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Reasons to Use a Reputable Business BrokerThe thesis of this article is that the
use of a reputable intermediary
(business broker) adds value on an ex-
ante basis by increasing both the
likelihood of a successful outcome and
the amount of the anticipated payout in
the purchase or sale of a business.Intermediary selection is critical as
the quality and capabilities are highly
variable within the profession. At the
most basic level, the intermediary
should be properly licensed and
insured. The International Business
Brokers Association ("IBBA") is the
preeminent industry group. They offer
two levels of accreditation (Certified
Business Intermediary and Merger &
Acquisition Master Intermediary).
IBBA membership and accreditation
are strong positive indicators of a
reputable broker. Additionally, the
buyer or seller should ask for, and
follow-up with, references for the
broker..
How might one measure success?
Risk and reward are relevant metrics to
apply. Since we are dealing in capital
markets, it is appropriate to apply
financial definitions to these terms. In
the world of finance, risk is
qualitatively described as the reliability
of future outcomes. Quantitatively, it ismeasured in standard deviation units.
U.S Treasury notes are considered risk
free and would have a standard
deviation of zero as future payment is
certain. Other investments that present
a greater risk would have a greater
standard deviation.
Anticipated reward as a financial
term is often expressed as Net Present
Value ("NPV"). Future payments are
discounted to reflect both the perceived
payment risk and timing of payments.
For those readers with an interest inmathematics:
NPV =Σ pi / (1 + r)i
where p is the payment in period
(i) and r is the required return or
interest rate. Value is an inverse
function of both risk and time to
payment. The NPV calculation is
widely used and understood. The
problem with using the methodology
lies in determining an appropriate value
for r.
Another more sophisticated
methodology of quantifying reward
prior to the deal is in terms of ExpectedMonetary Value (EMV). Using this
methodology, a decision tree is drawn
for the various potential outcomes. The
forecast payouts are then multiplied by
the forecast probabilities to calculate an
EMV. For example, a $1 bet on red in
roulette, which has a possible payout of
$2 and a risk probability of success of
18/38, has an EMV of just less than 95
cents ($2*(18/38)) + ($0 *(20/38)). A
$1 bet on a single number, which has a
possible payout of $36 and a risk
probability of success of 1/38, has the
same EMV of 95 cents ($36*(1/38) +
($0*(1/38)) but a dramatically higher
risk. Red is therefore a better bet as it
has the same EMV but lower risk. The
time value of money concept embodied
in the NPV calculation can be overlaid
as required onto EMV using a risk-free
rate of return for r.
Risk
Let’s begin applying these lessons
to our thesis that a reputable broker adds value. Although risk and reward
are inextricably intertwined, let’s start
with risk. The Hippocratic Oath states:
"first do no harm." One risk in the sales
process is that sellers may harm
themselves by following a natural
tendency to not disclose adverse
information upfront in the business
sales process. Such information will
eventually come to light in the due
diligence process or after the sale and
potentially either derail the deal pre-
sale or raise the specter of litigation post-sale. To limit risk due to
inadequate disclosure, the intermediary
will coach the owner to disclose,
disclose, disclose.
Another risk is that a business can
be harmed by breaches in
confidentiality. For example, a buyer
may have competitive motives and no
true interest in purchasing a business.
For this reason a reputable business
broker will protect his seller client by
requiring a potential buyer to sign a
nondisclosure or confidentiality
agreement. In managing risk, an
intermediary is well positioned to
screen unqualified buyers and obtainsignatures on confident ial i ty
agreements with teeth. The broker wil
also advise the owners of the risk
inherent in marketing to direc
competitors. In each engagement, a
reputable broker will parse out the
relevant information commensurate
with the buyer’s demonstrated level o
commitment. These actions will reduce
the chance of having the sale process
damage the value of the business.
As we saw in the roulette example
one should consider the ex-ante
probabilities of achieving the variou
outcomes. Most small businesses tha
are listed for sale do not sell(1)
Unrealistic price expectations are the
most common issue. A business
broker’s market knowledge shou
inject realism while concurrently
enhancing the perception of the firm’s
value and marketability.
The ideal valuation process is
where the broker collects and presents
the relevant information about a firm toan accredited third-party appraiser. The
broker knows what drives value an
their involvement will provide a
justifiable higher price. Use of a
accredited third-party appraiser lends
credibility to the process and provides
the client with comfort that the correc
price is being placed on the business.
Two other reasons why listed
businesses do not sell are a business
failure to attract buyers and lack of
financing for the buyer. A broker’s
position in the marketplace provideconstant interaction with buyers and an
experienced broker knows how to bes
market a business. With respect to
financing, a reputable broker will also
be aligned with several lenders. Th
broker will obtain pre-appro
requirements from lenders before going
to market and qualify buyers based
upon banking requirements.
