Experts repeatedly warn that the aging financial advisor population needs to get its succession plans in order, but a new report says advisors need to straighten out something else: their heads.
The emotional side of selling or buying an advisor business, and the tactics an advisor can use to get through a deal without going nuts, is the subject of a new white paper by Fiduciary Network LLC, an investor in wealth management firms. The report was written by Fiduciary Network's CEO Mark Hurley, COO Yvonne Cantor, and managing directors Benjamin Robins and Steve Cortez.
The findings of the report were based on its experiences with the 17 investments it has made in advisors, and more significantly, the countless other deals it was involved in that never materialized.
The failed deals, in fact, are what led to the white paper. Fiduciary Network officials say psychological factors—including unrealistic expectations by sellers and buyers—were key reasons deals failed.
“In these transactions, a combination of the buyers’ and sellers’ inexperience and each side’s inability to understand the other’s perspective became insurmountable obstacles to completing a deal," the report states.
Delusional Sellers
The report focused on the psychological aspects of being both a seller and a buyer, while cautioning that the paper is a collection of laymen’s observations rather than a clinical psychological study. “We do not consider ourselves to be psychologists and do not pretend that this report is any sort of scientific study,” Fiduciary Network writes in the report.
Nonetheless, the report does argue that delusional thinking is a key reason why advisor merger and acquisition deals fall flat; it also spells out how buyers and sellers can use psychology to gain an edge over the those sitting on the other side of the bargaining table.
The white paper, for example, offered the following advice for sellers who want to mentally prepare for a deal:
Do not come to market until you are emotionally ready to sell.
The report suggests that advisors should get emotionally prepared to sell by not dwelling on the transaction, but by focusing on the lives they will lead after their business is passed onto someone else.
Many advisors find it hard to let go of their business—the reason many of them enter into an agreement to sell and then ultimately fail to pull the trigger to close the deal, the report notes.
Advisors who successfully make the transition frequently spend time preparing for life after the sale, with some going as far as hiring a life coach to shepherd them through the process.
“Long before they bring their firms to market, smart selling owners are already excited about moving onto what is next in their lives,” the report states. “They have identified new challenges and opportunities, often far different from what they have been doing for the last couple of decades.”
Do your homework.
Advisors who have successfully pulled off a sale share another trait, according to the report: They thoroughly researched how deals are structured, put into motion and ultimately completed.
One of the most important things an advisor can do, the report states, is talk to people who have already sold their practices.
This is in addition to researching professional advisors who can help get through the transaction, the buyer’s market and the potential value of their business, according to the report.
“Most importantly, they develop a general understanding of what the M&A market will likely pay for their firm and under what conditions,” the report states.
Become realistic about what buyers are willing to do.
Advisors can have an inflated view of the quality of their practice and, consequently, its selling price, according to the report.
A key to a successful sale is being able to look at your business objectively.
“Savvy owners force themselves to move beyond these emotions (fantasies, really) and become realistic about what it is they are actually selling,” the report states. “They accept that what they own is simply a very tiny business that … does not make very much money.”
Accept that clients are realistic about your need for succession.
Advisors need to realize that clients understand that the business will eventually transition to new ownership, the report states. The focus should be on maintaining the practice’s independence.
“It’s much easier to have a conversation with clients regarding a sale to another wealth manager than it is regarding a sale to a bank or a roll-up [firm],” the report states.
Prepare for a long, emotionally grueling transaction process.
The typical sale usually creates an “emotional roller coaster ride” that lasts from nine to 15 months, according to the report. That includes about two to three months to narrow down the field of candidate buyers. Once that is completed, a potential buyer is usually given exclusive rights to negotiate an agreement for 90 to 120 days.
What follows, according to the report, is best described as a “grind.”
“A typical wealth manager M&A transaction involves three to four inches of documents,” the report states. “Each will have to be reviewed by counsel and will undergo significant revisions at least a dozen times.”
Enhancing Bargaining Power
The report also lists four ways in which sellers can reduce the bargaining power of their future successors, while discouraging them from abandoning a succession plan.
The report offered the following advice:
1. Fully institutionalize client relationships: Clients should view themselves as clients of the firm rather than clients of a particular employee, according to the report. This limits a successor’s ability to leave the firm and take clients.
2. Broaden ownership in exchange for successors tying themselves more closely to the firm: Another way to discourage successors from leaving is to offer financial inducements, according to the report. “No rational successor professional is going to voluntarily handcuff themselves to a firm without first receiving a material inducement for doing so,” the report states.
3. Put in place a detailed internal operating agreement and financial transparency: A clearly spelled out plan makes it easier to enforce the conditions of a contract, according to the report.
4. Bring your firm to market several years before you need to: Advisors shouldn’t wait until their backs are against the wall to initiate a sale, according to the report, because being in such a position reduces bargaining power. “”Successors can almost always figure out when the selling owners are in a position in which they have to sell,” the report states.
Buyer Psychology
The report also explored buyer psychology, and offered several ways in which buyers can mentally get themselves ready for a sale. The advice included doing extensive due diligence on the firm’s ownership and any restrictive covenants on successors.
Among the tips given to potential buyers:
• Find out who has voting control over a potential deal before commiting to it.
• Determine whether the sellers are emotionally capable of selling the business. One warning sign is if the owner tried to sell the business previously and failed.
• Determine whether the seller has a realistic view of the firm’s value.