Should You Use a Business Broker?

Today, we're gonna talk about business brokers. If you've been thinking about selling your business or if you're thinking about buying a business, then this episode is made for you. Now, most business owners only sell their business once in their life. It is essentially the biggest financial transaction they're ever gonna make, and yet most of them go into it completely unprepared. 

They rely on gut instinct. They rely on advice from a neighbor, and they generally lose money when they do that. But today, we're gonna talk about fixing that. We're gonna cover what brokers actually do, how they get paid, the red flags to watch for, and the questions you need to ask before you sign anything. 

So stick around. This could help you save up to six figures 

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Should You Use a Business Broker? 

Roger: Welcome back. Today, we're going to talk about business brokers. If you've been thinking about selling your business or if you're thinking about buying a business, then this episode is made for you. Now, most business owners only sell their business once in their life. It is essentially the biggest financial transaction they're ever going to make, and yet most of them go into it completely unprepared. 

They rely on gut instinct. They rely on advice from a neighbor, and they generally lose money when they do that. But today, we're going to talk about fixing that. We're going to cover what brokers actually do, how they get paid, the red flags to watch for, and the questions you need to ask before you sign anything. 

So stick around. This could help you save up to six figures.

Announcer: You are listening to the Mastering Business Basics podcast, where we discuss how to build a solid foundation under your small business to improve your chances of success. And now, here is your host, Roger Pearson. 

Roger: This subject came up because I had a client, one of my tax clients, call me. They were thinking about buying a coffee shop, and they were talking to a business broker, and the only thing that-- of course, the business broker made it sound like a very good deal, but the only thing he would send them is the last three years of tax returns. 

That's my business. And he wouldn't send them profit and loss statements or anything like that. But I know how to use a profit and loss statement to create a tax return, so I just worked it backwards to figure out what this business was doing. And it was being sold by somebody that this was more of a side thing than his main business. 

He was pretty well off, and he made a lot of money elsewhere. So this was just a pet project. But he got tired of it after three years and wanted to sell it. I looked at these tax returns, and he was losing money all three years. But I had no documentation to know exactly why he was. 

I saw the payrolls taken. I said, maybe he's taking a huge payroll, and it's making it come out negative." And yet they told me, "No, he was-- this is what he was giving himself to manage the business." And I said, that's a fair amount." But something was just not right. I advised my client that this was probably not a good deal because there was just too many red flags there. 

And so I then realized, a lot of people out there probably don't know about business brokers, and there's a few things that you need to learn if you're going to use one. So that prompted me to say, "Okay, I'm going to just take one of my podcast episodes, and we're going to talk about it a while." And I don't know whether you'll ever use one. 

Most people try to just start theirs from scratch, or they go the franchise route , and buy a complete system that way. But that's risky too because I see franchises go out of business all the time. And you really have to be careful if you're going to buy an existing business because you have a lot more to lose than if you're starting a business and you're still not into it so deep that you're going to lose your shirt. 

So let's get into this. Let's start with the basics. What exactly does a business broker do? We have to think of them like a real estate agent. But instead of selling you a house, they sell you a company. 

And here's a breakdown of their job. There's certain things they will do for you, and the first is dealing with the valuation. Now, a good broker's going to tell you what the business is worth, not what you hope it's worth, but what the market will actually pay for your business. They look at your financials, they look at your industry, they look at comparable sales. 

The second thing they do for you is the marketing, and this is really critical. You do not want your employees to know you're going to sell your business, and you do not want your customers at all to know you're going to sell your business. So a broker markets your business confidentially. They use blind listings. They require non-disclosure agreements. They protect your privacy. 

The third thing they'll do for you is they'll screen the buyers, and this is the biggest time-saver of all. most people ask about a business for sale, they're never going to buy it. They're tire kickers. They're window shoppers. And a broker will filter all these non-serious people so that they're only going to bring you serious qualified buyers, and that's important. Why waste your time on the rest? And if you're trying to do this yourself, do you really have the time to go qualify all these people? 

