Factors To Consider Before Signing a Broker Listing Agreement

A small business owner has many factors to consider when selling their business. One important factor is whether or not to hire a business broker to assist in the sale. An experienced broker can provide significant value to a business owner. However, business owners should pay special attention to several parts of the business listing agreement before signing it.

This article discusses the factors a small business owner may consider before signing a broker listing agreement. It describes business brokers and the value they can provide to buyers and sellers before examining the broker listing agreement, including specific terms and clauses to consider.

Business Brokers Explained

Business brokers assist business owners in buying or selling businesses. Think of them like real estate agents for businesses.

An experienced business broker understands the ins and outs of purchasing or selling businesses. They can help with the proper paperwork and most other requirements, such as licensing. All this can lead to a higher selling price or a lower purchase price for their clients.

For sellers, the advantages of working with a business broker include the following:

• Networking: Professional brokers often have an extensive network of contacts, including potential qualified buyers. They can market your business to their network. A broker may also have access to exclusive listing websites, expanding the pool of potential buyers.
• Experience: Experienced brokers have helped business owners buy or sell many businesses. Some brokers have sold their own businesses, so they know the technical and personal aspects of selling a business. Brokers also have continuing education responsibilities, which keep them on top of the latest industry developments and trends.
• Less on the business owner's plate: Most small business owners still have to run their business while they try to sell it. A broker helps lighten the load by handling the marketing, business valuation, sales process, and more.
• Confidentiality: Brokers and business owners typically sign non-disclosure agreements (NDA) and confidentiality agreements as part of the listing agreement. As part of the sale, the seller will have to give confidential information to the broker, and the broker promises to keep that information private. When the broker identifies a potential buyer, they'll execute an NDA and confidentiality agreement with the potential buyer before discussing specific business information.
• Vetting buyers: Brokers also vet potential buyers to ensure they can afford the purchase price or secure necessary loans.

Some of the above-listed benefits also apply to buyers. Another advantage to buyers is the broker's ability to secure financing, such as a small business loan. Buyers may find FindLaw's Due Diligence Checklist regarding buying a business helpful as they prepare to purchase an existing company.

Broker Listing Agreement Basics

When a small business owner and a broker decide to work together, they enter into a broker listing agreement, also called a client engagement agreement. The listing agreement is a contract between the business owner(s) and the broker. In it, the business owner or prospective buyer is the principal. The broker is the principal's agent.

The listing agreement sets out the owners' and brokers' various agreements and obligations. While the entire agreement is important, it is critical the parties understand and clarify the following:

• The listing agreement's duration
• Whether the agreement has a “tail"
• The broker's commission and any upfront fees
• How and under what circumstances the parties may terminate the listing agreement

This section describes these provisions in detail, along with several other considerations.

Listing Agreement Duration and Fee Tails

An essential part of any contract is its duration. The business owner and broker must discuss and confirm the listing agreement's duration before agreeing to the contract.

The agreement's duration affects other critical contractual provisions. For example, suppose a small business owner and a broker enter into a one-year listing agreement. During that period, the broker introduces several qualified potential buyers to the small business owner. For one reason or another, the small business owner and broker fail to sell the business. After one year, the broker has not yet found a buyer, and the listing agreement expires.

After the contract expires, the small business owner reaches out to one of the qualified potential buyers the broker introduced to them. One month after the contract expires, the small business owner agrees to sell their business to the buyer. They close the deal shortly thereafter.

Done deal, right? Not quite. Most listing agreements contain a provision called a “tail." If the listing agreement contains a tail, the broker can collect a commission fee if the business owner sells the business within a certain period after the agreement expires.

Often, the broker may only collect the fee if the business owner sold the business to someone the broker introduced to them. This prevents business owners from slow-playing a sale to avoid paying a broker the commission they earned.

