Small Business Owner Pays Business Broker Almost $100,000

Podcast Interview Screenshot

We’ve written about business brokers before, and how easy it is to be tricked into the common belief that they add more value than they cost.  A recent interview on the Mixergy podcast provided a classic example of this, with a business owner who was clearly intelligent and capable, yet was tricked into believing that the best way to sell his business was to use a broker.

The story provides a great insight into how business brokers work, how much they charge, and what can happen when you use them.  The example is even more powerful because the broker’s fee was at the extreme upper end of the range, and because it shows how people can become entirely convinced of the necessity of a broker, despite all of the evidence to the contrary.

This is the story of David Rogenmoser, and how he sold his company, PayFunnels.  The interview is largely about Rogenmoser’s new company, Proof.  But the fascinating part – and the topic of this short post – is the story of selling PayFunnels through a business broker.

Rogenmoser explains that he had thought about selling the business (a software-as-a-service or SAAS business) himself, but wasn’t confident that he knew what he was doing – in particular that the valuation would be incorrect. 

 

“I was just thinking if I go into this alone, either I’m going to get hosed, or the buyer is going to get hosed, and I don’t know which one that’s going to be until down the road, and I didn’t want to mess anything up. And so I decided to go hire a company that had done it before to kind of walk me through the whole process.”

 

First of all, this is crazy.  Learning how to value your business is not that hard.  For someone who has built a successful business, it will not even be in the top 100 most difficult things they’ve had to learn.  And in this case, a SAAS business, there are established metrics already: industry rules of thumb indicating what SAAS businesses typically sell for, at different sizes and growth rates.  There is a relatively liquid market for software companies (compared to other industries), and the data is even more readily available.  A quick search provides data here, here and here for example.  Even the broker he eventually chose has a guide to the valuation of SAAS companies on its own website.  With a little research Mr Rogenmoser would have developed a good understanding of how to value his business and he would have determined an accurate valuation.  There was absolutely no reason to use a broker just for this purpose.

Furthermore, “or the buyer is going to get hosed…”  Seriously?  Buyers are not stupid and do not pay more for businesses than they are worth.  The only risk here was that he would lose, not the buyer.

In any case, he Googles and finds a broker, FE International, who agrees to handle the sale for a fee of 20% of the sale price.  20%!  This is for a sale price of “mid to a little below mid six figures”, so $500,000 or just below.  In the UK a fee of 5% is typical at this level, and even this is an unnecessary expense in most cases.  In the US the broker’s commission is typically closer to an eye-watering 10% for businesses of this size.  But 20% is extreme.

The interviewer, Andrew Warner, asks him if he thinks it was worth paying this price instead of listing the business on Flippa, a self-service marketplace for selling website businesses which charges 12% commission.  (Note: for a business of this size we would never recommend paying 12% commission to a self-service website – there are better ways to find buyers, without the commission).  But Warner has a point that Flippa’s 12% fee is, at least, better than the 20% he paid to FE International.  Rogenmoser admits that he didn’t really even look into the competition very much.  He just found this broker and decided to go with them.

It’s hard to blame him for this.  Business owners are incredibly busy people.  And this particular broker has carved out a strong niche in the SAAS space, dominating Google listings for search terms in this field, so it is no surprise that he found them and chose them.  Sure, he should have searched harder and considered more options.  In fact, he shouldn’t have used a broker at all.  But given how much we hear about brokers in the media, and how they have positioned themselves as the default choice for business owners, it is understandable that so many people believe their marketing and hire them.

Mr Rogenmoser goes on to explain that he was hesitant about selling the business, but the broker helped him to decide to go through with it.

(Before even reading the next part of the transcript, think about this: a commission-only broker is always going to try to convince you to sell.  Like a real estate agent, they get paid on the deal closing, and they just want it to close.  They don’t want to get the best price, they just want to sell it.  So they put a lot of their effort into convincing the seller to accept a deal, rather than looking for the best deal.  The mathematics of their incentives were well captured in the book Freakonomics by Stephen Dubner and Stephen Levitt – explained by the authors in the quick 3 minute video below.  Commission-only business brokers are similar to real estate agents: their incentives are simply not aligned with their clients, when it comes to getting the best price.  They are incentivised to make sure the deal goes through quickly.  Getting a better price for their client is usually not worth the extra work for the broker personally.)

