Financing
One of the most burning questions for sellers and acquirers alike-once they get past the valuation question-is "How in the world are they going to pay for this?" There are three ways to finance an internal transition. In order of prevalence of use they include:
Through compensation: An individual uses their incentive pay, ownership distributions and perhaps salary increases to finance the purchase.
Through internal borrowing: The business lends the money from cash flow, repaid by the individual over time, with interest.
Through outside borrowing: Financing comes from banks or other sources.
Funding the acquisition through personal earnings and cash flow is the most common method, and is a viable option in smaller firms and/or where the value of the equity being purchased is manageable. However, if the stake being sold cannot be paid off over a term of five to ten years, we would suggest that another method of financing needs to be considered.
While bank financing may be unavailable or too expensive, some organizations (particularly larger ones) have been able to arrange favorable terms with banks with which they have good relationships to facilitate borrowing by team members to whom they are transitioning ownership.
Some interesting external financing alternatives are available specifically to advisory firms. If you are willing to give up some control in return for capital then you may be amenable to working with a more hands-on professional acquirer, including Focus Financial, United Capital, NFP or Mesa Holdings-the more active national players. But for internal transitions, the focus of this article, the purest solution providers are Fiduciary Network and Asset Management Finance.
The Fiduciary Network (FN, coming soon to http://www.fiduciarynetwork.net) offers unique, if somewhat complicated, financing that involves multiple classes of equity. With some $600 million in funding from the Milstein family, owners of Emigrant Savings Bank, FN is looking to become a passive investor in advisory firms.
An FN transaction creates the means for a company to either broaden its ownership or gradually conduct a generational transition, or both. Mechanically it works as follows: The current owners sell equity in the firm to their successors over many years. FN lends the next generation the money to purchase as much equity as possible while FN in parallel buys the remainder. FN's investment is done in the form of an instrument that converts into nonvoting stock so control always remains with the current and future management regardless of how much FN may ever own.
Asset Management Finance Corp. (AMF) also has a creative solution. Instead of purchasing a share of the firm's net cash flow, AMF bypasses the expense line completely by purchasing "revenue-share interests" from the firm, which is simply a right to a fixed percentage share of the firm's total gross revenue for a finite time period. The revenue share interests have a limited contractual life after which 100% of the firm's revenue returns to its internal owners.
When AMF's capital is used for generation transitioning, AMF often does not deal directly with the next-generation ownership team, but instead provides capital to the existing owners. These owners are then free to transfer equity to the next generation when and how they want to. The transfer of equity can be accomplished with internal financing or through other customized equity transfer structures. At no point during the process does AMF acquire an equity stake (passive or otherwise) in the firm, allowing the owners to maintain their independence.
Remember To Think Strategically
Although this column has been focused on implementation, don't forget to start your planning process with the strategic considerations outlined in part one of the column in the February issue. Throughout the process of planning and implementing your transition, continue to go back to your strategic planning as your touchstone to ensure you are implementing your plan in a way that is consistent with the objectives you originally outlined. There is a risk of getting so wrapped up in the implementation-and the sense of victory at finally negotiating a valuating acceptable to both parties-that you lose focus on the strategic objectives.
Internal transition is the desired growth plan and succession plan for the vast majority of advisors and good planning, strategic thinking and thoughtful implementation will allow many to enact a transaction that ensures the desired outcomes for their staff, their clients and themselves.