01 Sept 2019
Let's cut to the chase. Do buyers really pay the 'business broker commission' through inflated prices that the seller has factored into the asking price? In Australia where sellers have entrusted the sale of their businesses to business brokers, the commission payable on settlement is usually invoiced to the seller. However, a popular misconception with buyers is that sellers often put up their asking price to cover the commission paid to brokers. And it is this fear that drives buyers away from business brokers and onto Gumtree.com.au to find a 'bargain'. Let's find out.
The Psychology Behind Negotiations
Self interest prevails - it is the enduring human nature. Buyers will always offer a price based on their own self interest and reasons. A buyer would not care what the seller wants or how much the seller is paying business broker commission.
Tell a buyer to pay more to cover the commission won't get any traction from the buyer.
Remorse is also human nature. A seller that agrees to an initial low offer without some kind of counter offer will result in seller's remorse. Sellers are left wondering if they could have sold for more. Rarely do sellers agree to a low offer without a counter offer.
If the seller agrees to the initial low offer from the buyer, then this may result in buyer's remorse. The buyer is left wondering if he/she has offered too much.. Could they have bought the business for less?
These thoughts happen whether the business is sold via a broker or not.
The right side of the brain is the home to emotions and the left brain logic. Despite what you may think, it is the right side of the brain (emotions) that calls the shot on price.
Both the buyer and seller dance through a negotiation process that satisfies their right brain (emotions). Out of this process, a final agreed price will present itself.
The agreed price will not be influenced by the commission paid by the seller. The agreed price has surfaced because both parties have found an equilibrium between the highest price the buyer is willing to pay, and the lowest price that the seller is willing to sell. And this has nothing to do with commission paid to the broker.
In any event, the idea of passing the business broker commission to the buyer only exists in the minds of the parties. It cannot possibly occur.
Like Einstein theory of relativity, the earth does not revolve around the sun, nor the sun around the earth - they are only relative to each other because the universe has no concept of a fixed point.
Similarly, there is no universal directory of prices that either party can use to calculate who has actually paid for the transactional cost (e.g. broker's commission). It's really just a 'psychological itch' to be satisfied in the negotiation process.
An equilibrium between the highest price the buyer is willing to pay & the lowest price that the seller is willing to accept will result in an agreed price that is not influenced by the business broker commission. Photo: Steven Depolo (Flickr.com)
What About Valuations?
What about business valuations? Can't the valuation provides a point of reference to decide who is really paying for the business broker commission? For micro, small and medium sized businesses, the problem with valuations is that it is more art than science. There are many ways to value a business depending on the context. The differences can be huge - huge enough to make business broker commission irrelevant. An accountant can tell a cafe owner that the cafe should sell for $300,000 because of an accounting valuation principle. However, the buyer will only offer $120,000 because the other cafes in the vicinity are sold at around that price (market price). In the end, both parties agreed to $180,000. The buyer felt that he/she over-paid. The seller felt that he/she got less than deserved. The business broker commission of $20,000 becomes indistinguishable because each of the parties both feel that they paid for the commission. The true valuation of any business is the price that meets the market. Therefore the most correct form of valuation is the price that the parties both agreed on. The business broker commission is intrinsic to this price and cannot be seen as a separate component for the purpose of ascertaining 'who is really paying for the commission'.
So Who 'Overpays'?
If the most accurate form of valuation is the price that the parties both agreed on, then no buyers will ever 'over-pay'? Something doesn't add up...
Businesses valuations are based on the aggregate prices of all businesses. Therefore there will be buyers who paid more, buyers who paid less and an average price across the board.
This is very strong anecdotal evidence to suggest that buyers who have bought businesses privately without a broker have overpaid, sometimes 2-3 times more. We know that these buyers paid over-inflated prices because when they wanted to sell, there are no takers at the price that they had paid originally.
An accountant I know paid $600,000 for a retail business without help from a broker. She had valued the business at more than $600,000 based on her accounting principles and thought that she had snared a bargain. Two years later, she approached me and I appraised that buyers were only willing to pay around $150-200K for her type of business. She had overpaid by a massive $400,000.
Another buyer I know from overseas bought a business he saw at Gumtree.com.au for 2.5x the annual net profit. In his home country, businesses are valued at 3-4 times the annual net profit so he made a rash decision to buy without a broker. I later appraised that buyers were only willing to pay 1.4x the annual net profit for this type of business.
Generally within a 2-3 year window, businesses that were bought through an intermediary were able to re-sell at a price that did not deviate too far from the original purchase price.
What's In It For The Parties?
Business brokers want the sale to happen because they are paid business broker commission only if the sale happens. This means that the broker will inevitably create a fair and conducive environment where the sellers and buyers can find an equilibrium price to create the sale. Firstly, the business broker can provide valuable insights into the thoughts of the parties. For example, the broker can provide clues to the lowest price the seller will take so as to maximise the chance of a sale. This may pleasantly surprise the buyer who had originally intended to pay much, much more. Also, the business broker can help to filter businesses that are suited to the buyer, thus saving time for both the seller and buyer. The broker can educate the buyers on the landlord or franchise requirements early on to avoid time wasted. Most importantly, business brokers have established processes to protect the interests of both parties. A private buyer may be scammed by private sellers, or a seller may be tricked unwittingly into handing over confidential business documents to competitors posing as buyers. Business brokers will do their best to police these situations because these kind of activities do not result in a sale and actually create problems for the brokers. Lastly, to close the sale, business brokers are hugely motivated to help the parties solve problems and to resolve any issues with solicitors, landlords, franchisers, migration agents, government agencies, accountants, strata managers, real estate agencies, regulatory bodies, the local council, tax office and the likes. Without an intermediary, the buyer would usually walk away at the first sign of trouble, or the seller simply doesn't know how to resolve these problems to reach settlement. If a sale reaches settlement, this means that the business broker has fulfilled the task entrusted by the parties and deserves the business broker commission that is legally and ethically due. Neither the buyers nor the sellers should feel remorse at the fees paid.
Josh Foo contributed to this post.
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