Published in the Journal of the DuPage County Bar Association
J o s e p h A s s o c i a t e s I n t e r n a t i o n a l , I n c . - B u s i n e s s B r o k e r s
1 4 1 W . J a c k s o n B l v d . S u i t e 3 4 2 0 C h i c a g o , I L 6 0 6 0 4 • T e l e p h o n e : 3 1 2 . 2 1 2 . 8 0 4 6 • F a x : 6 3 0 . 3 5 5 . 6 1 9 1 •
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Trust and communication between
the parties and the broker are critical.
Once engaged with a serious buyer, a
good broker will maintain continuous
contact with both sides. An attorney,
who is limited by ethical rules from
communicating with a party
represented by another attorney, does
not have this same freedom of
communication. The intermediary canmanage expectations on both sides
while coaching and directing the parties
through the sale process. This reduces
the risk of a surprise and reduces
anxiety induced by lack of process
knowledge. The buyer and seller’s
personal relationship must survive the
sale process. An intermediary provides
a buffer zone that will be tested during
negotiation and due diligence.
Deals that drag are deals that die.
A fully documented offering
memorandum will speed the buyer’squest for financing. A good broker will
have thoroughly prepared the seller for
due diligence and the information
needed by the buyer. This should
eliminate deal-killing surprises and
keep things moving. The broker will
also maintain regular communication
during due diligence with both parties’
attorneys and other advisors to
maintain deal momentum. If well
prepared, the attorneys will likely
borrow heavily from the broker’s work
product when drafting schedules for the
closing documents.
The consequences of not selling a
business vary case by case. The EMV
for using a broker increases with the
level of seller compulsion to sell. The
reason is that the broker has better odds
of closing a deal and thereby avoiding
the negative outcome of not selling the
business.
Reward
Let’s now focus on reward. Sellersare interested in maximizing post-tax
proceeds with a strong bias for cash at
closing. They would like to have no
residual risk. Once again we see
conflicting goals. The all-cash stock
sale will not command the same price
as an asset sale with some level of
seller financing.
Deal structure strongly influences
value. An experienced broker can help
in the search for an optimum in
balancing these objectives. Advisors
lacking M&A experience often
recommend against holding any debt
from the buyer as payment is not
assured. This sends a strong adverse
signal to both the buyer and their
financing source. Banks are less likelyto lend and buyers are less likely to
buy. The result is reduced marketability
and lower value. An experienced broker
will point out that a seller note for ten
percent of the transaction amount will
typically raise value by a comparable
amount while increasing marketability.
Any EMV assigned to the seller note
should therefore be welcomed as
additional proceeds. Clearly, the
balance swings against the seller as
their portion of financing increases.
Business owners often look to their accountants to help them sell their
business. Most accounting firms do not
have a brokerage or investment banking
group and therefore lack the necessary
resources to effectively market a
business. The accountants’ professional
organization (American Institute of
Certified Public Accountants) offers an
accreditation in business valuation but
few accountants have earned these
designations.
The typical CPA is often put into a
difficult position when asked for an
opinion of value by their client. The
CPA is often reluctant to admit their
professional limitations. He may be
worried about digging too deeply into
reported discretionary expenses as this
might force them into recommending
that the client file an amended return.
There may also be a concern about
preserving the client relationship. Even
if the accountant does a perfect job in
determining value, the accountants’
report may lack the credibility of athird-party accredited appraiser.
Summary
In summary, a reputable broker has
the means and motive to lower risk and
increase reward for the client. In so
doing, the EMV of their services should
more than offset their fees and provide
added value relative to the alternatives
of for-sale-by-owner or attempts to
market by other advisors such as
bankers, accountants and attorneys.
One final word of caution: mos
attorneys focus only on reviewing the
intermediary’s listing or engagemen
agreement. This is a big mistake. An
attorney serves the client best by
helping find and engage the righ
broker with the right listing agreementThe wrong broker with a grea
agreement will prove to be a lingering
disservice.
By Joseph McCaul
References:
1. Business Reference Guide, Tom
West, Business Brokers Press, 2005.
Joseph McCaul is the president and
founder of Joseph Associates
International, Inc., an Illinois registered business brokerage &
advisory firm focused on ownership
transfers of privately held business. Joe
McCaul holds an MBA from Case
Western Reserve University and
engineering degrees from the
Polytechnic University. He is a member
of the International Business Brokers
Association, World Trade Center of
Chicago and Naperville Area Chamber
of Commerce.
J o s e p h A s s o c i a t e s I n t e r n a t i o n a l , I n c . - B u s i n e s s B r o k e r s
1 4 1 W . J a c k s o n B l v d . S u i t e 3 4 2 0 C h i c a g o , I L 6 0 6 0 4 • T e l e p h o n e : 3 1 2 . 2 1 2 . 8 0 4 6 • F a x : 6 3 0 . 3 5 5 . 6 1 9 1 •
w w w . B r o k e r C h i c a g o . c o m