Negotiating The Commission Agreement
Engaging a business broker is a sensible move when selling your business. Savvy sellers recognize that business brokers add tremendous value to M&A transactions in many ways. Among other things, brokers connect sellers with potential purchasers within the broker's network, coordinate due diligence, prepare marketing materials, educate sellers about the sale process, and otherwise help maximize profits and ensure a smooth closing. In fact, in many cases, a deal will not even occur but for the involvement of the broker.
Before signing up with a broker, though, there are certain items that sellers should consider.
Level The Playing Field
It's important to recognize that business brokers are experts on the topic of negotiating business brokerage contracts. Entering into brokerage contracts, after all, is part of their daily business. Many sellers, on the other hand, have rarely (if ever) negotiated a business brokerage agreement. As a result, there is a disparity in the playing field. To combat this, sellers should educate themselves in advance, to ensure that the disparity does not put themselves at a disadvantage
Its appropriate for sellers to perform due diligence on potential brokers before deciding which broker to engage. Such due diligence often includes assessing the broker's industry expertise, service offerings, fee structure, NDA policy, time availability, buyer-network scope, sales strategy, track record, credentials, references and more. This is an exciting time and most sellers are eager to commence the sale process once a suitable broker has been identified.
But wait! Before selecting a broker and executing his or her brokerage agreement, prospective sellers should ensure they fully understand “the fine print” of the broker's proposed contract.
Pro Tip: In many cases, the terms of a brokerage contract are negotiable. Sellers should use the opportunity to negotiate terms, and it makes sense for those negotiations to occur simultaneously with the interview process itself and before the broker has been selected. The time period before selection of the broker is when the seller has its greatest leverage to negotiate contract terms.
As with any contract, failure to carefully understand, negotiate and draft the terms of a brokerage agreement can lead to unintended and costly consequences.
Using a qualified business attorney before executing a brokerage contract is a wise choice. The Law Office of Jennifer M. Settles represents sellers in the negotiation of business brokerage agreements. Contact us today at (602) 617-3938, or through the Contact Form on our website, for a FREE initial consultation.
4 Tips For Negotiating A Better Brokerage Agreement
Below are 4 tips for sellers to consider before selecting a broker and executing the brokerage agreement.
1. Commission Rate
What commission rate is the broker charging? Is this rate negotiable? Is there a requirement to also reimburse the broker's out-of-pocket fees and expenses? Does the seller have approval rights before out-of-pocket fees and expenses are incurred? These items should be discussed with the prospective broker and appropriately addressed in the brokerage agreement.
2. Tail Period
Does the brokerage agreement contain a “tail period”? A tail period is the period of time after termination or expiration of the brokerage agreement, through a subsequent specified date. Having a tail period means that even if the brokerage agreement is terminated or expired, if a sale transaction ultimately closes within the tail period, the seller still owes the broker a commission. This can potentially be the case even if the buyer was not secured or referred by the broker, and even if the seller has moved on and entered into a brokerage agreement with a new broker.
In some instances, a tail can be as long as 18 months. Even worse, conceivably a situation could arise where a seller is on the hook for two commissions – one to the first broker under the tail clause, and one to the second broker who actually closes the deal. This could be a devastating situation to the seller.
Pro Tip: From the seller's perspective, no tail (or a short tail) is much better than a long tail. Sellers should carefully review and negotiate the brokerage agreement, with special consideration given to any proposed tail provision.
3. How Is The Commission Calculated?
On what portion of the purchase price is the commission calculated? For instance, if the transaction purchase price includes a deferred component (such as an earnout or promissory note), is the commission based on (i) the maximum potential purchase price paid to seller, including the cash paid at closing plus an assumed full earnout and full payment under the promissory note, or (ii) the cash component paid at closing plus the deferred components which are actually ultimately paid; or (iii) solely the cash component paid at closing without factoring in any potential deferred components?
Obviously, from the seller's perspective, the smaller the base amount for commission calculation purposes, the better – as this will lead to a lower commission amount.
Another item for sellers to consider is that commissions are normally based on the gross sales price of the transaction, and not the net proceeds after seller's repayment of debt and other fees. If the commission is based on gross proceeds and there is a large debt payoff and/or other substantial transaction expenses due at closing, it's conceivable that a seller may have to come out-of-pocket to pay the broker's commission.
Accordingly, sellers must make sure they fully understand the manner in which the commission is calculated, and should seek to negotiate favorable terms before executing the brokerage agreement.
4.Timing Of The Commission Payment
What is the timing of the payment of the commission? If the commission is in fact based on both the cash portion of the purchase price paid at closing and the deferred component which is paid to the seller at a later date, is the full commission nonetheless due at closing, or can the portion of the commission which is based on the deferred component be paid on a deferred contingent basis, if and when the deferred portion of the purchase price is actually paid to the seller?
Each of the above items should be carefully considered and negotiated by sellers. Brokerage agreements are a material aspect of any brokered M&A transaction, and have significant financial consequences to the seller.
Using a qualified business attorney before executing a brokerage contract is a wise choice. The Law Office of Jennifer M. Settles represents parties in the negotiation of brokerage agreements. Contact Prime Legal today at (602) 617-3938, or through the Contact From on the website, for a FREE initial consultation.
Jennifer M. Settles, Esq. is a corporate lawyer at the Law Office of Jennifer M. Settles. She advises clients on M&A transactions, commercial contracts, real estate matters, financing transactions and corporate law. To schedule a free consultation with Jennifer, please call 602-617-3938, or email us through the Contact Form on our website, www.jsettleslaw.com.
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