Over the past few years, independent advisors looking to buy practices have started receiving better financing options from lenders.
This has led to increased liquidity for them, and attracted more potential buyers to the market. Due to the laws of supply and demand, this influx of would-be purchasers competing for roughly the same number of sellers is leading to higher deal multiples for advisors ready to exit their businesses.
Let’s take a look at how this works from a valuation and lending perspective, and what that means for advisors pursuing M&A or succession planning deals.
Seller Notes
Prior to modern financing innovations, buyers often would rely on a seller’s note to purchase a practice, where the exiting advisor supplies a loan with a four- to five-year term and high monthly payments on a fixed rate, typically putting the buyer under financial stress during that time period.
Although common, this arrangement has always been less than ideal for either party. Sellers have tended to think, “I do all the work and take all the risk,” while buyers have tended to think, “I’m giving the exiting advisor too much influence over my business.”
Seller’s notes usually produce a relatively small down payment for the seller based on the buyer’s cash on hand. Due to the deal terms, this has resulted in eligibility falling only to those buyers whose own practices already generate significant free cash flow to meet the debt obligation. In other words, despite numerous advisors who wanted to purchase a practice, only a few actually could do so.
Bank Financing
Positive disruption in recent years has changed the game. Institutional financing from banks came first in the form of SBA loans and more recently conventional loans. Banks have long been hesitant to enter the fray of lending to the independent wealth management space, largely due to lack of familiarity with advisor business models and concerns that the average advisor’s lack of collateral would prove too risky.
The advent of Small Business Administration loans to advisors was a clear improvement over seller’s notes in that banks could serve as an objective source of financing removed from the often emotional buyer-seller dynamic. However SBA loans come with floating rates, put liens on the buyer’s personal residence and are generally arduous to conduct.