Fee Scandal: Business Brokers & Corporate Finance
Summary: It has long been suspected that many intermediaries handling the sale of businesses make most of their money from the retainers they charge, not from actually selling their clients' businesses. The UK's largest broker is a certain corporate finance firm that is now listed on AIM. That's interesting because as a listed company their Annual Report is publicly available and their latest report, just published, shows that 60% of their revenue comes from retainers. They sell fewer than 10% of the businesses on their books! There are many firms with even worse stats.
Note: This article isn't about business transfer agents and business brokers at the bottom end of the market - the no-sale-no-fee type brokers. They already have a terrible reputation as exposed in the Mirror and elsewhere. This is about other big names in the industry - corporate finance firms, M&A advisories and so on.
Introduction to fees in the industry
Barring some low end bucket shops, most business brokers and corporate finance firms taking on business disposal mandates charge a retainer at the time of signing the client on and then a "success fee" when the client's business is sold - a split between a non-contingent element and a contingent one.
The retainer tends to be a fixed amount and the success fee is usually a percentage of the value at which the sale occurs. Retainers tend to be anywhere from a few thousand pounds for smaller businesses to £50K or more for lower mid market businesses (businesses with turnover of £2m - £50m).
Fees and fee structures can get complicated - there are sometimes milestone payments, and ratchets, but more on fees here. The vast majority of the 1000+ firms in the UK follow the Retainer (non-contingent) + Success Fee (contingent) model.
But why even pay a retainer?
Intermediaries justify charging retainers as there is a lot of early stage work to be done to prepare a business for sale - normalising of accounts, creation of an Information Memorandum, taking the business through a dummy due diligence exercise etc. Then there's the expense of marketing and fielding of questions from prospective buyers, not to mention vetting each buyer.
If the intermediary invests considerable work, they're adding value to the business. Should the business owner subsequently change his mind about selling, the intermediary has no chance of earning any compensation for the time he spent on the job.
Intermediaries insist that the retainer only part covers the cost of all the early stage work, and it keeps the vendor motivated enough to stay the course.
Which sounds fair enough.
How do you know whether you're getting good value?
Business owners often worry about whether the retainer is good value. Who's to say whether the broker's promises, optimistic outlook on probability of sale, and the value at which they claim they can sell the business, aren't completely fictional and driven solely by their desire to get their hands on the nice, large retainer?
That's a valid concern. There are some brokers who spend much time, energy and money chasing new clients and are willing to say anything to get the client to sign on the dotted line. They regularly make bold claims about how successful they are with selling businesses. But the client has no way of verifying those claims.
The client simply has to trust them. £50K is a small fortune with which to be trusting someone though!
Business owners are right to be cautious.
The true picture
Business owners have no way of validating any broker's claim on either the percentage of client businesses they've sold - and they often make claims that they are successful in +80% of cases - nor any way of verifying the broker's claim on the average multiples he's able to achieve (not that averages are a good metric to be going on anyway).
So the broker with the best sales pitch, the most convincing patter, ends up winning the client despite the fact that they may, in reality, be utterly useless at actually selling businesses.
Because of our unique position in the ecosystem we get to hear hundreds of complaints from business owners who attempted to sell through broker X or broker Y and who, even after a year or two, didn't get any serious buyer enquiries despite the £30K - £50K retainer.
There are some names that we come across a lot more than others and these are some of the most common names in the industry, some of the largest intermediary firms in the UK. A non-profit organisation called CEBTA keeps track of complaints at the lower end of the market (brokers selling sub £1m t/o businesses).
The top intermediary in the UK, in terms of sheer size / volume of business done, happens to be a listed company. This is interesting because as with all listed companies they need to disclose a lot of information to the market. Their latest annual report is very revealing and is one we've analysed here.
60% of their revenue comes from retainers and it appears they sell fewer than 10% of the businesses they take on!
This is not uncommon in this industry. In fact, there are several other firms where the figures are not public but we worked out a way to estimate their real success rates and discovered that many sell fewer than 5% of the businesses they sign up as clients.
The good news
The UK has a well deserved reputation for expertise and talent in various financial services. When it comes to strategic planning / M&A / business disposals we have some of the world's best talent.
But one takeaway: That talent won't cold call to say they've got lots of eager and well funded buyers looking for businesses just like yours. And if business owners approach the best intermediaries directly, they are likely to get turned down, partly because the top intermediaries tend to be running to capacity and partly because they prefer to have clients referred to them through accountants and other professional advisers who don't need EBITDA or DCF explained to them.
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After doing an undergrad degree in accounting (India) and reading for an MBA in finance (USA) - in addition to taking professional exams in Cost & Works accounting and in Banking - I decided that this is all too complicated. So I spent 35 years buying and selling small businesses, and running them.
My full time occupation now is...