It has been well documented that culture is the No. 1 component to a successful M&A transaction. If the buyer and seller do not align culturally, it will be difficult for a merger to achieve the desired synergies that everyone saw on paper before the transaction was consummated. The buyer and seller must also agree on the ideal client for the post-merger firm—who will the combined firm service? Do the buyer and seller have similar strengths and similar focus on the same client persona going into the merger? Or perhaps the buyer is interested in the seller solely because they service a different client segment and the buyer is looking to expand its service offering. Either way, it is vitally important that everyone agrees and clearly defines who the new, combined firm will be serving in the future.
Another key consideration is geography. Is the seller located in an area of the country that the buyer is interested in? Some buyers will look only at sellers located in an area where they already have a presence and they can simply roll the seller into their existing office space/infrastructure. Other buyers will look to this acquisition as a way to expand and create a presence in a new and exciting location, serving a different segment of the population.
The last hurdle in the M&A sweepstakes is valuation—can the buyer and seller come to terms on what price to pay for the business and the terms associated with that valuation?
Recently, we have spoken with several frustrated firms that could not complete an acquisition despite alignment of culture, ideal client, geography and valuation. “We got all the way to the finish line, and had to back away in the 11th hour.” They all cited the same deal-breaking hiccup: investment philosophy. In our experience, investment philosophy kills more potential mergers than valuation.
Beyond just the desire to receive a large payout, a main reason a seller looks to merge with a buyer is to gain access to a larger infrastructure that can alleviate the seller of HR, compliance, technology, etc., and hopefully open up access to a broader range of investment options as they leverage the larger firm’s investment platform. From the buyer’s perspective, they are entering into this transaction with hopes of aligning themselves with the seller’s future growth in AUM, revenue and, ultimately, earnings. In that regard, the buyer is very much incentivized to alleviate the seller of any administrative burdens that could potentially keep them from focusing on client service and business development. The buyer will want to rid the seller of not only business administration tasks but also investment management as well. And this is precisely where merger negotiations get dicey.
Meeting after meeting, phone call after phone call, dinner after dinner, the buyer and seller continue to move toward final agreement of a merger: Culture? Check. Ideal client? Check. Geography? Check. Valuation and deal terms? Check. But then the buyer says, “And when you join our firm, we will take over the burden of asset allocation, investment selection and rebalancing of portfolios—so you won’t need to worry about that anymore. We just want you focused on clients and prospects.”
The seller oftentimes balks and says, “I got into this business 25 years ago to be an investor/portfolio manager. It’s what I love.”
To which the buyer says, “Of course! And you’ve done a fantastic job! You’ve built a beautiful business for yourself! But we have a robust investment team that handles that. In the new world, you will no longer be a portfolio manager, you will be a relationship manager. As we’ve discussed, your business is beginning to suffer from the law of large numbers—at your size, you can’t continue to grow at the rate we are basing this deal on if you are researching investments all day and you’re tied to a Bloomberg terminal. We need you 100% focused on gathering assets.”
The seller then sits back and says, “Well, this changes everything … I actually enjoy investment research more than I enjoy relationship management. I was hoping to join, and perhaps someday even run, your investment committee. I envisioned myself spending my days speaking to investment managers and building macro-economic models, and only occasionally speaking to clients. Don’t you see the size of business I’ve grown based on my investment acumen? Did you think I was going to join your firm and let someone else choose the investments that go into my client portfolios?”
The buyer, thinking of all the zeroes in the check they are about to write based solely on the seller’s ability to gather assets, not pick investments, is forced to walk away from the negotiating table. The deal is lost, along with the months spent negotiating.
The tension between a buyer’s need for aggressive growth immediately following the deal’s close and the seller’s desire to “take my foot off the gas pedal and really focus on the parts of the business I truly love (investments)” is very real, and exists in almost every M&A transaction. We feel it is critical that buyer and seller resolve this tension very early in the negotiating process.
If the collective vision for investment philosophy—who will be managing the portfolios and choosing what the best investments are for client portfolios—cannot be agreed upon, there is no reason to continue down the path of exploring culture, ideal client, geography, and hashing out valuation and deal terms. Just as is the case with an organic growth strategy, you want to get to a “no” as quickly as possible and move on to another prospective client that better aligns with your firm’s culture and service offering; when pursuing an inorganic growth strategy, it is wise to lead with investment philosophy and ferret out advisors who do not align on this most critical aspect of M&A negotiations.