Here's what you should consider when you plan to buy another firm.

First in a three-part series

    Growth is your goal. You're not planning to retire anytime soon, and you're not one of those advisors who no longer takes new clients. You want more clients and you want them now.
    What are your options? Your first option is the traditional one of acquiring one client at a time. The more you invest in seminars, direct mail and referral programs, the more clients you bring in. But traditional marketing methods yield fairly linear growth accompanied by pitfalls that veteran advisors well understand. Getting results is a time-consuming, expensive, trial and error process, leading many advisors to discontinue their marketing campaigns before they completely pay off. If you are successful in getting prospects' attention, you must qualify them: do they meet your age, occupational or gender criteria? Can they benefit from your unique expertise? Do they have the right financial characteristics, and will they pay your fee? Nothing is guaranteed.
    Your second option is to expand your business exponentially by acquiring an existing client base from someone who already has invested many years and resources building a practice the hard way. By acquiring his practice, you pick up where the seller left off, with no interruption in revenues. Instead of marketing, you spend your time servicing your newly acquired clients (in addition to your existing clients). That is, you engage in a service process rather than a sales cycle.
    I learned this lesson myself in 2001 as the seller of the small advisory practice I'd been building since 1981. The smart buyer of my client base believed it would be more efficient to pursue the practice acquisition method of growth and began to research the business transitions market. He acquired my practice in May of that year and went on to buy yet another practice the following year. Kristofor Behn, president of Fieldstone Financial Management Group LLC-my buyer-says, "There's no better way to build a practice than through strategic acquisitions."
    "However," adds Behn, "the challenge in the practice acquisition marketplace is catching the seller's attention and enticing him to enter into an introductory discussion. In today's market, sellers routinely entertain 30 to 40 offers. Of necessity, they must find one or two bits of information about their would-be buyers so as to eliminate most of them from consideration, simply because they must get down to a manageable number from which to choose."
    Therefore, understanding a seller's motivation is key to preparing one's bid for a practice, and ultimately in getting a seller's attention. Always remember the seller's top priority: He wants a buyer his clients will stay with. They will stay with a buyer if they are being well served, and the seller will therefore get paid.
    To appreciate this is to appreciate the mechanics of the typical, small-firm deal. There are four components: the multiple of revenues, the downpayment, the earn-out and the payment period. The purchase price is first established as some multiple of the seller's revenues. For example, it's not unusual for a fee-only practice, like the one I transitioned, to sell for two times the previous 12 months' fees, or gross revenues, from those clients being sold. The downpayment the buyer will pay to the seller at closing is some percentage of this total purchase price. The remainder of the purchase price is usually paid monthly or quarterly as a percentage of realized revenues for an agreed-upon payment period.
    Consider this example: The seller wants to transfer 40 client relationships that earned him gross revenues in the previous 12 months of $200,000. He and the buyer agree upon a 2.0 multiple and a 25% downpayment, meaning the buyer pays the seller $100,000 at closing. They then agree upon a payment period of three years for the remaining $300,000 to be paid. Therefore, the buyer will pay $100,000 a year, or 50% of the revenues from the clients, in each of the three years after closing. (If the seller is smart enough to demand a 2.0-multiple purchase price on a present-value basis, then the payments will somewhat exceed $100,000 a year, depending upon the agreed-to discount rate).
    Ah, but there are nuances. First, the subsequent payments can be guaranteed or not. If the buyer signs a promissory note, while not the norm, he is guaranteeing the future payments whether or not he retains the clients. More typically, the buyer and the seller share the risk of client retention by agreeing that the seller will receive his 50% of revenues for all clients who remain with the buyer. If a client quits, both the buyer and seller are out some future income.
    The interplay of these components explains why deal terms are what they are. A high downpayment shifts more risk to the buyer; a lower one shifts more risk to the seller. A longer payment period shifts risk to the seller; a shorter one to the buyer. If the buyer strongly desires a longer payment period, everything else being equal, the seller might demand a higher multiple to rebalance the risk. And so on.
    In the second part of this series, we will examine how Behn did all the right things to rise to the top of my own 40 would-be-buyers list. First, let's look at what he did right before I even put my practice on the market.
    He obtained the right credentials and experience. If the seller's primary concerns are ensuring a high quality of continued service to his clients and getting paid for the income annuity he has transferred to the buyer, will he value an experienced, credentialed buyer more highly than an inexperienced, uncredentialed one? You bet. Anything that contributes to the likelihood that the seller is going to maximize future revenue is going to inure to the buyer's advantage.
    Can you buy a practice without credentials and experience? In some cases, yes. Most commonly, such a buyer will have worked in an advisory firm for some period of time and will negotiate to buy some of the clients he's served as he prepares to leave his employer and establish his own practice. However, a buyer in the open market who has a CFP designation and no experience will be at a distinct disadvantage, forcing a seller to seek terms that compensate for the high level of client retention risk the buyer's inexperience poses. A would-be buyer with neither a CFP designation nor any real experience is not a realistic candidate to attract the attention of an open-market seller.
    Behn was a CFP with five years' experience when he approached me-not an industry veteran, but experienced enough to have amassed his own client base and to have enjoyed some success as both an advisor and an entrepreneur.
    He achieved proficiency with technology. A major component of every business transition that both parties often overlook is technology. A financial advisory firm runs on some combination of technology, and that combination is different for every firm. As a buyer, should you limit your bidding only to those firms that use exactly the same kind of computer network, the same accounting software, the same portfolio reporting system, the same financial planning program, and the same client relationship management (CRM) software that you do?
    That would be unrealistic, of course. After all, if there were, say, three possibilities for each of these components, then there would be 243 possible technology combinations. That would make a buyer's market impossibly small. It's much better to be able to demonstrate a proficiency with technology that convinces a seller that you can absorb his client data, regardless of the systems he uses, and be up and running quickly. Behn demonstrated such proficiency.
    He arranged financing. Sure, the seller's probably going to finance the majority of the deal, but not the whole thing. As a buyer, you need a downpayment and you need to be able to cover your portion of the closing costs. If you go through a marketplace like that provided by Business Transitions Inc. of Portland, Ore., you're going to have some commissions to pay, too. All told, you could be looking at $100,000 or more for a small practice. And a smart seller, just like a first-mortgage lender, wants to know that you didn't borrow the downpayment from an entity that will have any claim to the client revenues needed to meet the seller's earn-out requirements.
    Behn secured lending from family and friends that was subordinated to my claims.
    To summarize, Behn was prepared to step into the marketplace. He gathered or cultivated the resources he needed to meet most sellers' minimum requirements. Armed with these tools, Behn could look seriously for a seller to court. His next job would be to learn the tricks of the marketplace: how to get a seller's attention, how to make a favorable impression and how to coax the result he wanted. We'll see how the buyer can gain a market advantage next month.

David J. Drucker, CFP , a fee-only financial advisor since 1981, is a principal in Practice Merger Consultants Ltd. (, and editor of the Virtual Office News monthly newsletter (