If you’re an owner considering selling your business, you may land on one of a growing number of platforms and firms that market themselves as “0% fee to sellers” — we don’t charge you, we charge the buyers. But there’s a presumption in this statement that somehow value can be created for the business owner simply by charging the fee to the buyer — hence the title of this article, a nod to the first law of thermodynamics. This shows how the choice of language leads us astray. Because it’s not really “charging the fee to the buyer.” Rather, it’s the “buyer charging the fee to you.” In the same way that it’s the sell-side advisor “charging the fee to you.”
To appreciate this nuance, we merely need to understand the funds flow. The funds flow is an analysis — prepared ahead of closing — that maps out a transaction’s sources and uses, and how each dollar is to be transferred.
Now investors don’t have access to unlimited capital, even though it may seem that way particularly when you read everyday headlines. Take a private equity firm as an example. They will have a fund of a certain size, and they will allocate portions of that fund across various investments. They will also be very careful about the extent of diligence expenses they undertake. The greater the expenses, the less capital they can deploy towards great assets.
They want to keep the expenses to a minimum. This is also why you as the seller want to be as prepared as possible. And why a good sell-side advisor delivers value. By helping you get your house in order and all the associated third-party materials buttoned up, you obtain a bargaining chip. The buyer’s diligence is alleviated, and you can now push for higher value.
Clearest example of this is a Phase 1 Environmental Site Assessment. Don’t do one, and your process will be a disaster. Not only will the buyer need to pay to do one (again reducing how much they can pay you), but they end up controlling all the information associated with the report (reducing how much they are willing to pay you). On the other hand, when the sell-side completes the Phase 1, the buyer often simply relies on it and moves on with their diligence efficiently.
So, returning to the funds flow, it will stipulate how much a buyer is willing and able to pay for a particular investment opportunity. Say the total amount of sources is around $120. And assume that the buyer’s expenses are $14. That leaves $106 to go to the seller. Now assume that the seller has a sell-side advisor that charges $2, leaving them with proceeds of $104. For simplicity here, assume no cash, no debt, and no other expenses — just the basics.
Now assume there’s no sell-side advisor, but a buy-side advisor that charges $2. The buyer’s expenses are now $16 instead of $14, again leaving the seller with proceeds of $104. Now maybe you think this is all just wonky math, so here’s what an independent sponsor told me last week that says it better than any math can: “A third of the time we use buy-side advisors for sourcing. We don’t love it, because we’d rather pay those fees to the owners.”