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. (www.practicemergers.com), and editor of the Virtual
Office News monthly newsletter (www.virtualofficenews.com)