Although now well established, buyer's premium fees are still relatively new and their impact on recovery in liquidation sales must be measured. When estates are liquidated in bankruptcy, are they being affected in a positive or negative way by this new fee structure? There have been no statistical studies, but there have been estimates by auctioneers and buyers that may be of interest.
What Is It?
The "buyer's premium" was initially used in the Netherlands and has been used throughout Europe for many years. Simply stated, it is adding the sales commission as an obligation to the buyer after the bid. For example, if the bid is $100 and the buyer's premium is 10 percent, the invoice to the buyer would be $110. In the United States, auctions traditionally consist of the bidding, followed by the payment of the full amount of the high bid by the successful buyer. The proceeds realized by the seller would be the full amount of the high bid less a deduction for the fees for the sale. For example, if $100 was the highest bid, it would be paid by the buyer, and assuming a 10 percent fee, $90 would be paid to the seller. In both methods (fees deducted or buyer's premium added), any expenses would typically be deducted from the proceeds of the sale.
Buyer's Premium Strategy
One might consider a buyer's premium somewhat of a gimmick, and in some ways, it is. How often have we seen an advertisement stating that if you buy a certain amount of product or service, you will be given other things? Even though logic says no one gives anything away, buyers sometimes fall for that type of gimmick. There is a strategy used by many retailers of marking items that do not sell at the original expected price to a higher price. Then the retailer marks down the product to the same price at which it was originally priced but at which it would not sell. In some cases, the items start selling because of an imagined discount that is not real. There are many examples of this in U.S. marketing that seem to work, and this is certainly one reason that the buyer's premium has worked so well.
Effect on Recovery
The U.S. auction market is in an excellent position to measure the effect of buyer's premium on sales. For many years, industrial auctions were based on straight commission without the addition of buyers' premium. In the last few years, most sales have been held with buyer's premiums, and a comparison can be made to recovery with and without the buyer's premium fees, subject to some adjustments for inflation. Most believe that it is reasonable for the following to occur when comparing sales with and without buyer's premium:
- 5 percent = no effect
- 7 or 7.5 percent = 1 percent to no effect
- 10 percent = 2 to 3 percent (Note: some argue 0 percent and others 5 percent)
- Greater than 10 percent = Typically not recommended
Auctioneer Fee Strategy
For many years, auction guarantees were very popular. Auctioneers would, of course, charge additional fees for those risks. There were some strategies with these guarantees that caused a seller to accept one auctioneer over another. However, in many cases, that may not have been the best decision when considering the highest net result to the estate. Reputable auctioneers could negotiate a fair fee without additional points added for risk and, in most cases, this would result in a higher net result to the estate. Now that buyers' premiums have become acceptable, there are various strategies used by auctioneers. For example, auctioneers may say that they will conduct the sale at no cost to the seller and will simply add in a percentage (buyer's premium), which will be their fee. However, in most of these negotiations, expenses for advertising, promotion, set-up and evaluation of the items to the appropriate buyers, including all related travel expenses, are deducted from the proceeds. There are some auctioneers who say that a portion of the buyer's premium will be returned to the estate. This results in other alterations of the sale agreement, such as a percentage of expenses being the responsibility of the estate.
In multi-million dollar auctions, auctioneers may negotiate a buyer's premium and absorb 100 percent of the expenses. The seller must be careful that the buyer's premium is not excessive, thereby adversely affecting the net result. Some types of sales are more sensitive to buyer's premium percentages than others. The earlier discussion of the effects of a buyer's premium shows the results on average, which may change depending upon the types of assets and/or sale locations. If at all possible, engage an independent evaluator who is familiar with these types of sales and who has some advice on the strategy for fees and expenses that would allow the highest net results.
The seller must be careful on expenses. Too little may be to the disadvantage of the gross sale, and too much may be a disadvantage to the net result. There are times when a 5 percent buyer's premium is reasonable and other times when 10 percent would be reasonable. There are some very difficult sales in which a combination of a buyer's premium sale and additional fee should be paid by the estate. To obtain the good services of a reputable auctioneer, this would be a sale in which a portion of the fee is paid by the buyers and a portion by the sellers so that the buyer's bids are not affected by the higher fee percentage that is warranted. Sellers will be approached with all types of buyer's premium liquidation proposals that may sound good on the surface, but sellers must carefully analyze these proposals in terms of their effect on net realization.
An auction was recently held outside of Houston in which the assets were live plants consisting of trees, shrubs and ground cover, as well as related nursery equipment. A 10 percent buyer's premium was made a part of the sale, but the expenses came out of gross proceeds so that the seller received the bid price minus the expenses. I attended this sale, and in my opinion, the bid amounts were affected very little by the 10 percent buyer's premium. It was estimated that approximately -2 to -3 percent may have been an overall gross effect, but this would be a difficult estimate to defend. Many of the plants brought in more than would be expected, and others brought in less. One must consider the average when looking at the effects of buyer's premium. There were more than 150 buyers, and with the heat at 105 degrees and no wind, it was almost unbearable if you stayed the entire day. The sale lasted from 10:00 am until 8:45 pm, with approximately 20 to 30 lots being sold in darkness and 30 to 40 bidders still there. It is very rare to see a nursery inventory sold at auction. Properly handled, such an auction is a good thing because it cuts off the care expenses while gaining the highest net result by auction. Certainly, there is an incentive to sell those types of asset as a total unit in order to cut expenses. However, there may be a price paid, through a heavy discount. An auction can be the best choice.
It might be well to discuss the assets of estates with both liquidators and appraisers to evaluate proper strategies, waiting periods, advertising, fees, etc. Surprisingly, many sales are now conducted by sealed bid. There was an extremely successful sale of real estate sold by sealed bid in which eight out of 10 properties were sold at acceptable or higher-than-anticipated prices.
Caution is advised when receiving advice from consultants who could have a vested interest. The seller should always look toward the highest net result, rather than the largest gross liquidation number. Obviously, the seller will always wish to sell assets as a going operation. In most cases, after a bankruptcy has occurred, the potential buyers for the unit or business would be known prior to or shortly after the bankruptcy filing. Bankruptcy tends to stimulate interested buyers to make inquiries and offers. Most of the competition knows the economic state of the subject and there is not much that could occur after the fact to bring these people forward. If there have not been any inquiries shortly after the filing, generally there will be few offers greater than the piecemeal liquidation numbers that could be achieved through a liquidation sale. In a few cases, the mere advertising of selling at liquidation may bring some hold-outs forward, but this very seldom happens.
The use of a "buyer's premium" has raised the results at some open auction liquidations. It is very difficult to use this fee method in liquidations using sealed bids or orderly negotiations as the buyers have time to adjust the premiums out of their offers. This is less likely to occur in open competitive bidding, with its inherent faster pace. Trustees, creditors' committees, liquidations through arrangements, etc. should consider fair fees and expenses appropriate to the type of sale being conducted in order to have the very best liquidator possible and the highest net results. Negotiations for the lowest fee or expenses may not provide the highest net result.
Friday, October 1, 1999