In a recent white paper, Brave New World of Wealth Management, Fiduciary Network noted that the wealth management industry is at a crossroads: Owners and clients are aging. Advisors face heightened competition and increasing operational complexity. Their costs are accelerating, and the industry’s pioneers face inevitable retirement. All these changes will reshape the industry.
In this environment, acquisitions could offer advisors (both buyers and sellers) attractive strategies for dealing with these challenges. But, unfortunately, the inexperience of firm owners with M&A transactions makes it hard for them to actually close deals. In fact, for this reason, it’s likely that far fewer transactions will actually be completed than many industry observers have forecast.
Fiduciary Network receives numerous inquiries from firms of all sizes about how to best position themselves as either buyers or sellers. The following is a summary of the traits we have found in the wealth management industry among those who are successful:
Traits Of The Most Successful Sellers
1. They decide to sell when they are still attractive and material to potential acquirers. A wealth manager can become less attractive as a takeover target over time in the consistency of its cash flow and client base as the average age of its clients increases.
Also, size matters. For any given seller, there is a limited universe of potentially interested buyers, and as prospective buyers become much larger firms, wealth managers that today might be attractive acquisitions quickly become immaterial (and, thus, uninteresting) opportunities.
Consequently, smart sellers carefully analyze their firms’ future economics and client demographics as well as the landscape of potential acquirers in their geographic area, allowing them to make much more informed decisions about whether and when to sell. And if they choose to come to market, they do so while they are still attractive and material to their universe of prospective buyers.
2. They do not go to market until they are mentally prepared to sell their businesses. At the same time, sophisticated sellers do not come to market until they are mentally prepared to actually let go of their firms. They understand that an owner must cross a sort of “mental Rubicon” or it will be emotionally impossible for them to consummate a transaction. Moreover, should they come to market but find themselves with cold feet at the last moment, they will have substantially damaged the potential value they may achieve from any future sale. Not surprisingly, buyers are unwilling to incur the significant costs (in both time and out-of-pocket expense) in a sale process with a seller who has a history of walking away just prior to closing.
3. They are realistic about the economics they will achieve if they retain their firms. The most successful sellers also have a realistic, detailed understanding of stand-alone firms’ future economics on a standalone basis. Acquirers have little difficulty determining the actual trajectory of a potential seller’s business and will price a transaction accordingly. But if a seller is unrealistic about the business’s future profitability—or has delusional expectations about the price—he or she will also kill the deal.
4. They are prepared for a difficult, very emotional and time-consuming process. All sale processes are long and emotionally draining. Selling your business is hard. The most successful sellers accept that there is little they can do to change this and they prepare accordingly. They discipline themselves so they won’t overreact to the ebb and flow of the negotiation. They likewise appreciate that they might not fully understand the true intent of certain bargaining positions taken by the buyer, and avoid the temptation to feel personally slighted or insulted, recognizing that no rational buyer would ever want such an outcome. Moreover, they remain focused on the big picture (namely, the aggregate outcomes from the transaction) and do not let the inevitable minutiae of a deal influence their decision-making.
5. They understand the buyer’s perspective and make it easier for them to bid. An advisor who is selling his or her firm may see many potential buyers, but smart sellers recognize that there are very few good fits; perhaps only one or two that are both culturally attractive and have the financial resources to fund a transaction. Because the pool is small, advisors do not want to discourage any firm from bidding.
Sophisticated sellers are also empathetic to difficult challenges facing prospective buyers, in particular those that have never previously closed an acquisition.Thus, they work closely with buyers’ management, helping those who are advocates for a transaction build an internal consensus within the acquiring company to participate in the bidding process.
6. They recognize that buyers invariably underpay for rapid assumption of risk and overpay for certainty. The most successful sellers recognize this calculus. Thus, they work closely with the bidders to help them better measure and understand the risks of client retention and prepare integration plans to ensure a seamless post-closing transition.
7. They recognize that transparency benefits the seller and helps buyers understand the “facts.” In a similar vein, a buyer’s uncertainty about the quality of a target firm’s client base, personnel and systems can be very costly to a seller. The acquirers, lacking good information, assume the worst and adjust their bids accordingly. Consequently, the most successful sellers are as transparent as possible, providing any and all information requested by potential bidders.
They also educate the potential buyers about the true condition of their business and avoid offering unrealistic projections of its future financial performance as a stand-alone enterprise.
8. They recognize that pricing is based solely on contribution and not EBITDA, AUM or revenues. Smart sellers recognize that the post-closing contribution to the buyer’s earnings is the only factor in the buyer’s pricing model; metrics such as the selling firm’s stand-alone EBITDA, its AUM or its revenue are irrelevant. Each buyer will independently prepare its own estimate of that contribution, and the efforts of potential sellers to influence that calculation are a waste of time and potentially counterproductive. Further, sophisticated sellers avoid the temptation of using their own analysis of potential contribution as the basis for their own expectations about what buyers will pay for their firms.
9. They accept that they are selling their firm to, and not merging with, the buyer. Buyers view acquisitions solely as economic transactions and will take the necessary steps to maximize their own financial outcomes. Thus, the operations of the selling firm will be very different after the deal is closed, as will the role of the seller’s previous owners. This aspect of a sale can be incredibly emotionally difficult for selling owners, and smart ones prepare for it before ever bringing their firms to market. Many even retain an executive coach or counselor to help them plan the next phase of their lives.
10. They make wise choices in selecting and managing their transaction advisors. Smart sellers recognize that they will require a great deal of sophisticated legal advice and, in some cases, advice from investment bankers. Legal advice for wealth manager transactions is highly specialized; M&A experience in other industries, including investment management, does not translate well. Moreover, there are only a handful of attorneys who understand the wealth management business and have completed multiple transactions. They charge a great deal for their intellectual capital, and smart sellers are willing to pay for it.
