The challenges of the Business Broker industry in Louisiana are a lack of communication among business brokers and a lack of communication with the public. The Business Broker industry in Louisiana is in need of an association.
NEW ORLEANS, LOUISIANA August 20, 2019--Most business brokers do not communicate about the terms of their listing agreements because it is illegal for them to conspire to set terms that are anti-competitive. However, there is almost no way around communicating illegally about listing agreement terms. Almost everything communicated can easily qualify as an illegal action according to this Federal Anti-Trust Law.
However, the issue may not be too much communication but, rather, the lack of communication about business brokering both with the public and with business brokers. With more than 55% of business buyers being first-time buyers "buying a job" (according to the International Business Broker's Association or "IBBA"), it's understandable why they come with certain expectations (usually expectations that business brokers act similarly to residential Realtors). This lack of communication is further exacerbated by the fact that there are several different types of business brokers and even more associations and regulatory agencies overseeing each. Among business brokers, we have
- Business “consultants” without a real estate license, securities license, or certification
- Business brokers with a real estate license who may or may not also be Realtors
- Business brokers with professional certifications and designations from associations
- Business brokers with other industry-related certifications like CPA’s
- Business brokers with a securities license (or without one but doing exempt actions)
- Business brokers with one or more combinations of the above
Russell Bernstein is a new business broker competing and making a name for himself amongst some of the most well-known and well-established business brokers. It’s almost like Russell is a baby in a sandbox; new to the world and finding his way. Alternatively, his competitors are like toddlers; in the world longer, well-adjusted, and set in their ways.
The successful actions that Russell has taken upon his entrance into the world of brokering businesses is like a baby throwing sand at all the other toddlers in a sand pit. Currently, he is the only Certified Business Intermediary (“CBI”) within 50 miles, and he was recently awarded the Rising Star Award from the Commercial Investment Division of the New Orleans Metropolitan Association of REALTORS. Russell’s actions have erupted chaos and tension in the local New Orleans business brokering field. But, this is the opposite of what he is setting out to do.
Russell wants to bridge the gap between new and experienced business brokers. He wants to help spearhead the foundation of the first Louisiana Association of Business Intermediaries with one of many mandates being to help the public and business brokers coordinate compliance with both the Louisiana Real Estate Commission and the Louisiana Office of Financial Institutions as well as their chosen business broker or other professional associations.
To make this happen, people like Russell who aspire to eliminate this divide need to take action. In order for this to be a success, the Louisiana Business Broker Industry needs a strong foundation. In order to establish that foundation locally, the differences between new business brokers and experienced ones needs to be recognized in order to find common ground and equality amongst all business brokers.
Finding common ground does not mean conspiring to use the same terms as others do in a listing agreement. That would be illegal.
Nonetheless, understanding why “some” business brokers use various terms can help one understand why the Business Broker market, without some form of communication, does not or cannot act independently and competitively with each other, with customers and clients, with referral partners, and with similarly-acting professionals (mostly, Realtors). However, for the sake of compliance with Federal Anti-Trust Laws in this article, especially as it refers to the number of business brokers acting in a certain way, it is first important to clarify that “some” neither means “most” nor “less than average” while also possibly meaning either “most” or “less than average”.
Russell is a newer business broker and is, therefore, working his way up in the industry. He needs to set a commission rate that is both reasonable yet competitive, which is why 8% for businesses under $1,000,000 in value is ideal for him today. However, Russell may increase his commission as he begins to take on more clients. “Some” business brokers in the Business Broker Industry charge commissions of 10%. The industry elite or other business brokers in unique situations could charge as much as 12% or higher depending on the circumstances.
There are also other methods of charging commission, especially for larger transactions. One method is referred to as "The Lehman Scale" with commission amounts like 5%, 4%, 3%, 2%, and 1% being charged on different segments of the total intended sale. There is also a "Double Lehman" going from 10% to 2% and a "Reverse Lehman" going from 1% to 5%. Sometimes business brokers will simplify the structure using fewer segments, such as 10% on a first amount then 15% on anything above that amount, depending on the motivations of the seller and broker and how the seller wants the broker to be motivated to sell.
It is easy to recognize why the elite business brokers have a consistent and steady client base and, therefore, have the flexibility to demand higher rates and take on listings for much less commission in order to limit the ability of newcomers to enter the market. However, for those unwilling to lower their rates, setting higher rates is also understandable in terms of taking on additional risk.
The more successful business brokers are naturally exposed to more risk by having more clients and by having more success, which results in more money to pursue. And, even though business brokers should use disclaimers and agreements holding them harmless from giving opinions on information provided to them upon which they do not perform due diligence, they still get sued. Even though it rarely occurs, “the #1 reason why business brokers get sued is because of the valuation”, according to AON Insurance, an Error & Omissions Insurance provider to the Business Broker industry.
