In 2015, a seller’s market will pose both opportunities and challenges for advisors seeking an acquisition or merger partner, making due diligence a key determinant of success. In fact, inadequate due diligence is the leading reason deals fail or fall short of expectations. But where do you begin?

Value The Business
Understanding what drives valuation and what sorts of things are negotiable in a merger or acquisition environment is critical to negotiating a deal that will achieve the short- and long-term outcomes you desire. I recommend advisors begin by quantifying what a particular acquisition would mean to them from a valuation and cash flow perspective, and what opportunities may exist in the book.

That can help avoid common missteps like paying too much for a firm that produced a lot of first-year commissionable business over the past 12 months, which can artificially inflate the firm’s revenue and production due to a non-recurring revenue source. That’s a common pitfall we see when advisors don’t know what to look for or aren’t conducting thorough due diligence.

Reviewing client demographics is another essential step. A large geographic dispersion can make it difficult to get in front of clients and a book where the majority of clients are retirees in the distribution phase can result in a declining revenue stream as clients draw down on their assets.

Structure The Sale
A thorough understanding of the tax implications of different deal structures also provides buyers a competitive advantage in 2015, enabling them to be more aggressive and more creative in their proposals and deal structures.

The most common deal structure my team sees is 30 percent down with the remaining 70 percent financed by the seller and paid out of over the next five years out of business cash flow at a pre-determined interest rate. The seller typically stays on to help transition the clients for six months or more. However, we’re starting to see some deviation from that structure with sellers coming in with specific demands. In the months to come, sellers will be in a position where they don’t have to sell, so they can be very specific about what they want. If a buyer is willing to meet their requirements they’ll be more likely to entertain the offer.

Focus On Financing
In most cases, the majority of the purchase price of the business can be funded out of the cash flows of the acquired business. However, advisors must be able to fund the down payment portion, which is often equal to a third of the purchase price. Most advisors rely on personal capital or lenders, including broker-dealers like LPL that have an acquisition loan program in place to assist advisors with the down payment.

Transition The Business
Working with a firm that has extensive experience transitioning advisor practices will be critical to a smooth transition. Yet, the operational process is only one aspect of the transition. A client retention plan is a principal component. You need a plan to determine how you will communicate to clients and retain both the relationships and assets.

I recommend that buyers and sellers sit down together to hash out the details, including how they will manage client expectations, who is going to reach out to clients and when, what communications will be developed and how they are going to work together to win over any relationships that may require special handling. The more prepared you are, the smoother the transition for all parties involved.

Gauge Success
While client retention is a key measure of success, client retention alone doesn’t determine profitability over time. Identifying any additional expenses that may be incurred to maintain staff and office space and the net cash flow required to keep the business running are important considerations. One thing advisors often overlook is that a large portion of what they pay for in the purchase price is allocated toward goodwill and has to be amortized over 15 years. That has to be taken in account when you’re looking at net cash flow. That is why we help advisors by mapping it all out: here’s the expected revenue, here’s the expected expenses and any additional expenses you may have to undertake in order to keep this business going.

Cash flow is something we really try to educate advisors on in terms of taking a conservative approach in their assumptions. It’s easy to get into trouble if the purchase price and deal structure is aggressive and they haven’t given themselves enough leeway.

As Senior Vice President of Strategic Business Solutions at LPL Financial, Jeremy Holly oversees an experienced team of industry consultants with backgrounds in finance, business consulting and succession planning. His team has facilitated and consulted on over 50 closed transitions this year.
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