Learn about finder agreements in Colorado, so you don’t lose your company to your business broker
- Finder agreements often require payment even if the sale does not close
- Be mindful on what items the broker is paid on (e.g., cash, leases and notes)
When it’s time to sell your business, you may be considering hiring a business broker to assist you in finding a buyer. Business brokers are a tremendous asset to any deal, and we highly recommend you hire a broker to assist you in the sale of your business. Nevertheless, business owners selling their businesses must be aware of the finder agreements that they enter into with the broker and the legal ramifications it may have.
When do you owe your broker a commission?
Most business owners believe that the commission is owed to the broker when the sale of the business is consummated and the buyer actually gives the seller money. However, most business broker finder agreements signed by business owners require payment when the broker brings a buyer ready to purchase the business — even if the deal does not go through.
Examples of when seller may be forced to pay broker under typical finder agreements include:
- When a buyer wants to buy, but the terms of the sale are not satisfactory to seller
- When a seller changes their mind on continuing with the sale
- The amount buyer is willing to pay is less than what the seller wants to accept
- Even if the broker did not provide any assistance in locating the buyer
This can be avoided. Most favorable to business owners are finder agreements that only require payment when the sale closes. Under this type of agreement, absent fraud or lack of good faith, the business owners can be assured that they will only be required to make a payment to the broker if they actually sell their business.
A compromise provision would be to negotiate a “walk away fee.” This allows the business owner to stop the sale process at any time and only pay a fee to the business broker. The fee and the requirement to pay can vary widely.
- Business brokers attempt to maximize the number of circumstances when a fee is paid
- Sellers should negotiate a “paid-when-paid” arrangement
- A compromise can be a walkaway fee or payment of expenses
To summarize, almost all finder agreements will include a provision requiring a fee that the broker must be paid even if the sale is not consummated. It is important that business owners negotiate the broker payment provision or a lawsuit may follow if the sale does not close.
What does the broker get paid?
First, similar to a real estate broker, most business brokers take a percent of the total sale in a commission. The typical percent for a business broker sale in a small to medium size business is 7 to 15 percent of the gross sale. Larger deals may use a Lehman or double Lehman formula. Because the broker is only compensated if the sale closes, they are highly motivated to get your business sold.
Here are some typical terms to consider:
- Business brokers typically receive the total fee upon closing, and for any compensation received by the seller.
- Sellers should calculate the broker’s fee before a finder agreement is entered into.
- Sellers should determine if all or a part of the broker’s fee accuses if only a partial sale occurs, whether of a portion of the equity in the company (stock) or a portion of the assets.
- Typical commissions for small and medium sized businesses are 7 to 14 percent. Larger businesses will be under a formula.
Almost as important as when a broker gets paid is what the broker gets paid on. A broker might be paid on any or all of the following under the finder agreement:
- Equity interest retained by seller
- Leases on real estate retained by seller
- Amounts the seller carries (notes, etc.)
- Escrowed amounts
- Debt assumed by buyer
- Other economic benefits: employment payments, non-compete payments, supply payments, licensing payments, etc.
For example, assume a business owner sells their business for $1 million and the buyer leases the real estate from the seller under the following terms: $200,000 of cash, seller carried note for $800,000, and a 5 year lease of $5,000 per month. Assume the broker commission is 10 percent. Here is what happens under a typical finder agreement provision:
- $200,000 + $800,000 note + $300,000 ($5,000 rent x 60 months) = $1,300,000.00 total compensation to the seller.
- Under this scenario, the broker commission is $130,000, and the seller only receives $70,000 in cash at closing!
And, it can get worse. If the buyer then breaches the agreement to the seller and does not pay the note, the broker is still entitled to their commission, and the seller is potentially out of a business and the money.
Exclusivity & potential buyer candidates
When negotiating with a business broker or business finder, sellers must deal with the terms of exclusivity and determining the candidates or types of candidates that will cause the broker’s commission to accrue.
What do Brokers Want?
A business finder or broker will want an exclusive agreement with the business. This means (1) that the seller cannot work with any other broker during the term of the agreement and (2) that any potential candidate — whether the broker makes the introduction or not — will cause the commission to be owed. Finally, business brokers will also want a tail at the end of the agreement for a period of time in the event the sale closes after the agreement terminates.
What Do Sellers Want?
Seller should seek to allow multiple brokers in a nonexclusive arrangement, which will maximize the potential leads that are delivered to the seller. If an exclusive listing agreement will be entered into, sellers must limit the duration of the agreement, so that the seller is released from his or her obligation after a number of months.
Sellers should also be concerned that the broker is actively pursuing leads for the benefit of the seller. Thus, sellers should require that the broker make the recommendation before a commission accrues. Likewise, sellers should consider excluding their direct competitors as candidates so that their competition does not gain access into the company’s financial information.
Contact us for help
If you would like assistance in negotiating a listing agreement with a broker and selling your business, please call us at 303-688-0944. Our business attorneys help sellers in Colorado and have offices in Denver,Castle Rock, and Colorado Springs. We are dedicated to your best interests in selling your business.