The Broker in the Room - Should you really trust the people that get paid to get your deal done?

Chapter II of my "Stop being Gullible" series. The sellers lose - only 7% ever sell The buyers lose - bad valuations --> bad DSCR ---> defaultChart 1. M&A failure rate vs. internal project failure rate. Lev & Gu analysis of 40,000 transactions over 40 years. A deal closes. The broker collects 6% of $12M: $720,000. The banker collects 3%: $360,000. The lawyers collect $280,000. Total fees at close: $1.36M, every dollar of it earned the moment ink hits paper. Eighteen months later, the buyer misses his DSCR covenant by 11 basis points. Nobody calls the broker. This is the central problem with how the advisory market around M&A is structured. Every professional in the transaction is paid at close. Nobody is paid to be right afterward. And the primary instrument used to justify the price - a growth rate borrowed from an industry market research report - carries no accountability at all, before or after. I. The Structure of the Problem The business brokerage and M&A advisory market is structured, almost perfectly, to produce bad outcomes for the parties who need good ones most. This is not an accident. It is a fee structure. Brokers compete for listings. They get listings by quoting the highest number. The seller, rationally, picks the broker who told him his business is worth the most. The broker, having promised a number he cannot deliver, lists the business at that number. The listing sits. A 2024 survey by the Australian Institute of Business Brokers found that 52% of brokers identified overvaluation as a major problem in their own industry. This is not outsiders complaining about brokers. This is brokers complaining about each other. The consequence is mechanical. The IBBA reports that approximately 40% of business listings start with asking prices that exceed realistic market valuations by more than 25%. Overpriced listings sit on the market 12 to 18 months longer than appropriately priced businesses and ultimately sell for 15 to 25% less than their initial asking price - when they sell at all. When they sell at all is doing a lot of work in that sentence. Chart 2. Of 100 businesses listed for sale, approximately 6 close. Median close rate 6.46%, BizBuySell###-###-#### . The BizBuySell Insight Report - the most comprehensive data source on the small business transaction market - shows a median close rate of 6.46% across all listed businesses from 2018 to###-###-#### Six out of one hundred businesses that list for sale actually close. The conventional explanation is that most businesses are not sellable. The more accurate explanation is that most businesses are listed at prices that make them unsellable - and the people who set those prices have already been paid. The broker's reach is also expanding. Active M&A brokers on the Axial platform - the largest lower middle market deal network in the US - doubled from 793 to 1,663 between 2020 and###-###-#### The supply side is growing too: BizBuySell data shows the number of US businesses listed for sale has grown by over 50% since 2015, and the BizBuySell 2025 Insight Report finds that 72% of brokers expect even more owners to come to market in###-###-#### More sellers who have never sold a business before, more brokers competing for their listing, and no mechanism in the fee structure to reward accurate pricing over flattering pricing. The problem described in this article is not getting smaller. It is compounding. Chart 3. Active M&A brokers on Axial platform 2020 vs. 2024, with corroborating supply indicators. Sources: Axial; BizBuySell Insight Report; Texas Association of Business Brokers. Note: Axial intermediate-year data not publicly published. At the higher end of the market, the dynamics shift but the incentive problem does not. Investment bankers advising on lower-middle-market and mid-market deals are paid almost exclusively on close. No close, no fee. As Alex Edmans of London Business School observed in his research on M&A advisory conflicts: individual bankers have substantial incentives to do bad deals. Completing a deal gets you promoted. Missing one gets you called into a senior committee to explain yourself. The structure does not reward you for walking away from an overpriced transaction. It punishes you for it. II. The Model Builds the Fiction Here is how the valuation gets built. A business broker or M&A advisor wants to justify a price. The most common valuation methodology in the lower middle market is an EBITDA multiple. You pick a multiple, you apply it to EBITDA. The multiple is supported by comps. The EBITDA is whatever the recast financials say it is after the broker's add-backs (a subject deserving its own article). Neither the multiple nor the EBITDA is particularly controversial in a well-run process. The problem is the growth assumption layered on top. Sophisticated buyers - and their lenders - do not just pay on current EBITDA. They pay on projected EBITDA, which reflects how they expect the business to perform post-close. That projection requires a growth rate. And growth rates, as we established in The CAGR Con, are almost always borrowed from an industry market research report that has no obligation to be accurate and a strong commercial incentive to be optimistic. The result is that the deal model contains an assumption - let us say 15% revenue