Marketing Fees and Selling a Business
The curse of marketing fees became a sticking point in a discussion with a prospective client recently. He asked why he should pay marketing fees up front when I would be making money on the commission upon the sale of the business.
In the end, my answer didn’t resonate with him. Although he became a client, it may be on the strength of my referring partner rather than on the intrinsic worth that I provide but had failed to communicate.
It left me with a feeling of defeat and prompted me to look at marketing fees or agency costs in a different way.
A standard response to the question of why charge upfront marketing fees when selling your business would provide answers to what they cover.
Preparing a Business for Sale
These include the costs associated with preparing the business for sale and the marketing and advertising of the business. This must be done in a way that maintains the confidentiality of the business.
In addition, there is the cost of preparing an information memorandum. This is a document that outlines the selling points of the business including financial information, industry, staff and property information and a list of plant and equipment.
When all of this is prepared, it is time to embark on the process that takes the most work. Finding and talking to people who have an interest in the business. Getting a deal on paper and then getting it to completion.
This will involve dealing with many stakeholders besides the buyer and seller. It may include dealing with two accountants, a landlord and three solicitors. It may also include liaising with the provider of finance. It goes on.
Pay Now, Pay Later or Both
Although there is a long list of tasks a business broker will have to do to sell your business, this does not make it clear that they cannot be covered in the commission that is paid at the end and that an upfront marketing fee needs to be charged.
Current marketing leads us to believe that we can buy now and pay later. The real choice we face is whether we pay now or pay later. Paying now is generally cheaper.
Although the topic of buy now pay later is only tangentially related to this article. An example of the difficulties this approach can lead to has been written about extensively. An example of this is in the following article.”Devastating reality of buy now, pay later schemes: ‘Growing problem“.
There are three other reasons why a marketing or agency fee is payable upfront.
Finance and the Discount Rate
The first is a simple question of finance. A dollar amount paid to a broker, or to anyone for that matter, in the future, is worth less than the same dollar amount paid now. In technical terms, future payments are discounted to bring them to a present value.
Combine the length of time it takes to sell your business with the risk that the business may never sell, and you soon discover that the discount rate that would be applied to a commission that is required to compensate for this is quite high. Put more simply, you can’t charge enough commission to cover the risks without looking silly.
This is the same reason that an insurance company charges an excess. The higher the excess the lower the premium.
What needs to be considered is that a business is a very illiquid asset. They are also dynamic and require effort to keep up to date. Playing the role of market maker for such an asset places limits on how many businesses a broker can viably market.
Success is hard fought as a business broker. To pay a broker solely based on a success fee at the end of the client relationship takes the cost of that success outside the reach of the market for business broker services. An upfront fee for selling your business is an effective way of bringing them back to the market and making them affordable.
Cross Subsidies
Cross subsidies are another reason for charging marketing or agency fees upfront. This can be a more sophisticated argument to run but it is critical to the success of a business broker.
A business broker has a greater success rate when they have a greater number of businesses for sale. This is because if you attract a buyer to one of your businesses, there is a higher chance that they will come back and look at other businesses. It is the same with getting listings which are the lifeblood of business brokers. The greater the number of listings, the more listings the broker attracts.
This means that there is a free rider problem in that businesses that have not paid in support of the broker’s activities are taking advantage of those who have. This can quickly get out of hand and can lead to a broker listing businesses that should not be listed for sale.
An analogy that can help make sense of this would be to take a trip to the supermarket. If you want to buy a can of sardines, you will be confronted with a host of different brands. You, the customer, will choose one of those. Is it fair that the brand that is chosen pays the marketing fees for the ones that are not? I think not.
That is precisely what would happen in the business sales process if upfront fees were not charged. A business operating on that basis would not survive and a customer counting on it would not get satisfaction.
Skin In the Game
A final reason for upfront fees for selling your business that I will discuss here is that the relationship between the seller and the broker is critical to success. The degree of investment by the broker to the success of the sale is quite high. If no sale occurs there is no income for the broker. On the other hand, the seller keeps operating the business without loss.
When I was a young business broker starting out, I would occasionally take a listing without an upfront fee. The other thing I would do occasionally is take an open listing. I learned my lesson fast. It did not embitter me. But it came close. If you are willing to work for someone without payment or guarantee of some sort, you have entered the world of serfdom. This is a world best avoided.
If a broker brings an offer to a seller, there is no guarantee that they will accept it. You do want to know that they will at least consider it. You don’t want to find out that they are simply using you to see if they can win the lotto in the hope that the broker will find them a wood duck.
If the seller has no skin in the game by having paid something up front and being in an exclusive arrangement, the broker is on a beating to nothing. A lame gazelle on the Serengeti comes to mind. It pays to remember that the participants in business sales are assumed to be sophisticated players. The protections that apply to retail leases or home buyers do not apply in this world. Don’t get eaten is a good rule to live by.
Increased Chance of Success
Basically, the reason for charging an agency fee or marketing upfront is to increase the odds in favour of success.
To get the balance in business sales right takes a lot of factors coming together. This includes how the relationship between a seller and a broker is structured. Success flows from finding success in establishing that important initial relationship. How you pay someone will determine what they do for you, so it pays to get that right.
If you like reading my articles, you may like the one I have written about preparing your business for sale. It’s called “How to sell your business in three easy steps“.
