Stories from the trenches: how buying and selling advisory firms is changing.

Make no mistake-when it comes to mergers and acquisitions among advisory firms, it's still a seller's market. But that doesn't mean buyers aren't striking deals that fit their strategic needs superbly, too. Just ask Augustine Hong, who acquired a Virginia planning firm to help his New Jersey-based money management business launch wealth management services. Or Michael Leonetti, who is growing his advisory firm by folding existing practices and practitioners into his Buffalo Grove, Ill., company.

These folks are part of a new breed of advisors who want to get bigger and are willing to make strategic acquisitions-sometimes more than one- to do it. The action is reflected in the accelerating pace of acquisitions in the wealth management industry, according to Berkshire Capital Corp. In fact, wealth management firms were the one shining star in an otherwise retreating M&A marketplace among asset management firms. While overall M&A transactions declined by 11% in deal value (to $9.3 billion) and transferred assets under management fell to the lowest level ($375 billion) in a decade, activity among wealth management firms soared. At the high end of the market, Mellon Financial acquired Atlanta-based Arden Group and its $750 million in client assets, adding a strategic Southern presence to its $69 billion, 60-office wealth management business.

But big firms were not the only sector of the market busily being courted and acquired in 2003. More than 2,850 buyers, who range from smaller practitioners to CPA firms and broker-dealers, are currently registered on FP Transitions, a Web-based brokerage service for advisory firms. More than 150 firms sold through the service in 2003, and there were about 30 potential buyers for every seller. As important, average down payments and selling prices also jumped in both 2003 and 2004, says David Grau, president of parent company Business Transitions LLC, Portland, Ore.

The average sales price for fee-only firms rose to 2.08 times annual gross revenues in 2003, while commission-based shops sold for 1.1 times annual gross revenues.

"Most of the sellers we see are still one-principal shops with zero to five-person staffs and $10 million or less in assets. Buyers are all over the place but tend to mirror the sellers, though a third of buyers tend to be bigger, out-of-state firms," Grau says.

While large acquirers may want to buy businesses and leave principals in place to grow assets, that is less often the case when smaller practices are acquired.

One major factor driving M&A, although not the only one, is the aging advisory population. Simply put, older advisors are steadily moving toward retirement. The average age for fee-only advisors is 48, while the average age for an independent registered rep is 50, says Chip Roame, president of Tiburon Associates. "The industry is steadily aging, while at the same time interest in advisory firm acquisitions remains high, a combination that is likely to create more M&A," Roame says. "At the same time, the big stock market downturn made for an exhausting ride for some planners and advisors who may not want to rebuild their practices," the consultant adds.

Age and the desire to golf motivated Tom Grzymala, principal of Alexandria Financial Associates LTD, in Alexandria, Va., to start thinking about retirement about three years ago. "I'm 63 years old, and it's time to start slowing down a bit and enjoying more golf courses," Grzymala, a former Navy commander, declares.

To prepare to sell his firm, which had $85 million in assets under management, Grzymala and his partner and wife, Barbara, who ran the firm's tax practice, began to transition clients to other planners at the firm starting about three years ago. The purpose, Grzymala says, was to create a turnkey business that could be sold seamlessly, without having to disrupt client relationships. Advisors at the firm were fully apprised of the Grzymalas' desire to sell and were given the first right of refusal, but declined to purchase the firm.

To find a buyer, Grzymala listed the firm on FP Transitions and got about 30 inquiries. They seriously interviewed about eight firms before deciding the best fit was Augustine Hong and his partner, Munish Sood, who run Botree Asset Management, a Princeton, N.J.-money management firm with $1.2 billion in assets from institutional clients. Working with individual clients appealed to them as an opportunity to diversify.

One of the selling points, besides personality fit, was Botree's decision to leave Alexandria Associates intact and bring on a managing partner to run it. "I could just sense that these guys, who managed $1.2 billion, would be a good fit for my clients and my employees," says Grzymala.

The planner fetched a little more than two times annual gross revenues in the sale. "The way the deal worked is we got a down payment (a third of the selling price), a third as a promissory note and third as an earnout," adds Grzymala, who along with wife Barbara will stay on until March to assist with the transition.

Hong says his goal is to cross-pollinate services a little bit between planning and money management, "but more importantly to better leverage our expertise in creating an ideal and efficient wealth management practice." Before creating Botree, Hong was chief operating officer at Global Value Investors.

In addition to bringing on a managing director at the advisory firm, which will be moved to more efficient space in the coming months, Botree has spent about $50,000 creating a technology tunnel between the New Jersey and Virginia offices, to close the physical gap and create immediacy. The firm plans to spend another $15,000 to $20,000 to complete the first phase of technology improvements.

The strategy is not to change how advice is delivered, Hong says, but to improve on back-office functionality and free up planners' time so they can spend it with clients and prospects. "The real test in terms of profitability will be in the second year, when there should be a bump in revenues and we can see if our challenge to everyone to do things a bit differently pans out."

The firm will also be focusing on bringing in higher-end clients. "We do plan to swim upstream," says Hong. "Before, the practice itself didn't have the discriminating authority to turn away clients, but we're looking for clients with at least a few million in assets and we're not opposed to letting those with a few hundred thousand go."

Currently, the firm is at about $100 million in wealth management assets and would like to get to $500 million in the next two to three years through marketing and more acquisitions. "We're looking for firms in the Northeast corridor between New York and Virginia that will benefit from our infrastructure, are generating wealth management fees and are not advisor-dependent," Hong adds.

While Hong does not plan to retain principals in any of his acquisitions, the opposite is true for advisor Michael Leonetti. He finished one acquisition in the past year and is about to complete two more-all in a strategic bid to grow by acquiring assets and building a structure at his firm that allows him to go after larger clients and even provide family office services when needed. Currently the firm has eight planners and each has an assigned paraplanner and assistant.

