As head of acquisitions for United Capital, I’ve worked on dozens of transactions involving wealth management businesses over the last decade. Selling firms are often led by incredibly capable entrepreneurs, but I’ve observed a surprising lack of understanding in the value of the equity these folks might be receiving from the buying firm.
There is an unprecedented amount of private equity money in the wealth management industry right now and we can assume much of that cash will be used for acquisitions. It’s always been a priority for us to provide transparency to our potential partners so they have a complete understanding of how their equity in United Capital works. But not all buyers do this. Private equity investors often use clever financial engineering to capture a rate of return, and the sellers can end up literally paying the price.
The Capitalization (Cap) Table and Share Classes
The cap table provides a snapshot of the organization’s ownership. It helps you understand the acquiring company’s capital structure and the varying share classes and rights. At the end of the day, the cap table is an indication of who is really running the show with a control position, and who is entitled to what if there is a liquidity event.
Share classes are not too dissimilar from classes in air travel. First-class passengers board and debark first, enjoy more legroom and dine on finer food not available to those in coach. A controlling position will have all first-class features, but they can also change destination mid-flight. You may have packed for a fishing trip to Alaska, but over Seattle the folks up front decide South Beach sounds better. They might also have the ability to get off the plane but put everyone in coach when it takes off again.
To avoid any surprises upon arrival or on pre-boarding, I suggest you ask, at a minimum, the following:
- What are the various share classes that make up the cap table?
- What are the various features and rights of each share class?
- Which share class will I own?
- What is the path to liquidity for my shares?
- What rights to liquidity do others have that I don’t?
You may discover that certain share classes have anti-dilution provisions, preferred rates of return and/or participating dividends that certain share classes don’t enjoy.
The cap table is the ethos of the organization and a true telling of what the future holds for you and your clients. After all, the buyer of your firm needs to make a rate of return and that is very much affected by the cost of the equity in their cap table.
While in discussions with a potential new advisor to our firm, my partner, Joe Duran, once said, “There are only two ways to make money if you are a buyer: either you take a bigger slice of the pie than you paid for, or you make the pie bigger.”
Understanding the economics of a sale can be the difference between a good outcome and regret, and knowing how everyone intends to make money can tell you an awful lot about your future partnership.