermediary, getting a proper valuation of tangible and intangible assets, and letting an expert manage the sale.
“Intermediary” is a broad term for anyone who facilitates, or coordinates more efficiently, economic activity. Intermediaries appear once a market becomes too big or complex for individual actors to confidently navigate.
For example, retail bankers intermediate between savers and borrowers who likely never have, and never will meet. Some intermediaries even coordinate across time. For example, a pension fund intermediates between a present worker’s wages and his future consumption.
Few markets are as ripe for intermediaries as mergers and acquisitions. In fact, Deloitte reports that “2018 was the fifth consecutive year when deal values exceeded the $3 trillion mark.” A great deal of information and negotiation is required to move trillions of dollars of financial capital, and most business owners don’t have enough time or expertise. Thus, intermediaries play a significant role in this process.
When making the decision to use an intermediary to facilitate your sale, it’s important to understand your options. There are two major types of M&A intermediaries: Investment bankers and business brokers.
Business brokers tend to handle smaller M&A transactions (this is not a universal rule, however). A maximum threshold of $5 million in enterprise value is often cited for business brokers in the United States. In fact, some estimates suggest that business brokers handle 80 percent of M&A deal volume, but less than 5 percent of total deal value. They are the dominant intermediary used by smaller family-owned companies or single-entity partnerships.
Just like a real estate broker for your home, a business broker lists your company for sale and advertises to prospective buyers on your behalf. The seller and broker discuss an asking price beforehand, but afterward the broker handles outreach and initial negotiations.
Business Broker Scenario: You hire a business broker to list your company. You agree the company is worth $800,000. A prospective buyer makes an inquiry; your broker determines the offer is serious enough to warrant further action.
Thanks to the broker, the buyer executes a confidentiality agreement, sometimes called a non-disclosure agreement (NDA). This protects your sensitive information and keeps competitors or employees from hearing about the deal before completion.
The prospective buyer signs the NDA. You and your broker show him the books of the business, and he is interested enough to make a purchase offer. After some negotiation, you settle on terms and the buyer finds a way to finance a $725,000 deal. For more on how buyers finance deals, read 4 Acquisition Financing Structures for Buyers. The broker charges a 10% “success fee” (commission), or $72,500.
It might seem high to pay 10%, but it is a common rate for business brokers. Some charge 12% fees and others 8% – 9%. Larger transactions may see even smaller rates, but 10% is very common.
Some transactions involve a buy-side and sell-side business broker. One 10% commission is typically split between each broker in these cases.
Do an internet search for the term “investment bankers” and you will see that major websites target the same clientele over and over again: sophisticated businesses. You will also encounter the words “complex” and “auction.”
A lot of the information you find may be also contradictory or confusing. This is because the first modern definition of investment banking was codified by the 1933 Banking Act (better known for one of its key provisions, Glass-Steagall). Over time, however, investment banking became a more inclusive term. Today it is applied liberally across the M&A space.
Investment bankers are often active in middle market transactions (generally defined as deals between $50 million and $500 million) and upper market transactions ($501+ million). The largest investment banks will only take multi-billion dollar deals. Lower-middle market bankers may set a minimum threshold around $500,000 in recurring EBITDA.
Many, though not all, investment bankers deal in securities. These bankers need securities licenses issued by the SEC, are monitored by FINRA, and work under strict state and federal supervision.
Unlike business brokers, investment bankers rarely act like a real estate broker. Whereas a business broker focuses on simple marketing and one-off negotiations, an investment banker commonly works to create a controlled auction among several large buyers simultaneously.
IB Scenario: An investment bank’s M&A department agrees to help sell your business (their service to you is referred to as “target representation” or “sell-side work”). Most bankers prefer to work with sellers because a higher percentage of sell-side projects turn into a completed transaction.
As a part of their advisory process, the bankers create different valuation models; the idea is to create a range of possible valuations, each based on different buyer scenarios, before the auction begins. This initial diligence phase may take a month or two. They determine your business is potentially worth $45 million – $55 million to the right buyer.
The investment bankers communicate with possible buyers, often initiating contact (as opposed to waiting for buyer contact). They hope to create an auction between multiple prospective buyers. Finding the right buyer for your business is key. After an NDA is in place, investment bankers will use a very detailed “selling memorandum” for marketing material.
You have a very interested buyer, but financing is a concern. The investment bank works diligently to figure out an appropriate purchase price and helps raise capital. The investment bank already charged you a non-refundable $70,000 retainer for the service, paid monthly. After the completed deal, the bank charges a “Double Lehman” success fee: 10% on the first $1 million, 8% on the second, 6% on the third, 4% on the fourth, and 2% for every $1 million afterwards. (Investment banking fees and services are fairly diverse. The Double Lehman structure is common but certainly not universal.)
Most people who try to sell their business have never done so before, and the process can be overwhelming for the underprepared. Assemble a transition team of trusted experts to increase the odds of a strong, timely sale.
A good M&A intermediary can save you a considerable amount of time and, ultimately, help maximize your sale. Of course, no industry is without charlatans of one form or another — you need to carefully scrutinize any investment banker or business broker before signing up for what is an expensive service.
On the other hand, you may already be very well-connected and highly knowledgeable about financial markets. You may have enough time (or have advisors with time) to perform diligence, marketing and negotiations without an intermediary. If that is the case, go forth and conquer!
The size of your company will tell you which service you should probably use. If your business is valued at less than $5 million or $10 million, or has less than $500,000 – $2 million in EBITDA, it may be difficult to find a willing investment banker. On the other hand, very large company acquisitions typically require financing knowledge and licenses that many business brokers do not possess.
Factor in the kinds of acquirers who are most likely to be interested. Business brokers tend to work with individuals or small groups. Investment bankers frequently work with large corporations or extremely wealthy individual investors.
Do not forget to find a specialist who understands your industry and your business model. The rise of boutique M&A firms in recent years has made this search easier.
[Editor’s Note: If you want to read more about how to sell or otherwise exit a business, be sure to read “Business Transition and Exit Planning: Welcome to the Jungle!” It will lead you step-by-step through what you need to know.
To learn more about this and related topics, you may want to attend the following webinar series: Valuation in Corporate Transactions Series, Business Advice: From Start-Up to Sale Series and the Private Company M & A Bootcamp Series. This is an updated version of an article originally published on June 7, 2016.]
©All Rights Reserved. June, 2020. DailyDAC™, LLC d/b/a/ Financial Poise™
Michele has been a director with Financial Poise since 2012.
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