By Scott Wetzel
As wealth management M&A and succession planning activity continues to accelerate, sellers interested in closing a full or partial liquidity event need to negotiate transaction structures with qualified buyers that help—not hurt—bank financing.
Oftentimes, buyers create and propose succession and acquisition deal structures that behoove buyer interests yet lack awareness of bank financing structural requirements for sellers seeking liquidity. As you approach the sale of your advisory practice, the following factors impact accessibility of bank financing and ultimately cash at closing.
Most banks require some “skin in the game”—a cash infusion—from prospective buyers. Banks may require 5 to 10 percent depending on their credit policy. If you are working with a small business administration (SBA) lender, they will require 10 percent down. However, 5 percent can come from the seller in the form of a seller note.
As a result, the selling advisor must evaluate a prospective buyer’s ability to provide cash at closing to secure bank financing. Succession buyouts can run afoul when junior advisors have failed to adequately save for the buyer-equity requirement.
Succession planning buyers and sellers nearing a liquidity event can increase the probability of retaining bank financing by structuring bonuses to the buyer at least three to six months in advance of applying for financing, to buoy his or her liquidity position. Bank financing enables sellers to recapture this capital allocation to the buyer at closing.
Seller Note Terms
Commonly, seller notes are structured over three- to five-year time horizons whereas bank loans are structured over a seven- or 10-year time horizon. Seller notes can provide a lower-cost financing option for buyers, yet when combined with bank financing their relatively shorter terms can weigh on cash flow for the newly formed entity.
Today’s sellers have increased bank financing options that may alleviate the need for a seller note. Prior to determining deal structures with onerous seller note payments, buyers and sellers should consider cash flow ramifications.
Seller Departure Time Horizon
The seller’s plans for departing the practice post-closing impact options available for financing. SBA loans require that the seller depart the practice entirely within 12 months of closing. Emerging options in conventional financing allow for partial or tranche sales over time. The buyer and seller need to determine what retirement glide path is in both of their best interests as well as that of clients, while obtaining accommodative financing.
A seller note incentivizes the seller to help the buyer with client conversion, over the three- to five-year term of the note as the seller’s clients are successfully converted over to the buyer’s practice. In the absence of a seller note, clawback provisions create a similar incentive for sellers. Commonly, clawback provisions outline client conversion hurdles that are required to convert to the buyer’s practice to release the remainder of the purchase price held in escrow.
When clawback provisions are utilized for 20 to 30 percent of the acquisition price, the entity escrowing the proceeds is very relevant to the lender. Savvy buyers willing to place the escrowed proceeds with the funding bank will increase bank options. The escrowed proceeds provide the bank with a credit enhancement as well as a lower cost of funds.
Buyers and sellers retain attorneys to protect their respective best interests, but oftentimes, counsel for one or both parties creates unnecessary complications. Bank underwriters meticulously review all acquisition documents. When purchase agreements and other contracts become increasingly complex and difficult to understand, underwriters may become wary. As a result, such contracts may cause delay or refusal to fund.
Both parties need counsel, yet buyers and sellers also need to recognize the importance of structuring agreements to facilitate seamless bank underwriter review and approval.
Perhaps the most important action a seller can take to increase buyer bank financing options centers around deposits garnered by the funding bank after the transaction. Most banks require the buyer’s operating bank accounts. In addition, when sellers are willing to hold a portion of newly retained liquidity with the funding bank, the buyer/borrower will have significantly more bank financing options to provide the seller with desired capital at close.
Willingness by the buyer and seller to place their deposits with their funding bank will reduce the bank’s cost of funds and enable the banker to envision a business banking relationship that exceeds merely extending credit.
In summary, sellers interested in realizing their enterprise value by securing cash at closing—with bank financing—can increase the options for the prospective buyer by placing proceeds with the funding lender.
Scott Wetzel is founder and managing partner of Succession Lending, a correspondent lender focused exclusively on supporting independent financial advisor M&A transactions.