Many sophisticated sellers do not, however, need investment bankers to help them identify potential buyers and analyze bids. But such professionals are most useful when a firm has a diverse shareholder base and needs help building internal consensus for a transaction. In other instances, a banker can be helpful by serving as the owner’s “psychiatrist” during the lengthy and emotional transaction process. Regardless, no rational seller ever pays investment banking fees on consideration paid as stock until such time as the stock is liquid and free to trade.
Traits Of The Most Successful Acquirers
1. They understand that all commercial activity with wealth managers is predated by relationships. Wealth managers generally are reluctant to transact with any entity (money managers, custodians, etc.) with which they do not already have a pre-existing relationship. Given that the most significant transaction any owner will ever enter into is the sale of his or her firm, sophisticated buyers should invest a large amount of time in building relationships with the owners and professional staff of those prospective sellers in their geographic area long before these firms are ever brought to market. Such buyers make efforts to learn about, and genuinely understand, the potential seller’s values and capabilities. Doing so helps the target firm become comfortable with the buyer’s organization.
2. They understand that all potential acquisitions are very low probability events. Sophisticated acquirers also recognize that the likelihood of completing any acquisition, regardless of its size, is extremely low, as many factors (e.g., timing, pricing, personalities, etc.) must line up all at once for any deal to be consummated. Thus, they do not waste their time on acquisitions that will not immediately and materially improve their organization’s profitability. They also limit the time and emotional energy they invest in a prospective transaction until they are confident that it offers reasonably attractive economics and know they are dealing with a rational seller who is emotionally prepared to sell his or her business. And under no circumstances will they disrupt their own organizations until they are convinced such conditions exist.
3. They appreciate that the longer it takes for a deal to get done, the less likely it is to close. Time can be the enemy of successful transactions. Sophisticated acquirers understand that the longer it takes to consummate a transaction, the less likely it is to close. Sellers may get cold feet, successor professionals may attempt to sabotage the transaction, financing may fall away and all parties suffering “deal fatigue” may begin to act irrationally. Thus, when buyers have an opportunity to make a material acquisition, they do whatever they can to sustain the momentum of the transaction even if it requires working nights and weekends and effectively having a second full-time job.
4. They are pragmatic in evaluating potential sellers and how an acquisition will change their own organizations. As pragmatists, sophisticated buyers accept that every acquisition comes with its own set of idiosyncratic problems and challenges and avoid the temptation to quickly disqualify potential opportunities simply because they are less than perfect. Further, they recognize that no successful deal has ever been closed without compromises on both sides. Even the acquirer will be a different organization after closing. However, smart buyers are willing to accept all of these trade-offs provided the benefits outweigh the associated costs and brain damage.
5. They accept that they are going to have to pay sellers a large amount of consideration, including at closing. Another shared trait of smart buyers is that they accept they will have to make a significant cash payment (including a significant closing payment) for any material, attractive acquisition. Some buyers believe that sellers should accept a well-below-market price for the honor and privilege of joining their firms. Smarter buyers keep their focus on their own economics and not on how much a seller might be paid. They also understand that risk allocation matters far more than price.
6. They recognize that their capital-raising options are limited and will include unattractive aspects. A consequence of having to pay a full price for a material acquisition is that most wealth managers will have to raise permanent capital. Sophisticated buyers, recognizing that even the industry’s largest firms are at best small businesses, accept that they have limited capital-raising options. All capital is expensive and comes with defined cash-flow rights as well as some say in the future governance of the acquirer. Further, few (if any) providers are willing to endure the headaches of transactions involving multiple investors.
7. They recognize that success in transactions is ultimately based more on psychology than finance. Sophisticated acquirers understand that offering to pay a lot of money is only a necessary but grossly insufficient condition to completing an acquisition. During the transaction process, many sellers are more emotional than a pubescent teenager, making psychology a far greater determinant of success than finance. Thus, smart buyers go out of their way to make the selling owners as comfortable with their organizations as possible and are extremely patient and are careful to not say anything that can be taken out of context.
8. They understand and appreciate that the seller’s successor professionals are important and scared. As noted earlier, every wealth manager M&A transaction is effectively a “three-handed” deal because the seller’s successor professionals are essential to the ultimate success of the transaction. Consequently, sophisticated acquirers allocate a substantial portion of the transaction’s aggregate economics to the successors and, in some cases, offer them the opportunity to become shareholders of the new combined entity. Equally important, they designcustomized recruitment and retention packages to meet the needs of each successor professional. They also recognize how unnerving a transaction can be to these individuals and spend a great deal of time and energy getting them comfortable with the acquirer’s organization.
9. They are focused on ensuring (and communicating to the seller the importance of) a continuity of client experience. Smart acquirers recognize every selling owner has some anxiety about the potential for client loss should the acquirer make dramatic changes post-closing. They also accept that the seller’s clients are getting nothing out of the transaction. Thus, these buyers ensure that the client experience remains largely constant and that any and all changes are implemented gradually. And they communicate to prospective sellers that they will follow this approach when integrating the firms.
10. They prepare detailed transition plans. Similarly, sophisticated buyers understand that successfully integrating two firms involves an extraordinary amount of highly detailed planning and preparation. To ensure a successful post-closing integration, smart buyers will enlist the seller to help them develop an individual transition plan for each client that identifies the team members from each organization who will be assigned to each of the seller’s clients, creates a schedule for beginning to include employees from the buyer in the client meetings and specifies the nature of the services and ongoing reporting that will be required.