Business brokers like to play games in order to trick newcomers into overpaying, I will list their tricks below:

1. Broker Documents:

Everybody knows about the dreaded broker documents, you can excuse the NDA as it's sole purpose is to maintain the confidentiality of the information being provided, but never use broker documents, always have an attorney issue your own documents and maintain control of them.

Brokers like to put in certain provisions that affect business buyers:

I'll state a couple examples:

1. Escrows: I've seen LOI's that request more than one escrow even up to 6 escrows totaling 100k before a PSA which is non-refundable if the deal doesn't go through. - This is theft.

2. I've also seeing LOI documents where there is no liability clause for the seller if they lie or cook the books thus the buyer assuming all liability, this is detrimental to the buyer because the offer you send in the LOI is not subject to financial or legal liability; essentially trying to lock you in on the first offer you made even if you found that the numbers aren't what they said after due diligence.

Brokers like to use cheap template documents that put business buyers at a disadvantage and try to lock you in at high offers.

Remember, when it comes to legal documents it's not just what's written that matters, but what's not written is also as or even more important. Keep that in mind.

2. Using outdated financials:

Brokers love to cling onto the best numbers. these includes financials as old as 2018 in order to justify a sale price, any person doing this should have their license revoked.

2020 was a hard pill to swallow for a lot of brokers as the numbers did not work in their favor, thus trying to cling onto 2019 numbers justifying that 2021 will be as good, as we've seen it hasn't been as good as 2019 for the majority of businesses, but it has leveled out to a more stable number.

3. Averaging financial data:

Another trick brokers are using is averaging financials from the past 3 years with an emphasis on 2019 as their main, this makes the numbers look better than what they are, but the truth of the matter is that the numbers stated don't exist, unless they can prove the "Cash Flow" they state with updated financial records / contracts it's all a lie.

4. Not doing proper financial analysis:

I've seen a lot of things go under the radar for business brokers, you understand a business runs on numbers.. So having a broker not understand numbers when they are supposed to be the experts puts new buyers at risk.

5. Negotiations:

Business brokers have no right and are not qualified to negotiate deals on behalf of the seller, the broker has neither stake or genuine interest or otherwise incentivized for the continuous growth of the business after the close of the sale.

6. Cheap Sales Tactics:

These are examples of how brokers are not qualified to negotiate.

1) They lie about interest from other buyers, if a buyer is offering you more than what I am; then why are you wasting your time with me. Obviously you would go with the highest bidder, apparently that's not the case as it's just a tactic to make you increase your offering as they know you are interested in the business. They are just instilling the fear of missing out and false urgency.

2) You can't speak with the owner until after you sign the LOI - That's the same as giving a down payment on a car without test driving it, if I'm going to spend millions of dollars the least you can do is allow me to speak with the owner of the business I'm looking to buy, essentially brokers are lazy and just want to collect offers and move onto the highest bidder, as you can see brokers are interested in the sell price more than the continuation or future growth of the business.

3) POF ( Proof of Funds )

What to do when a broker ask you for proof of funds (POF).

Say “sure I’d love to provide you a our POF. Could you send over a list of all of the closed transactions that you’ve completed for the past 6 months? We want to ensure that the seller is dealing with someone who actually close deals. In fact, you can send that over to our bank/financial partners and we’ll be glad to send over the POF right away. Thanks”
They will not be able to send that over since a large number of brokers don’t actually close multiple deals in less than a year, or any.

7. Inexperienced / Lack of Knowledge:

Brokers have a loophole, if you are a Real Estate Agent you can broker business if they have property attached to it as this falls under "Commercial Real Estate" now the problem is these Agents have zero business knowledge regarding valuations, and thus they use "Rule of Thumbs" mainly EBITDA and Multiples as these are easy to calculate.

The problem with that, is that there is no 'Rule of Thumbs' in finance as these lead to overvaluations because EBITDA and Multiples don't take into account the financial structure of a business, which leads to over leveraging cash-flows that usually ends up with bankruptcy down the line.

8. Overvaluations:

As examples stated previously, business brokers don't have financial knowledge. They try to take a cookie cutter approach with business valuations, thus leading to the buyer overpaying which leads to over-leverage of cash-flows which eventually leads to bankruptcy, though the broker does not care about this as his job is to sell the business for the highest price.

When trying to use alternative valuation metrics that do take into account the business financial structure they usually become defensive and emotional, as they know their commission will be cut by a large percentage.

Whenever a broker gives me a business valuation, I immediately deduct $1M-$2M.

9. They have the owners best interest:

You can't have the owners best interest because you work for a brokerage firm and the goal for that firm is to bring in as much revenue as possible for that year.

Also taking into account the less we pay the seller, the less the broker makes. Thus it doesn't work on his favor as the time it takes to get a sale they try to compensate for a larger commission.

10. Add-backs:

A lot of these add-backs are unrealistic, and unspecified. I'm not accounting one time expenses as add-backs.

Brokers love depreciation, they want you to pay full-price for depreciated assets, specially with asset-heavy businesses as these are millions of dollars they can add back.

11. Tax Returns

Brokers don't like to go off tax returns for true add-backs and cash-flows. They use inflated numbers from the P&L and don't cross reference it with other documents.

WARNING: If you are not savy or you are a newcomer the broker doesn't have your interest as a buyer and will have you overpay and structure the business where it benefits the seller the most. Essentially they will take advantage of your lack of knowledge.

They can smell fresh meat.

Like I've said before: Ignorance is expensive.

Side note:

Why fund-less sponsors or independent sponsors starting out shouldn't be in a hurry to close a deal, as desperation will be your downfall. Just because you were able to fund the deal, doesn't mean the structure was beneficial to you, in the end the one assuming the liability is YOU.

If you would like to be a guest on our Podcast: Elite Acquisitions & Investment Banking, where we discuss business valuations and the proper metrics for SME's.