Attention shoppers: Those of you looking to purchase a financial advisory practice should be prepared for an arduous search. For every practice sporting a “For Sale” sign, there are 30 or 40 potential buyers out there, according to FP Transitions, a Portland, Ore.-based firm that helps brokers sell their books of business.
Of course, this is great news for those who happen to be selling a practice. Still, for both sides of the equation, the process of handing over a book is not one to be taken lightly. Arriving at a fair price for the business is hard enough, but it's only the beginning. An equally important part of the sale is measuring the potential buyer's fit with the investment style and personality of the client base — something not easily accomplished.
“Without careful preparation I would be skeptical of the chances of any practice being sold and realizing good value for either party,” says Philip Palaveev, an analyst with Moss Adams, a Seattle-based accounting firm specializing in independent financial professionals.
There are a number of reasons why practices come to the open market. In some cases, sellers are at large firms looking to get more muscle by merging with a CPA firm or bank. In others, they're small guys trying to upgrade their services by allying with someone bigger.
But the No. 1 motivation for selling advisory practices is the seller's desire for a career change, according to David Grau, president of FP Transitions. Swelling the ranks of industry refugees is a ready pool of advisors eager to retire. Over the past two or three years, many would-be sellers put retirement plans on hold, either because the value of their practices had declined or because they didn't want to abandon long-standing clients in their time of worst need. However, with the markets improving all around, many are deciding the time is ripe to make a move. That's why, while the majority of sellers were under age 50 in 2002, this year most are older, according to Grau.
On the other side of the transaction, the motivations are more straightforward: Most buyers, including Bruce Vaughn of Financial Network Investment Corp., in Vienna, Va., are looking to expand their businesses. Vaughn, a 20-year veteran of the brokerage business, decided four years ago the most effective way to expand was through acquisition.
“I'm not a very good marketer,” he says. “This seemed a more efficient way to go about it.”
Since then, he has made four purchases. As a result, he has doubled the size of revenues and assets under management. “I've grown 30 percent a year during a tough time,” he says.
Advisors usually begin the process of buying or selling in a very mundane way — by asking business acquaintances, friends and family members, as well as accountants and attorneys, for names of firms interested in moving their practices.
Vaughn, for instance, learned about a few of his purchases through a mutual fund wholesaler he worked with. Others have sent out feelers at industry meetings and conferences.
Then there are more formal channels, such as FP Transitions, broker/dealers or Charles Schwab (which recently launched a new match-making service for advisors looking to buy, sell, or merge practices).
If you're a seller looking for buyer candidates, chances are you'll quickly find an embarrassment of riches. The experience of Ron Pasquinelli, a Monterey, Calif.-based advisor, is typical. When he listed his 30-year-old practice on the FP Transitions site a year and a half ago, he received more than 50 responses, which he quickly whittled down to six serious contenders.
On the other hand, if you're a buyer, you can expect to be up against at least several other competitors.
In either case, you'll have to check out possible partners carefully. Buyers will probably want to check with the SEC for negative reports, and to investigate billings, as well as client documents, for any history of complaints or dissatisfaction. The investigations make for an awkward situation. Buyers want to find out as much as they can, while sellers need to protect the confidentiality of client information, especially if they're negotiating with a competitor. The middle ground, often, is the seller agreeing to provide information about the type of account each client holds, with a sampling of investments, but leaving out specific client names.
Dollars and Sense
When you start getting serious about a deal, buyer and seller will have to set a value for the practice. This process starts with deciding how the purchase will be conducted — by buying the assets of a business or by acquiring the stock. Buyers favor the first route, because it lets them avoid taking on the business' liability baggage. Indeed, “Most buyers won't do a stock purchase,” says Jim Almond, an advisor with Financial Network Investment Corp., in Dallas, who has bought four practices in the past 10 years.
But, for the seller, a stock transaction is preferable, since an asset transaction is taxed as ordinary income, while a stock sale is realized as capital gains (which carries a lower tax rate). Typically buyers will increase their purchase price to make up for the additional tax the seller will have to pay. Almond, for example, raised his price about 10 percent.
Valuations are based on a multiple of trailing one-year earnings. But, the calculations springing from those core figures can get considerably complicated. “It's not a matter of a simple multiple,” says Moss Adams' Palaveev.
Other considerations include how much cash the buyer pays up front (the more cash, the greater the discount to the seller), the amount of overhead, the demographics of the client base, the maturity of the practice and whether it's high-growth or has multiple advisors who will remain with the firm after the purchase (they go for a premium).
The Advisor You Know
There's also the question of whether or not to sell a practice to a key employee. About 44 percent of RIA owners plan to make such an inside sale, according to Cerulli Associates, a market research firm in Boston. The inside handoff is even more common at big firms: Sixty percent of practices with six or more employees figure they'll make an internal sale, while 37 percent of firms with one or two employees plan to do so.
Trouble is, that's not always the most lucrative route, at least for the seller, who tends to be softer on trusted associates than strangers. “When you go on the open market for a buyer, you get a better quality buyer and a better deal,” says Grau of FP Transitions.
Usually, deals are structured in two steps. There's a non-refundable cash down-payment made by the buyer, of anywhere from 20 percent to 50 percent of the purchase price. Then, there's an earn-out, a way to make sure “seller and buyer work together to deliver and retain clients after the deal is closed,” says Grau. “You create a team approach.”
Over a period of three to five years, the seller typically receives the balance of the purchase price in installments, depending on how successful buyer and seller are in retaining existing clients.
To be sure you keep as much business as possible, it's a good idea to map out exactly what the seller's duties will be. The seller should help with hand-holding duties for at least the first year, and he should get things going with a letter to clients explaining what's happening.
Trying It On
The hardest part of the sales process may be figuring out whether there's a good fit. That means making sure you share everything from the same investment philosophy to your approach to client service and how you charge. Michael Leonetti, of Leonetti & Assoc, Buffalo Grove, Ill., decided against doing a deal with one potential seller, in part because he felt the other firm was too rigid in the number of meetings clients were allowed to have with advisors each year.
The worst thing sellers can do, say the experts, is to go for the highest bidder, without giving adequate consideration to other matters. Leonetti lost out on a purchase a few years ago, when the potential seller opted for the more lucrative deal. Turned out, the buyers had a completely different investment philosophy and wanted him to sell products, something he hadn't done before. After two years, “the deal blew up and he ended up buying back the practice,” says Leonetti. “There wasn't a good fit.”
If you don't want to buy or sell an entire book of business, you can also go the partial route. When Vaughn made his third purchase, in July 2002, he decided to buy only a dozen 401k plans, and not the seller's 180 clients, whose assets were considerably smaller than those of his accounts. Sellers who want to redirect their business can also just put certain clients on the block. “A fee-based advisor who wants to raise the minimum client level can sell smaller accounts to someone more attuned to helping that type of client,” says Grau. “They can reshape their practice without going out of business.”
In the meantime, buyers willing to put off their purchases, might find a lot more practices for sale a few years down the line. While only 2 percent of planners are thinking of retiring in the next three years, 16 percent want to make that move in the next six to 10 years, according to Grau. Whether it's a buyer or seller's market, however, the hard truth is this: The process is unlikely to ever be an easy one.