Instead of buying practices and shedding the practitioners, Leonetti favors bringing some practitioners onboard, usually in exchange for equity. "We want to position ourselves as a firm that can address sophisticated clients with highly personalized service, so we need these practitioners," says Leonetti, who is acquiring both veteran and younger planners' practices.

The aging planners are obvious targets, says Leonetti. "They want out and don't want to have to rebuild clients or assets after the market fall. But the younger advisors are fascinating, too," he says, "because a lot of them are entrepreneurial and, in essence, victims of their own success."

There are only so many hours in the day for the owner of a one-principal shop, especially one that has begun to accumulate serious assets, Leonetti says. "One way they can open up their options for growth and equity is to bring their clients and skill base to a firm like ours."

Late last year, Leonetti acquired Successful Financial Solutions Inc., and its $39 million in client assets, and moved one of the principals and his staff into Leonetti's firm in Buffalo Grove, Ill. "Once we agreed on a valuation, we paid cash to one retired principal, cashed out a partner who had 9% equity and brought on one of the partners for equity in our firm," Leonetti says.

The acquisition brought Leonetti's total assets to about $350 million and is a less expensive way for him to grow his firm than marketing. "It doesn't cost me anything," the advisor says. He uses the acquired firm's cash flows to cash out principals over a couple years and to pay practitioners who come aboard at Leonetti & Associates.

His target market, like Hong's, is firms that have higher-end clients and talented advisors but with operating inefficiencies he can exploit. "What I'm trying to find in these deals are companies that aren't run as businesses, but as practices-firms that don't have systems in place. With the Successful Financial Solutions deal, we were able to take a firm that wasn't profitable, cut out two principals' salaries and a staffer's salary and eliminate their rent, overlapping technology and other costs. The transaction created an immediate profit," Leonetti says. "This was just the right firm, the right structure, the right numbers and the right people at the right time."

The other two acquisitions he has in the works involve similar deals, albeit with young, one-principal practitioners who have grown sizeable practices but need a more structured environment in order to continue growing. Both practitioners are interested in bringing their practices to Leonetti & Associates in return for equity. The larger of the two planned acquisitions will add approximately $150 million more in assets to Leonetti's $350 million.

"The competitive environment is tough these days, even for fee-only planners," says Leonetti, who fits the profile of someone building a business a little bit more than of a planner these days. "In the beginning when I launched my firm, I was a practitioner," he says. "Now, most of my time is spent on business planning and acquisitions. The people who don't want to make that transition-those who want to stay as planners-they're our next acquisition opportunities."

As for problems, Leonetti says avoiding them is part of finding the right deal in the first place. Beyond making sure the numbers work, it's crucial to ensure that the people or clients fit your firm. "Finding the right mix and not jumping the gun is important," the planner says.

The absorption or transition period post-acquisition could be trying, he says, but so far the only hurdle he's found is in trying to get principals who come on to let go of their way of doing things. "For instance one planner wants to offer simplified planning, like net-worth-statement and insurance planning. But our plans are comprehensive, so they're having to make that transition."

Leonetti's strategy of growing his firm by bringing on entrepreneurial advisors who have already built practices, as opposed to bringing on junior planners, can be a stroke of genius because it doesn't really cost the acquiring firm anything. "Basically you're giving the advisor the equity they brought to your firm in the first place," says Roame. "It's a fairly savvy growth strategy."

Of course, it's a fact of life that not all deals work the way they should, which underscores the need for advisors to plan for all legal contingencies and strive for a match that will be a good fit. Kabarec Financial Advisors Ltd., in Palatine, Ill., sold half its $150 million in client assets in 1999, only to buy them back in 2002. "We were being courted by several money management firms, even H&R Block, which started talking about offering us real money," says the firm's principal, 55-year-old Michael P. Kabarec.

The thought of such a deal peaked the interest of Kabarec and his wife and business partner, Karen, in expanding their business, while being able to cash out part of their equity. Uninterested in the first suitors who came calling, Kabarec turned to the local office of his broker-dealer Charles Schwab, which introduced the advisor to money management firm and buyer Optimum Financial Advisors of Chicago. The synergies were enticing on paper.

By acquiring half of a planning firm in the form of preferred stock, Optimum would be able to refer all interested money management clients for planning, thereby creating additional cash flows and the type of relationships that comprehensive financial planning can produce.

In return for the cash flow from 50% of Kabarec's clients, Optimum agreed to pay Kabarec a purchase price and ongoing payments on notes. "We were throwing them cash flow, and they were throwing us cash right back to pay notes," Kabarec says.

While the relationship was amicable from start to finish, the market downturn and Optimum's culture sidetracked the desired cross-pollination of money management clients. They were referring few clients for planning, so in essence they were paying for a planning firm they weren't using or growing.

In 2002, both parties decided to undo the deal. "We bought our stock back at a deep discount," Kabarec says. "It was a highly lucrative deal for us." The planning clients had always remained with Kabarec Financial Advisors, so there was little or no disruption.

Crucial to the unwinding of the deal was the contract, which stipulated that if Optimum defaulted on its notes Kabarec would get to keep its preferred stock, which it held as collateral. The trial acquisition run, says Kabarec, gave them the incentive to begin structuring their firm as a turnkey operation that they can gracefully exit as part of an even more profitable sale in three or four years. "Almost all of our new clients are assigned to another professional in our office who will go on to the new firm," says Kabarec.

They've also designed a successful marketing program-the first, Kabarec admits, since he founded the firm 22 years ago-and hope to grow revenues and the ultimate payout to more than $2 million for he and his wife. "We've been approached by several reputable firms, but we're just not ready yet," Kabarec says.