If you are contemplating selling your technology company…well, while the economy is still hot, you will want to pay particular attention to how business brokers or M&A advisors calculate their fees for their services, because while they may seem similar on the surface, they vary considerably. There are many articles on broker fees, but this article is specifically focused on technology companies under $100M in revenue. Larger companies typically use an investment banker who may charge very different fees given the size of the transaction.
While writing Get Acquired for Millions, I researched the top 8 most active M&A advisors in the sub- $100M technology services industry in both the U.S. and Canada and was surprised to find a range of fees, different types of fees, and variations in how future payouts are handled. Understanding the different types of fees, the services you will receive and how future earn-outs are handled can vary greatly by broker, so it is important to understand. Let’s dive into each one.
Types of Fees
Fees to sell your company typically come in three forms: initial engagement/commitment fee, monthly retainer fees and success fees. They can work independent of one another or in combination, so you may see only one, or all three in an agreement. Here are the three most prevalent fees:
Engagement/Commitment Fee – This fee is typically a nonrefundable fee to get the process started and to make sure the seller has some skin in the game. This fee usually covers the costs of preparing your company profile and Confidential Information Memorandum (CIM). It also will cover the costs to market your firm.
This fee also begins the process of contacting potential buyers, either via personal contacts, email blasts or posting your profile on certain buyer websites and managing the buying process.
From the brokers we surveyed, this fee typically does not include an extensive review of your financial data for proper presentation or give much guidance for Adjusted EBITDA calculations. The broker/advisor will leave it up to you and your accountant to figure that out. To be cost effective, many advisors will mass distribute your company data to a prospective buyer list, since they are not being compensated for their time to hand pick your buyers. Of course, there are exceptions to this, but think about it…since there is no guarantee that you will find a suitable buyer or that you might walk from a deal at the 11th hour, they might never reap the success fee. And they have worked all this time for a small commitment fee.
Fees range from $10,000 – $25,000.
Monthly retainer – Many advisors charge a monthly fee that you pay during the entire engagement (until you’re sold). This is typically charged by advisors to more thoroughly prepare your company for sale, and determine value through a formal valuation process, in addition to creating the blind profile and CIM. Advisors who charge monthly retainers will also typically spend more time determining your company value and vetting your buyers, as they are being compensated along the way to find you the best possible buyer. This monthly retainer can also extend into post-sale transition items. Typically, but not always, advisors who charge a monthly fee, also stand-up and manage a due diligence site or virtual data-room for prospective buyers.
Fees range from $1,500 – $7,500 per month
Success fee – This is the fee that is earned upon the successful closing of a transaction. The success fee is independent of the monthly retainer or commitment fee although we have seen brokers that reduce their success fee by the upfront commitment fee or monthly retainer. This is usually negotiated and not the standard practice. Also, if you feel the project dragged on due to the advisor not finding an adequate number of prospective buyers, netting the monthly retainer or portion thereof against the success fee is an option, but make sure you negotiate that upfront in the agreement.
In addition to the stated success fee, most brokers (66%) * state a minimum success fee as well in their agreements. This is the fee that must be paid regardless of how little the company sells for. These fees typically range from $100K – $200K. It is important to note this when reviewing your engagement letter with your broker as it is possible your minimum success fee could result in a very high percentage of the total sale value if your company is smaller.
Fee range: 2% – 5%
Two brokers surveyed did have starting fee ranges as high as 7.5% – 8%, but as they say, “everything is negotiable”.
There is actually one more fee that you might see, but it was not used by any of the brokers we surveyed, and that is a break fee. A break fee is assessed when the seller elects not to proceed with an offer they receive from a buyer, assuming it meets the requirements of the seller. Meeting the sellers’ requirements is so open to interpretation that very few brokers assess this fee.
How the Success Fee is calculated.
Success fees can be calculated a number of ways. The first is a scaled percentage formula where a company valuation target is set and a base-level success fee for this valuation is agreed upon by the buyer and seller, but if the broker is able to sell it for more than they can earn successively higher fees. For example, an $8M sale of the company earns a 3% fee, but if the company sells for more than $9M, then the fee would jump to 3.5% (for the proceeds over $8M) and if the company sells for more than $10M it may top out at 4%. This fee structure gives the broker/advisor an incentive to find the buyer the absolute highest price (which may include a higher earnout); more on that shortly.