Both parties should discuss and agree to the listing agreement's duration and tail, if any. Regarding the tail, the parties should determine how long the tail lasts and what exactly an introduction means. Does an introduction mean the broker gave the business owner a potential buyer's contact information? Does it mean setting up a formal meeting or negotiation about a sale?  

The definition or understanding of the tail's length and an introduction could mean a difference of thousands of dollars for both the broker and the business owner. Therefore, an agreement between the parties before entering into the listing agreement is essential.

Broker Commissions and Retainer Fees

As you might expect, brokers do not work for free. A zealous broker can provide significant value to prospective buyers and sellers, often reflected in the final sale price.

Most brokers work on a commission basis. This means they earn a percentage of the business's final sale price as payment, also called a “success fee." Brokers' commissions vary for small business sales and may range from six to 20 percent of the final sale price.

Some brokers use a tiered commission rate for larger business purchases or sales. For example, they may take 10 percent of the first $1 million, eight percent of the second $1 million, six percent of the third $1 million, etc.

Another important aspect of a broker's commission is its basis. It's common for brokers to base their commission on the final sale price, but some brokers base their commission on the transaction's total value.

The transaction's total value may include, for example, the business's accounts receivable or the buyer's assumption of the seller's debt. It may include the total value of the property and real estate sold. Agreeing to the specific commission basis is critical for the parties before entering into a listing agreement.

Some brokers also require a retainer fee. For example, a broker may request a lump sum of $15,000 before they do any work. This may go towards advertising, networking, or other services. Some brokers may reduce their sales commission by the retainer fee amount, while others may not.

Other brokers may not require a retainer fee but instead charge progress payments. The parties may negotiate the specific progress payments. In general, the parties agree to certain milestones in the sales process. Each time the broker achieves a milestone, the seller must pay them an agreed-upon fee.

The parties may negotiate the broker's commission, retainer, progress payments, and whether to reduce any commission by the retainer amount. The parties may negotiate these fees and memorialize them in the listing agreement.

Terminating the Listing Agreement

Another important aspect of the listing agreement involves how parties may terminate the agreement. The parties may negotiate the termination conditions.

For example, the parties may agree that either the broker or the business owner may terminate the listing agreement by giving notice within a certain period (e.g., 60 days notice).

Some brokers may require terms that carry a financial penalty if the business owner terminates the contract early. Therefore, the parties must understand and agree to the termination rules and consequences.

Other Terms and Considerations

Listing agreements contain several other provisions that business owners should consider. These considerations, while important, are straightforward. They include the following:

• Exclusivity: Most brokers require an exclusivity clause in the listing agreement. A business owner who agrees to the clause guarantees the broker the exclusive right to try to sell the business. In other words, the business owner can only hire one broker at a time to try and sell the business.
• Indemnification: Most listing agreements will contain a clause that holds the broker harmless for certain things that may happen. For example, the clause may state the seller agrees to hold the broker harmless for any lawsuits that arise out of the sales process.
• Broker obligations: The listing agreement should contain a section listing the broker's various obligations. It states that the broker will try their best to sell the business. Parties may place the exclusivity clause within the obligations.
• List price: The listing agreement may state the selling price the broker will initially advertise to qualified buyers. The list price does not mean the business will sell for that price, but it binds the broker about initial offers.
• Payment timing: The listing agreement states when the broker's payment is due. Often, a broker requests payment at the time of the sale.
• Sub-brokers: The listing agreement may allow the broker to hire sub-brokers to help find potential buyers.

Given the listing agreement's complexity and the money involved, a business owner may want to get a second set of eyes on the agreement. Contact a business or contract attorney if you have questions about entering a listing agreement.

Get Legal Help Drafting a Broker Listing Agreement

The process of selling a business will involve many statements and agreements. To ensure everything is in order with the sale of your business, contact a skilled contracts lawyer near you to help you understand your rights throughout the process.

An experienced attorney can provide helpful legal advice and guidance regarding a proposed listing agreement and give you a template for success. In doing so, they may save you both money and stress.