CAGR, which is a number I see regularly in CIMs for businesses in sectors that happen to have published a market research report with a large CAGR - that has no basis in the company's own history, no relationship to its customer contracts, and no connection to any identified mechanism for growth. It is simply the market's CAGR, applied to this company, because someone needed a number and that number was available. Chart 4. How a market research CAGR becomes an acquisition price. Each node inherits the error from the one above it. The buyer's lender then sizes the debt service against projected EBITDA. If the projections hold, DSCR is fine. If the projections do not hold - and the historical record on industry CAGR forecasts, which we documented at length, strongly suggests they will not - the buyer is in breach of covenant before the paint dries on the acquisition. Chart 5. Illustrative DSCR squeeze. Deal structured against 15% CAGR assumption; DSCR floor breached under flat or modest-decline scenarios within 2 years. A note on the DSCR math. If a deal is priced assuming Year 1 EBITDA of $2.5M and the lender sizes debt service at $1.9M (1.25x DSCR), flat organic growth of $2.1M - which is what the business was doing when you bought it - produces a DSCR of 1.1x. Many covenants breach at 1.20x or 1.15x. The company is technically in default not because anything went wrong but because the deal was priced on a fantasy and the fantasy did not materialize. This is not an edge case. It is the modal outcome for leveraged acquisitions built on industry CAGR projections. III. The Chain of Misaligned Incentives The broker inflates the valuation. The banker closes the deal. The CAGR justifies the model. The lender funds the debt. The buyer signs. Everyone in this chain gets paid at close. Nobody is accountable eighteen months later when the debt service does not cover. Chart 6. The chain of misaligned incentives in a leveraged acquisition. Every participant is paid at close. Nobody is paid to be right post-close. Let us be specific about each node. The broker is paid a success fee of typically 5 to 10% of deal value on close. The AIBB survey captures the mechanism clearly: a business owner gets quoted $1M by one broker and $2M by another, and naturally picks the higher number. The broker who quoted $2M knew it was not achievable. He also knew he would collect a retainer for however long the listing sat, and that some fraction of deals close on seller concessions. He was playing a numbers game, not giving advice. The investment banker at the deal level has the same incentive and more sophistication. Research by Edmans and Bao, published in the Review of Financial Studies, found that an investment bank's past performance in generating shareholder value for clients has no effect on its future market share. Banks that consistently destroy value do not lose mandates. The metric that predicts future market share is league table position - which is a function of deal volume, not deal quality. The incentive, in other words, is to do deals. Not good deals. Deals. Just like Barron’s and Forbes ranking by AUM (and not by return) – metrics you just couldn’t care less about… The buy-side / sell-side conflict compounds this further. Most M&A advisors work both sides of the table across different transactions. A banker advising a founder on a sale today does not want to antagonize the PE firm sitting across the table, because that PE firm may hire him to sell a portfolio company next year. As VistaPoint Advisors documents, this creates a structural disincentive to make the sale process competitive - which is the one mechanism that would actually protect the seller. The banker captures his fee. The PE firm wins a process that was not as competitive as it should have been. The seller leaves money on the table. Nobody is required to disclose any of this. IV. The Revenue Synergy Problem There is a second layer of fiction that operates at the deal level and that the broker and banker both have an incentive to leave in place: revenue synergies. When an acquirer buys a business, the deal model often contains synergy projections - the additional revenue that will result from cross-selling, pricing power, access to new markets, combined customer bases. These projections are used to justify acquisition premiums. They are almost systematically overstated. Cost synergies - headcount reductions, procurement savings, facility consolidations - are operational and largely within the acquirer's control. McKinsey research on post-merger integration consistently shows that cost synergies are realized at roughly 80% of what was projected. Revenue synergies, by contrast, land at roughly 30%. They are dependent on customer behavior, competitive dynamics, and market receptiveness - none of which the acquirer controls and all of which are harder to forecast than headcount. Chart 7. Post-M&A synergy realization: cost synergies roughly 80% delivered; revenue synergies roughly 30%. Source: McKinsey post-merger integration research. The implication for deal models is direct. If your acquisition thesis requires revenue synergies to close - or requires industry CAGR to materialize in this specific company's P&L - you do not have an acquisition thesis. You have a spreadsheet that says what someone needed it to say to close a deal. V. What a Legitimate Growth Assumption Looks