A simple percentage is just that; an agreed upon percentage regardless of value of the deal. While this is easy to calculate, it doesn’t incentivize the broker to find the highest price, but it does keep the broker focused more on the terms instead of the price. We typically see this method used when companies are under $5M in revenue and where EBITDA amounts can vary greatly.
Finally, the Lehman formula; which is where percentages start out high (say 5%) and then rachet down as the sales price increases. For example: The first $5M might be at 5% and the next $5M would be at 3% and the next at a lower percentage.
The majority of the advisors we polled either used a simple percentage or a scaled percentage formula. Per the 2018 – 2019 Divestopedia mid-market M&A Fee Guide, many advisors are moving away from the Lehman model and instead towards the scaled percentage module to more align with business owners to find the right deal and terms, vs. pushing the deal with the highest price.
Earn-outs and other future payments
Since 95% of the offers today in the lower mid-market (under $250M) contain some sort of earn-out which can consistent of as much as 25% – 45% of the purchase price, it is important to understand how it is treated. An earn-out is an amount that may be earned over time (typically 12- 36 months) given that certain performance metrics are achieved. An earn-out is never guaranteed, but typically 70+% of the time the earn-out is achieved. Other amounts associated with future payments such as holdbacks and seller financing, while received in the future, are not considered earn-outs since their likelihood of payment is much higher and they are not based on achieving performance metrics.
55%* of advisors surveyed in the Divestopedia study indicated that their success fee is paid in full on closing regardless of when the deferred amounts are received by the seller (earn-outs or otherwise). Ideally advisors would like to be paid in full at close, but not many sellers want to pay the advisor on amounts not yet earned, and which will not be earned if the performance metrics aren’t met. So, to keep both parties happy and aligned it may come down to negotiating a lesser fee on the earn-out.
For example: A seller receives a $6M offer which consists of $4M in cash and $1M in a note (payable in 12 months) and $1M in an earn-out to be earned over the next 18 months. The broker would receive their full commission (say 3%) on the $4M cash and $1M note, but maybe only 1% on the contingent amount for the final $1M. All would be paid at the time the transaction closes even though the note will be paid out in 1 year and the earn-out might be paid out after 12 months.
A final thought on fees
Any broker who is willing to work only for a success fee should be viewed with caution. Their reward only comes when your company is sold, and since they are not being paid to find you multiple buyers or offers, they will stop at the first offer that looks like it might work.
Don’t assume you are paying more in fees if your broker is charging you a monthly retainer. Typically deals of the size we have mentioned above take about 6 – 9 months to complete from the time you first engage with your advisor to the close – assuming no post-transaction engagement. Generally, advisors that include a monthly fee either charge a lower success fee or are willing to net it against the success fee on the back end. Run a sample calculation based upon a realistic sales price to help you make that decision.
Don’t choose your broker based solely upon who gives you the highest valuation price for your company. While each broker will give you the best assessment based on what they “see” in the market today, they may give you an optimistic number or mirror the one you are looking for, but once the ink dries on the engagement contract, any valuation number they gave you orally becomes irrelevant. If you want to commit your advisor to a number, then put it in the engagement letter and tie their success fee to achieving that valuation.
Beware of brokers that use the “spray and pray” approach. Meaning, your broker should be very selective in who they send out your Blind Profile or CIM to. Just because your broker professes to have a list of thousands of buyers, doesn’t mean they should be sending your profile to each and every one of them. First, a buyer may be masked as your competitor and secondly, you will likely be inundated with “shoppers” who either don’t have the capital, know nothing about your industry or aren’t that serious about making an acquisition.
Finally, check references and don’t just read the quotes from happy sellers on the advisor’s website. Afterall, these quotes are generated immediately after the sale, and who isn’t immediately happy when a massive amount of money shows up in your bank account. More importantly, ask for references of clients they weren’t able to sell. If they say they don’t have any, consider it a red flag as not every company is sellable and even the best advisors aren’t batting a thousand.
For more insights be sure to download the e-book: 100 Tips, Traps and Tactics for a Successful Sale
And look for the next post on how to choose a M&A Advisor.