The fourth thing they're going to do for you is negotiate. Price is only part of the deal. You have to consider the terms. There are structures involved. There's contingencies involved. And a good broker is going to know how to navigate all of this legal stuff for you. And finally, they manage the whole process. selling a business involves lawyers, accountants, lenders. It has a lot of moving parts to it. the broker keeps the train on the tracks, and without a broker, you're trying to do all of this yourself, and you're doing it while running your business, and that's, quite frankly, just a recipe for disaster. 

So how do you put together a deal? Most people probably don't know. But let's talk about the deal itself, and this is where most owners get confused. they think selling a business is like selling a car. You name a price, they write a check, and you hand over the keys. And it's really never that simple. 

First of all, let's talk about seller financing. This is very common. The buyer will say to you, "I'll pay you the full price, but I want to pay you over five years." You become the bank. If they default in year two, you get the business back. Might sound like a good deal, but the business might be worth nothing by then because probably the reason they can't pay you, in year three, is because they've run it into the ground, and they don't have the money to pay you. 

A good broker's going to help you structure this safely. And then there's something called the Earn-Out. The buyer says, "I will pay you the full price, but only if the business hits certain revenue targets." You're still on the hook. You're still working for them. You're still taking the risk, and a broker's going to tell you if this is a good idea, but nine times out of 10, usually it's not. 

Usually it's not unless they know the business that you're in and they know how to run it properly. That's what you have to learn in a situation like that. And have they spent the years' worth of experience that you have so that your business is running properly. So you really have to take a deep dive if you're going to go that route. But usually that's hard to find out, and so it's probably not a good deal. 

Then there's also the asset sale versus stock sale. this one affects your taxes. It affects your liability. If you get this wrong, the IRS is going to come knocking, and a broker will work with your accountant to make sure that you're protected from this type of thing. 

Now, these are all complex financial instruments, and you really need a professional to guide you. You're not just selling a business, you're selling a financial future, your financial future, and you do not want to leave that to chance?

Okay. So let's say you decide to hire a broker. How do you pick the right one? Because this industry has got very little regulation to it, so the quality varies wildly. But let's talk some red flags. When you go in to hire a broker, these are the things you need to look for. 

Red flag number one, the inflated valuation, I call it. If a broker tells you your business is worth way more than everybody else, be careful. 
 They might just be trying to win your listing, and then six months later they'll pressure you to drop the price. So you need to be asking for comparable sales. Make them prove their numbers, where they're getting their numbers. What other businesses like yours are being sold for? Things like that. 

Red flag number two, the long exclusive agreement. Do not ever sign a 12-month exclusive on the spot. the standard in the industry is six months. Make sure you have an out clause because if they're not performing, you should be able to walk away at any time. So in that agreement, you have to put something. If they don't meet these particular, points, then you should be able to get out of that agreement and go find somebody better. 

The third red flag is really poor communications. if they're slow to return your calls now, can you imagine how they will be later? So you need to view this person as a partner who's very responsive to you. 

So there's the three big red flags, but you should also be asking a potential broker some questions. 

The first question should be, how do you calculate the valuation of the business? You want to hear about cash flow multiples. You want to hear about SDE or EBITDA. Those are all fun things. Not just a gut feeling. 

The second question you should be asking a potential broker is how is your commission structured? Usually it's 10%. That's pretty much the industry standard. But there's something called upfront fees you have to be careful about. You have to know exactly what you're paying to the dollar. 

The third question is who's going to handle my listing? Will it be you or will it be a junior associate? you want to get the most experienced person. If they're this big firm and they have a lot of junior associates and just hand things off to them, that's not who you want. You want somebody that's going to treat this as if they owned it themselves. 

The fourth question you should ask a potential broker is how many businesses like mine have you actually sold? The industry matters. A broker who sells restaurants might not even know how to sell a manufacturing plant properly because they don't know the business. it's just like when I do taxes. When I do taxes for business people, I always tell them one of the things I have to do is I have to learn your business to be able to do my job properly.  And the same thing is true here when you're talking about a business broker. They have to know your industry if they're going to do a proper job for you. So find out. 

The fifth question you should be asking is what is the biggest obstacle to selling my business? A good broker is going to give you an honest answer.  A bad broker will tell you everything's going to be easy. You need to trust the one that's going to be honest with you, that's going to give you the bad as well as the good.  

Let's shift gears for a moment. 

