Advisors looking to sell their practices have a numerical advantage in a market flooded with buyers, but they face serious challenges when they get to the bargaining table.

Nevertheless, David Grau Sr., president and founder of FP Transitions in Lake Oswego, Ore., says that in recent months many more advisors have been trying to sell or transition their firms.

“One-in-10 independent advisors right now are selling,” says Grau, who adds that those advisors “only get one chance to do this right” in a rapidly changing industry.

Grau’s latest book, "Buying, Selling & Valuing Financial Practices: The FP Transitions M&A Guide" (Wiley 2016), was announced on Monday.

FP Transitions bills the book as a comprehensive guide for anyone contemplating buying, selling or transitioning a financial practice in the current environment, but Grau pays particular attention to selling and transitioning a book, practice or firm.

The surge of merger and acquisition activity in the past 12 months has been the greatest its been in the past 20 years, says Grau, driven in part by smaller, older advisors who have a dim outlook on the industry's future.

“It’s interesting that we see a lot of pessimism from more senior and experienced advisors,” Grau says. “If not pessimism, then significant concern. At the other end of the scale, younger buyers are typically larger, sustainable and stronger businesses.”

"Buying, Selling & Valuing Financial Practices" follows up a previous book from Grau and FP Transitions that focused more on advisor succession planning and creating sustainable businesses. Those sustainable businesses typically become buyers of smaller practices, says Grau.

Typically, older, smaller advisors sell to younger, larger ones, says Grau, who organizes advisor business models into four different types by size and ownership model: books, practices, businesses and firms. 

“Sellers need to sell to bigger, stronger models with multiple earners and staff with the capacity to take on additional client relationships,” Grau says. “They don’t want to sell to a sole proprietor. If something happens to the buyer, their clients would be left out in the cold.”

At the most basic level, an advisor builds a book of business, whose value and mode of compensation both reside in their top-line revenue generation. Most advisors, 70 percent, according to Grau, merely own a book of business.

Practices, which may include some support staff and infrastructure as well as other advisors who own their own books, rely on an “eat what you kill” model  of income generation and compensation where each advisor draws revenue from his or her own book of business. Grau estimates that practices account for 25 percent of the industry.

Businesses, which account for around 4 percent of the industry, are typically built on a structure of equity ownership and are sustainable entities that can be passed on through generations.

The final 1 percent consists of  firms—established multiowner and multigenerational entities focused on attracting top talent which creates some bottom-line profitability.

Firms tend to buy businesses, businesses buy practices, and practices buy books, says Grau.

“Among the buyers, who are also younger, there’s a sense of optimism and that it’s time to grow,” says Grau. “They’re not interested in just retaining cash flowing clients and assets. They want to build businesses that are strong and durable, and so they want to buy.”

Grau wants to level the playing field between the typically larger, more organized buyers and the smaller, less organized sellers—he goes so far as to encourage buyers to study his advice to sellers, and vice-versa, so that each knows best practices for the party on the other side of the table.

While today’s market may look positive for sellers, with potential buyers outnumbering sellers by 50:1, sellers are traditionally disadvantaged when it comes to transitioning advisory practices, says Grau.

“The market functions differently in this industry,” Grau says. “While the numbers are in the seller’s favor, the M&A market price is tilted steeply in the buyer’s favor."

Among the reasons for this are that advisors usually only have one opportunity to sell a business that they have built over the course of their careers, while buyers often can perfect their acquisition skills by conducting multiple transactions.

With many independent advisors at or near retirement age, the book is being published at a key moment for the financial industry.

Mergers and acquisitions among independent advisors have increased at an unprecedented pace, also driven in part by the pending enforcement of the Department of Labor’s fiduciary ruling.

“It’s the cumulative effect—remember that these folks have also seen a lot of new rules and regulations come to bear over the course of their careers, so you might think that one more isn’t too much,” Grau says. ”If you look out into the future, though, it doesn’t seem like taxes are going to go lower, so if you want to monetize your investment and get paid, now is the time.”

M&A activity is also accelerating due to more readily available bank financing and the development of new financing structures and valuation techniques.

Valuations play a central role in preparing a firm for a transition, says Grau, yet sellers are often unaware of the best ways to assess their practices.

“The most important part is to turn valuation over to a neutral, experienced and credentialed third party," he says. "Take the issue off the table early in the negotiation. It’s the lynchpin in the process. Valuations knock more deals off the table than any of the other elements combined.”

Advisors selling their practice are often concerned about profitability, which leads them to use an earnings-based valuation. However, the profitability of their business will change after it’s sold to a larger, more efficient firm.

Yet many sellers continue to use an earnings-based method to approximate the value of their business, Grau says.

“They’re applying the wrong approach to the wrong business model,” Grau says. “Since sellers most often come out of the book or practice ranks, they’re not highly profitable. The buyers won’t care.”

Valuation should take a realistic, market-based approach in lieu of an academic or theoretical one, adds Grau, using different metrics depending on the size and scope of the business.

Aging advisors are also likely to have an aging clientele, notes Grau, which means that lengthy planning and effort may be necessary to make the business attractive for sale.

“One of the most prominent issues is that independent advisory practices have a tendency to stop growing. We call that going into attrition mode,” Grau says. “Especially if the owner is a force of one or has a small staff—they start taking Friday afternoons off. Then they take all day Friday. They stop investing in marketing. Their demographics get worse. It’s easier to head off if you can get three to five years ahead of the problem. Sometimes it takes a merger into a smaller company to bring in someone younger, but with a lot of energy, sometimes it takes a new hire. Maybe that younger owner would become the buyer. Advisors should give themselves options.”

Grau’s book walks advisors through an up-to-date discussion of regulatory and legal considerations that must be addressed before a transition.

Grau also provides advice on due diligence and custodial changes, and closes his book with a discussion of how clients should be handled through a transition.

“That’s really the last part of the process,”Grau says. “There should be a post-closing transition plan on day one that is built into the valuation process. If a seller says that they’re not going to stay and help with a transition, that should affect the value of the business. Build a professional plan, because you cannot complete a transition on a two-and-a-half page blank broker-dealer form. It’s impossible, you’re going to end up short-changing your clients.”

In researching the book, Grau looked at more than 1,500 completed transactions and drew upon FP Transitions' database containing information on more than 8,000 advisory practices throughout the U.S.