So the business owner explains how he was hesitant, for good reason:

 

“Yeah, I mean, I pulled out once actually. So we had listed it at a certain price. We were about to get done. I had interested buyers, and I looked at it, and we’d grown significantly in about two or three months the first value of the company. And I was like, ‘It’s worth a lot more. It’s worth 30% more now than we listed it at. We need to pull this thing off. Like this is the wrong price.’ So I pulled it off against their desires, and we ended up relisting it again. And finally got a couple people that were back interested in (it). We kind of went through the due diligence. And on the last day, I mean this is like a five month process, because we’d pulled out once. Finally on the last day I call them to pull out again. And I promise I’m not like that sketchy of a guy here, but it’s just like an emotional decision. You’re selling your business, the most money you’ve ever got in your life. You’re like, ‘This could be worth way more later on.’ I’m like the optimist. And so I call him, and I’m like, ‘Hey, I think we’re just going to go ahead and pass on this, actually. I’m really sorry for the whole hassle. We don’t mean that at all. I think it’s what need to do.’”

 

Before we go on, think about this.  The business was listed, by the broker, at a price that was too low.  Who noticed this?  Did the broker alert him to it?  No, the owner had to recognise this fact himself.  The broker wasn’t “supporting him through the process” at all.  If it wasn’t for the owner looking into this, he would have sold at this very low price.

So when the owner brought up this issue with the broker, did they apologise for not realising their mistake, and say “Yes, you’re right”?  No, they still wanted to sell it at this price!  Rogenmoser says that taking it off the market was done against the desires of the brokers. 

Thankfully he did it anyway, because when he listed the business again at the higher price, he found buyers again.  The previous price would have been a huge bargain for the buyer, and a loss of value for the seller.

In any case, after listing it again at the higher price and finding more buyers, he was again having second thoughts about selling. He believed the business could be worth a lot more in future.  So he rang his broker to tell him that he was going to keep the business.

His broker put him through to his boss, the head of the business brokerage firm, who gave him this advice:

 

“He goes, ‘Listen, I don’t really care whether you sell it or not. This is not a huge piece of our revenue, but I would sell, brother. I would sell. You’re going to have a bad name in the SAAS space. If you like pull out again, it’s going to look bad on us. And I just think you’ve got a really big opportunity here to go focus and use the cash and put it all towards Proof (Mr Rogenmoser’s new venture).’ And at the end of the call I went in thinking I was going to totally pull out, and I left saying, ‘Sell it. Let’s do it.’ And that was a great decision. I’m really thankful for his advice there.”

 

Surprise, surprise, the broker convinces him to sell.  To do that, he suggests that if he doesn’t sell, his reputation will be damaged!

So after taking this advice, Mr Rogenmoser sold.  And not only that, he was so convinced by the broker, seemingly spellbound, that he thanked the broker for the advice (in addition to paying him almost $100,000).

We can never tell if selling the business was the right thing to do – maybe his instincts were right, and he would have made more money by keeping the business for longer (he was right the first time).  Or maybe selling was the right move. 

But we can tell four things:

  1. Mr Rogenmoser decided to use a business broker because he was worried he would get the valuation wrong – and then the business broker promptly got the valuation wrong
  2. Mr Rogenmoser wanted the broker to manage the process, but he had to manage a lot of the process himself, including critical decisions around pricing and whether or not to sell at all.  Further on in the interview he talks about how he was having Skype meetings with the potential buyers of the business – this is normal, because it is the owner of the business who actually does the work of explaining the business to the buyers – brokers never do this.  So he ended up doing most of the work himself, as is always the case
  3. As expected, the interview suggests that the commission-only broker was more interested in selling for any price, than selling for the best price.  If he had taken the broker’s advice in the first instance he would have sold for much less than the business was worth.  He had to intervene himself to stop this.  And in the end, we still don’t know if the price he sold for was too low
  4. He paid a fortune (almost $100,000) to the business broker for this privilege

If you are selling your business and you would prefer to avoid an experience like this, we would recommend not using a business broker.  This particular broker has a very good reputation: it is not like they are unusually adversarial.  And nothing they did was dishonest – it is just the nature of the industry and the way their incentives work.  This example, while being extreme in terms of the broker’s fees, is quite typical in most other ways.

We recommend that small business owners manage this process themselves, not only to avoid the brokers’ fees (which is reason enough), but in order to achieve the best sale price and terms.

As this example shows, hiring a business broker can easily result in a lower sale price, especially if the process is simply handed over to them without the owner managing the process every step of the way.  And if the owner is going to be required to manage the entire process, including managing the broker, what value is the broker adding?