On the opposite end of the spectrum, "some" Commercial Realtors (who usually focus just on the real estate and not also on the business that may operate within the real estate) do not take business listings. Yet, "some" do get involved in business transactions because the public is often confused by the services they offer and because they are often willing to take the risk of violating Article 11 of the National Association of REALTORS, which effectively discourages Realtors from doing things they are not experienced or trained to do.
Despite that risk, "some" Commercial Realtors charge less commission than business brokers. This is mostly because there are many more Commercial Realtors (about 250 in New Orleans) and even more residential Realtors (6500 in New Orleans) than business brokers (maybe 20 in New Orleans). A lower commission for the service of a Commercial Realtor may also be because it is what their clients have come to expect. A Commercial Realtor also further expects to split that with a participating Realtor also willing to take on similar risk.
However, transactions that aren’t priced right or that don’t have enough information to survive due diligence typically stay on the market so long that the business fails before a sale can occur. According to the IBBA, “the #1 reason why only 2 of 5 businesses sell is because they are overpriced”, and the #2 reason is because sellers are often slow at collecting and providing quality information requested by buyers before buyers find opportunities that have sufficient information and a low enough price to finalize a purchase elsewhere.
Due to the complexities of business sales and there being very few of them, most business brokers are able to represent both sides of the transaction (hence the nomenclature recently changing from "broker" to "intermediary"). This also increases the risk and thus justifies the demand for and ability to charge a higher commission and or more favorable terms.
"Some" refuse to work with other business brokers, and "some" do not even make their listings public and instead utilize a “walled-garden” listing approach by making their listings accessible only to those who pay a subscription fee or only to those who are uniquely qualified (usually "accredited" or "sophisticated") to gain access to view those deals. It’s not certain whether this is anti-competitive due to the extreme complexities involved in business transactions and how important information is as well as how information is regulated by various authorities assigned to regulate certain types of transactions.
Commission varies among business brokers also in the way that it is qualitatively dependent upon a variety of different listing agreement terms offered. While it is important to understand why certain commission rates are set, there are also many different listing agreement terms to further protect the risk that business brokers absorb in the course of facilitating the operation of their own business of selling businesses.
Although not pre-printed, Russell typically does a 12 month agreement with month-to-month automatic renewals thereafter; occasionally his agreements warrant up to 2-5 years; but all have no fee for early cancellation. "Some" business brokers, however, do have pre-printed minimum terms of 24 months with 24 month renewal clauses with early cancellations requiring commission. Surprisingly, the issue here is not necessarily the terms but the fact that they are pre-printed and not fill-in-the-blank. Pre-printed statements give the misleading impression of a “standard” or a “non-negotiable”, and this is a violation of Federal Anti-Trust Law.
Revisiting the terms (pre-printed or not), when comparing the duration of listing agreements of business sales to those of residential sales, it’s understandable why business brokers use 24 month listing agreements. First of all, whereas houses typically take 90 days to sell, businesses take 230 days to sell. And, beyond that time, while it’s just a matter of time and price to sell a house, a business is a source of income dependent upon the lifespan of the owner or of the customer, which is much more easily impacted by external forces. Further, finding a new home is relatively easy in comparison, but finding a new source of income when all you know is one type of income is difficult to let go of and easier to hold on to for another year or so.
Commission being required in the event of listing agreement cancellations also has valid reasons despite seemingly being a “customer-service no-no”. As stated earlier, only 2 of 5 businesses sell. However, failure is not always a reason for a business not selling.
Regardless of the reason, listing and marketing a business for a couple years is much more expensive in terms of potential time lost to a business broker in comparison to the potential loss faced by residential Realtors listing a house unsuccessfully for a couple of months. Plus, the reasons for a business not being able to sell are endless and beyond the scope of this particular article.
Valuation fees also vary in the Business Broker Industry. On the low end, "some" business brokers charge $0 with courtesy "back of the napkin” analysis. Russell charges $1,500 for his valuation. "Some" business brokers try to align themselves with the valuation fee schedules of Appraisers, CPA’s, CVA’s, CFA’s, and RIA’s by charging $3,500 to $7,500. However, unless a business broker is also one of those professionals, business broker valuations do not hold up to IRS scrutiny, court standards, or SBA lending guidelines (for businesses valued over $250,000)
Fees are also charged for “Confidential Business Reviews” (“CBR”) or “Confidential Business Memorandums”. The CBR is a document with a lot of quantitative and qualitative information about the finances and operations of a business. Buyers need to review CBR’s before reaching the due diligence phase of verifying this information.
Russell, for his CBR fee, charges $3,500. "Some" business brokers also charge this. However, a core difference is that most business brokers may make a CBR about 20 pages long, and Russell usually has a few versions of the CBR with the longest typically being 80-120 pages long for those who continue to ask for more information.
Even though Russell creates a thorough, unique, and comprehensive CBR, there have been buyers, in the course of negotiations, who thought it was important to say that they didn’t even read the CBR. Granted, many buyers only focus on certain parts, which is why brokers keep it at about 20 pages. But, Russell is a new business broker still establishing trust and an established client base which contributes to being more thorough, making sure nothing is left out.