Like Let us be constructive for a paragraph, since this article risks becoming a long list of reasons not to acquire anything. There are legitimate bases for above-inflation growth assumptions in an acquisition model. They are just narrower than most deal models acknowledge. Article content Everything else is an aspiration dressed as an assumption. Aspirations belong in your trash-can, your dreams and your pre-divorce justifications to the spouse. They do not belong in the base case. When they end up in the base case - because the broker needed a higher valuation and the banker needed the deal to close - the buyer is the one who discovers the distinction, and usually not at a convenient moment. VI. The Earnout: The Market's Acknowledgment That Nobody Believes the Model There is a limited evidence that suggests the deal market itself has started to notice this problem, even if nobody says it out loud. Earnout provisions - deal structures in which a portion of the purchase price is contingent on the acquired company hitting future financial targets - accounted for roughly one-quarter of private-target M&A deals in 2023, slightly up from 21% in 2022 according to the ABA Private Target M&A Deal Points Study. That is a significant jump. Earnouts exist because someone in the transaction does not believe the projections. The buyer does not believe the seller's growth assumptions. The seller wants to be valued on those assumptions. The earnout is the mechanism by which they agree to disagree and defer the argument until the projections have been tested against reality. In a functioning market with well-calibrated models, earnouts would be uncommon. The fact that they have become slightly more common is an implicit acknowledgment that the deal models being built to justify purchase prices are not believed by the parties building them. The broker produced a CIM. The banker produced a model. Everyone nodded at the 15% CAGR assumption. And then the buyer asked for an earnout, because that is what you do when you know the number is wrong but you still want to do the deal. The market's growing use of earnouts is not a sign of deal sophistication. It is a sign of shared skepticism about deal models that nobody is willing to fix. VII. What to Do Instead This is the part where I am supposed to say "hire the right advisors" (me) and "do your diligence." (me too) and most importantly - hire NEUTRAL advisors who are not incentivized by closure but by your best outcome (you guess it, it's me again...) That is true and also insufficient. The incentive problem in brokerage and M&A advisory is structural. Better advisors help. But the solution is not to find the one honest broker. It is to change what you require of any broker. Four things worth requiring before you rely on a growth assumption in an acquisition model: 1. Identify the source of the CAGR used. If it is a market research report from any of the Pune-based research aggregators - Technavio, Grand View Research, MarketsandMarkets, Mordor Intelligence - discount it to zero and rebuild the assumption from bottoms-up. 2. Separate the company's historical growth rate from the industry's projected growth rate. Ask explicitly: what has this company's revenue done over the past three years, and why would that change? 3. Require that every growth assumption above inflation be supported by a specific mechanism: contracted revenue, documented retention, identified white-space with a named mechanism, or evidence of pricing power with historical support. 4. Run DSCR at flat revenue. If the deal breaks at flat revenue, the deal is not priced for the risk you are taking. It is priced for the risk the seller's broker was willing to pretend did not exist. The broker is not your advisor. The banker is not your advisor. They are service providers with specific fee structures that reward deal completion, not deal accuracy. Act accordingly. ---------- Closing In the first piece in this series, I argued that the CAGR number on slide three of your pitch deck is a placeholder for an answer you have not given yet. The broker problem is the upstream version of the same disease. The valuation on the cover of the CIM is a placeholder for a negotiation the seller's advisor has already pre-loaded in his own favor. The fee structure described in the opening of this article is not unusual. It is the standard. Across thousands of deals a year, advisors collect at close and move to the next listing. The buyer inherits the model. The model inherits the CAGR. The CAGR inherits whatever number a market research firm decided to publish. By the time anyone asks whether any of it was true, the people who built it are long gone. The broker is not uniquely culpable. The incentive structure is. But the incentive structure does not change itself. The buyer has to change how they use it. ----------- Coming next: If the incentive structure is this broken, why don't sellers fix it? They have access to broker reviews, LinkedIn profiles, closed transaction histories. The information exists. The answer is that the business sale process is almost perfectly engineered to defeat the seller's ability to use it - and that is not an accident. Part three of this series will be about why rational people keep walking into both traps, and what the behavioral economics of a one-shot, high-stakes, zero-calibration transaction actually looks like.