The Dangers of Trusting Business Brokers When Loaning or Investing
Business brokers are traditionally considered to be professionals who are in the business of finding a buyer for someone who wants to sell a successful business in lieu of a succession plan.
Recently, however, we have received several calls from people who have simply invested in or loaned money to a business that was recommended by a questionable “Business Broker.” From our perspective, this is generally a bad idea for the person investing or loaning the money. The businesses that are looking for investors or lenders, rather than a complete sale of the business, are often not well conceived, not well run, and not well funded. In fact, these businesses are often seeking funding because they have inadequate cash flow and, as a result, cannot get funding from a bank or other professional lender and cannot convince any institutional investor to invest. Not only are these companies often problematic, but the terms of these loans/investments coordinated by the “business brokers” are often on such bad terms that a professional lender or institutional investor would never agree to them even if the business was viable enough to justify an investment or a loan.
Not All Business Brokers are Created Equal
As mentioned above, a skilled business broker can be helpful in putting together a buyer and a successful business owner in lieu of a succession plan by the business owner. However, this new breed of “business broker” who convinces people to loan money or invest in a business – rather than buy it – has effectively morphed into a pitch person or promotor for suspect businesses in dire need of cash.
We believe this new breed of “business broker” has come into existence because many of these brokers are not well qualified, not adequately regulated, and driven by a commission or referral/finders’ fee structure to make sure the transaction happens. As a result, even an honest business broker who discloses all conflicts of interest is often not competent to evaluate the value of the business or the terms of the loan/investment. This is because the licensing/education/experience requirements for a business broker often have little to do with the ability to analyze a business or funding terms. Depending on the state, many business brokers circumvent the prerequisites to becoming a business broker by using their experience and/or education in real estate as a surrogate for experience/education in business and financing. In my mind, the use of real estate knowledge as a surrogate for business and financing knowledge has always been a bad idea, but it is an especially bad idea in today’s world in which real estate is becoming a smaller and smaller component of the value of a business in light of the emergence of technology. This is true in both old economy businesses as well as newer technology-based businesses.
The Unfortunate Truth About Small Business Investments and Loans
In reality, it is usually a bad idea to loan money to or invest money in someone else’s small business under most circumstances. It is usually a very bad idea to do so based on the recommendation of a “business broker” who only gets paid if you invest or loan the money and who also has his or her licensing based on real estate expertise rather than business evaluation and financing expertise.
If you have an interest in investing or loaning money to a small business (which we believe is usually a bad idea as outlined above), we strongly urge you to do significant due diligence to find a business broker that is qualified, experienced, and ethical to advise you on: 1. Whether the business is well conceived, well managed, and financially viable; 2. whether the business is in a viable industry given economic trends at the time; and 3. whether the terms of the loan or investment are fair or favorable to you in terms of maximizing returns and minimizing risks.
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