Business brokers who have been in the industry for a while already have built a strong bond with clients, so creating a shorter CBR is something they can do. Short, quick, and to-the-point may seem great at face value, but being more comprehensive is worth it in the long run. After all, the insurance used by business brokers is called “Errors & Ommissions” Insurance, not “Errors” Insurance.
Russell still believes in being more comprehensive because he believes in disclosing as much pertinent information as possible, and you never know what you'll find until you analyze it. "Sometimes you discover very interesting aspects of value that cannot otherwise be communicated without a deeper analysis," says Russell.
However, on the other hand, doing this much analysis prevents Russell from gaining and closing more deals, which is what the other business brokers are accomplishing. Luckily, Russell is an adaptable and open-minded business broker who considers changing when he gets more deals and can no longer sustain a maximum level of comprehensiveness.
FEES AND COMMISSION
Russell charges both valuation and CBR fees and credits them toward commission while others charge fees in addition to commission. In fact, those with a securities license or other certifications may be required to charge separately. While this is a requirement for securities transactions, "some" business brokers do not have a securities license nor are they Registered Investment Advisors.
Russell’s fee doesn't vary based on project size because he's a Realtor, which limits his ability to do so as per article 14-2 for the National Association of REALTORS. To Russell’s advantage, "some" business brokers are not also Realtors, and "some" are not even real estate agents, so they can charge what they want because they don't subscribe to the same code of ethics.
LIMITATIONS OF REPRESENTATION
Russell is mindful of the fact that listing agreements also include limits of representation. It is important to note that business brokers without a real estate license can’t help with the lease or sale of the building of the business. In fact, "some" business broker’s listing agreements state that, if a business is sold, the client is still responsible for the transfer of the lease or sale of the building. Yet, because it is common amongst most business buyers to want the location with the sale of the business, this tiny term can have a drastic impact on the impression that the public has about business brokers, especially when a seller of a business is left with the remaining term of a lease.
Another important aspect to consider when entering a listing agreement with a business broker is the minimum fee charged. The fee is a good indicator of how reasonable and flexible a business broker is.
Russell’s minimum fee is $5,000 (including a $1,500 valuation and a $3,500 CBR), but "some" business broker’s minimum fee is $10,000 to $20,000, regardless of whether the business sells or not and usually not including a valuation and CBR. "Some" have even been known to charge as much $75,000 upfront before any business sale occurs.
A minimum fee is understandable, especially in business sales. As stated earlier, businesses take longer to sell and most don't sell. However, a topic that hasn't yet been mentioned but that is still a valid reason for charging a minimum fee is the fact that some business owners never intend to sell. In fact, some business owners list a business for sale merely to collect information to improve business operations and use the business broker to get a service similar to what a consultant might give but then try to justify not paying for that advice through the business broker's inability to sell the business (because the seller never accepts any offer). Finally, there are even business owners who attempt to circumvent the business broker commission and try to negotiate a unique deal with the buyer at the end of the transaction, and then the terms of a business broker's listing agreement or even the law may provide loopholes for a buyer and seller to legitimately cut out a business broker from the deal.
OTHER COMMON TOPICS
There is a wide variety of other topics not fully addressed in this article that may or may not have equal or more challenges associated with coordinating a better environment for the public and for business brokers to interact and compete with each other. There are also issues with representing buyers and referral fees.
Russell is aware that with the onset of online purchases occurring with companies like Airbnb and Zillow is disrupting the residential real estate Realtor industry. At some point, residential Realtors will begin flooding the Commercial Realtor market, which will force Commercial Realtors to then flood the Business Broker market. It is in the best interest of Business Brokers to prepare for this occurrence by participating with residential and Commercial Realtors on a referral basis so they can withstand the flood or else non-Realtors will be decimated by an oversaturation of the Business Broker market, not to mention by individuals who are far better at relationship development and marketing than most Business Brokers are today.
With all that being said, it is important - now more than ever - for Business Brokers to unite and create an established foundation for those currently in the industry to compete with these effects.
Russell knows that listing agreements are only one topic that sheds light on unstructured unregulated aspects of an industry that allows for so much variability. There is no set standard which only overwhelms and confuses the client on if they are being treated fairly or being overcharged. It doesn't have to be this way.
Russell wants to bring other Business Brokers together in the first Business Broker Association for the State of Louisiana to help administer and coordinate possible standards. Not standards of terms or commission rates, but standards of professionalism and a better system of education for both the public and business brokers about business brokering.
By taking action, the Louisiana Business Broker Industry can slowly bridge the gap between different types of business brokers and create a unified and cohesive industry with a level playing field designed to also make it fair for the public. This will only strengthen the Business Broker Industry and enhance the ability for business brokers to gain new clients and earn long lasting bonds and trust with the public.
For more information or if you are another Commercial REALTOR with an idea for a press release, reach out to:
Public Relations Intern