Now, selling your business is really emotional. This is your baby. You built it, you poured your life into it, and it's probably hard to let it go. And this is where a broker's actually going to act as a buffer for you. They handle negotiations, they handle the difficult conversations, and they allow you to stay professional instead of letting your emotions get in the middle of things and mucking them up. 
 That's one of the most important reasons to have a broker, I think. 

You also have to think about your preparation. before you call a broker, you better have your house in order. you have to give them what they need to do their job. You have to clean up your financials. You have to make sure your tax returns matches your profit and loss statements. 
 You have to make sure you've removed any personal expenses from the business. The cleaner your books are going to be, the higher price you're going to get because it's going to look like a more properly run business. That's the bottom line. 

So the other thing is, from an emotional standpoint, is you don't wanna wait until you're burned out to sell. You need to sell when the business is just really strong, You need to sell when you still have plenty of energy. That's when you're going to get the best price, and it's also the best time to walk away because you still have got a good life to live. You're going to have money. You're going to be able, if you want, to retire at that point, invest in another business, do it all over again, whatever the case may be. 

But you're going to have yourself in the best position at that time. You don't wanna wait until it's just, "Oh, I'm worn out doing this," "Let me sell this business. Just get out of it." You don't want to be in that position. Walk away on the top. 

So knowing all of this, should you use a business broker? And for most owners, the answer is yes. 

Now, a good broker's going to earn their commissions. They'll get you a better price. They're going to protect you from bad deals. They're going to save you time. But you have to do your homework. You have to interview a minimum of three different brokers. You have to check their references. You have to read the agreement twice, and then trust your gut for the right person.

Now , let's flip the table. 

What if you're not selling? What if you're looking to buy a business? Dealing with brokers is an entirely different ballgame, and if you don't know the rules, you can get burned pretty fast. So rule number one, remember who the broker works for. The listing broker is paid by the seller. Their legal duty is to the seller.  Their financial incentive to get the highest price possible is the seller. Now, they might be friendly, they may take you out to coffee, they might seem like they're on your side. They're not. 

The first thing is you should never reveal your maximum budget to a listing broker. You never negotiate against yourself. You're trying to get the best deal, and if they know what your maximum budget is, guess what? They're going to try to get more money out of you. 

Second thing, scrutinize the add backs. So when a broker sends you a prospectus, they're going to show you a number called SDE, which stands for seller's discretionary earnings. And to get that number, they take the net profit and they add back the owner expenses, things like personal vehicles, cell phones, travel, and one-time repairs. 

While some of these add backs are legitimate, but many of them, unfortunately, are pure fiction. A broker might try to add back essential software or routine maintenance claiming it was a one-time expense. And if you accept these numbers at face value without any proof, you're probably going to be overpaying for that business. So you need to make them prove every single line item with tax returns and bank statements. 

Third rule, how to get brokers to take you seriously. brokers get hundreds of emails from tire kickers every week, people who have a dream but no money. So if you want a broker to return your calls and show you good deals, you're going to have to look professional from minute one. 
 You have to have your non-disclosure agreement signed immediately. You have to have a personal financial statement ready to show them. You have to have proof that you have money in the bank. You have to tell them your exact acquisition criteria. Because when a broker knows you have the cash and the ability to close, you're going to jump to the front of the line, and you're going to see deals before they hit the public market. 

Rule number four, you have to consider a buy-side broker. Now, just like in real estate, you can hire a broker to represent you, the buyer. A buy-side broker helps you find off-market targets. they conduct initial due diligence, and they negotiate on your behalf. You may have to pay a retainer or fee, but having an experienced negotiator in your corner evens the playing field. 

They're going to look out for you, not the seller. So whether you're buying or selling, you never go into a transaction assuming the other side's broker is your friend. You need to only trust the data. You need to be verifying the numbers, and you need to protect your downside. I hope you found this information helpful. 

I realize it's not a huge market of people that do all of this, that buy or sell businesses, but hopefully you're going to be so successful in yours that time will come when you need to sell it. 

So, share this information with a business owner you know. They'll thank you for it, and I thank you for listening, and we'll see you next time  

Announcer: You have been listening to the Mastering Business Basics podcast with your host, Roger Pearson. For more information about all of the business education options that are available, we invite you to visit seagulltechnologies.com and continue your journey.