There’s no doubt the advisory industry is consolidating, but it’s not a process of splashy acquisitions. Instead, many top firms are joining forces with like-minded smaller firms, and at times with each other, to form bigger organizations with larger market footprints. Big acquisitions with high valuations garner all the publicity, but a quiet current of mergers is powerfully transforming the industry, and such combinations may become one of the primary succession mechanisms for midsize firms.

An investment banker told me once that “there is no such thing as a merger—someone is always being acquired.” While this may be true—and the vast majority of mergers in the industry are between larger firms and smaller ones—there must be a reason that firms prefer to call them “mergers.” I believe it indicates a sincere desire to collaborate.

The interplay can be amusing: It is clearly a market where everyone wants to buy, but no one is selling. In our 2016 survey of the industry, we found that 83% of all the firms in the industry had actively sought to buy a firm, but only 19% of the firms had sought to sell their own shares to external buyers. It’s more conspicuous among larger firms: The percentage of sellers drops to 5% if we only include firms with more than $250 million in AUM.

Yet 46% of all the firms in the survey had actively negotiated a merger. This means that while no one is selling, half the industry is considering merging. Somehow, no one is on Match.com but a lot of people are getting married!
 

What Is A Merger?
I believe the choice of mergers over acquisitions goes beyond semantics, and there are reasons both sides prefer the former:

• First of all, in most mergers, the founders and key executives of the smaller firm are not retiring or exiting but becoming very active in the new organization. In fact, this is usually a requirement of the other firm. Most firms would not want to merge with another if the founders are running out the door. Expectations are likely high for the new organization’s growth and development.

• There is little if any cash changing hands in many of the deals. Very often the two organizations exchange “paper for paper” and are both heavily invested in the future success or lack thereof. No one is putting money in the bank. In a way, both sides are doubling down on their investment.

• The client service history for both firms will be respected, and their compatibility is one of the vital criteria. The resulting combination should very rarely drastically depart from service methods that had worked before at both firms.

• The leaders of the smaller organization are not replaced or marginalized but asked to continue leading, only now in the context of the bigger firm. This is especially true in geographic expansions.

• A merger suggests a genuine desire to create a combination that represents the best of both worlds rather than a process of assimilation.
• Of course, no one wants to be acquired. It’s not something owners want to tell their clients or employees. “We are merging,” sounds better than “We are being acquired.”

The origin and history of the mergers are also different from those of acquisitions. Mergers tend to begin with conversations in a study group, drinks at the bar during a custodian conference, or from years of the principals knowing each other from common non-profits or industry boards. Mergers usually don’t begin with cold calls or the involvement of investment bankers—they tend to have more organic sources and follow a slower and more careful pattern of exploration.

Why Mergers Appeal To Many Firms
Founders often don’t want to simply sell because often they are either not “done” yet or they worry what will happen to their clients and staff if they give control to another entity.

We in the industry are keenly aware that founders are aging, but many of them outright reject the notion they are near retirement. Many are not in their 60s yet; in fact, more than half of the founders we work with are not yet 60. Even those who are often do not feel as if they are done. They still have the energy and the drive to do more and achieve more.

But they also realize that if they want to build a successful and competitive firm, they don’t have to do it on their own. One of the key things motivating advisors in the mergers we have observed is their desire to achieve more, not just “fund” their succession plan. Much like we see many experienced basketball players joining a contending team for their last one or two seasons, many founders involved in mergers want “one more run for a title.”

In an industry where attracting good advisors is becoming more difficult and more expensive, where technology is changing and evolving, where practice methodologies are progressing quickly and when serving high-net-worth individuals is getting more complex, many firms are asking a very important question: “Is the best way of achieving our vision working entirely on our own or should we join forces with someone else who has the same vision?”

Of course, many mergers are also rooted in concerns about the future of the profession. Almost every advisor worries about the next recession. Many also worry that fees may need to come down and that their profitability will not remain at its current enviable levels. Valuations have been high, but there is also a concern that when the entire generation of founders retires, they may flood the market and damage valuations. The logic is that it is easier to weather the storm on a larger ship.

Types of Mergers
The mergers in the industry can be classified in three categories:

• True mergers of equals. We have already seen several deals where large and very successful firms join forces and combine their respective people and strategies to create formidable competitors who are regional and will perhaps soon be national. Such deals are less common, but when they happen they transform the industry and many markets.

• The merger of large and small firms. These are combinations between midsize firms that are well established in one market and large firms with national or regional ambitions that seek a presence in that market. While one firm is larger and the other smaller, the combination is organic and driven by a desire to collaborate.

• The merger with a practice. Often, the owners of a successful solo practice choose to merge into a larger firm and join the existing partners. Such “tuck-in” mergers often go unnoticed from the outside, but the addition of one more owner and a great group of clients makes a real difference for the resulting firm.

Whatever the type of acquisition, they all tend to succeed or fail in the same way.

How Do Mergers Succeed?
The successful deals have one thing in common—both parties are very open and specific about their plans and goals.

The opposite is unfortunately true, too. If the deal struggles, or worse if the post-deal execution struggles, it is usually because the goals were misrepresented. At times, the larger firm has no respect for the smaller firm or its methods and can barely wait to change everything. That means it was never really a merger—it was an acquisition disguised to feel friendly. Smaller firms, on the other hand, often sabotage themselves by presenting their desire to grow and build together, but then it turns out the owners only wanted to retire and cash out. Frequently in the negotiation process, both firms try to present their best sides, but eventually the flaws that drove them to the deal become exposed after the signatures dry.

The best mergers are usually not those where investment philosophies are compatible or technologies integrate easily. Instead, the best deals are the ones between leaders who can’t wait to call each other “partner.” The excitement about building a business together with a like-minded group of people is a powerful driver that can overcome many of the financial and operational obstacles.

What Is The Process?
Which brings us to the terms. The simplest thing to know is that the two sides will be partners and share in everything—all the success or all the struggles. If the discussion starts with the topic of valuations or terms, chances are it will not go very far, or at best the deal will feel like an acquisition more than a merger.

The ideal process should resemble concentric circles with every next circle (meeting) getting you closer to the center:

1. Your Shared Vision. What are the reasons you are combining firms? How will the combination make you more successful and competitive? Who will be your target clients? What services will you provide? What will be your goals for the next five years and beyond? What culture are you looking to create and be part of?

2. Your Personal Goals. What motivates you as individuals? What business values do you hold? What do you enjoy and hate doing? What do you see as your strengths? What are your goals personally?

3. Your Shared Data. Are both organizations profitable and growing? What do benchmarks tell us about productivity and efficiency? What is the quality of client relationships and the pricing of services? What will the combined financials look like?

4. Business Planning. What will the new organization look like? Who and how will service clients? Who will develop business and what kind of business? What systems will survive the merger? What are the milestones for combining the firms?

5. Partnership Structure. What will be your responsibilities as partners? Who will get paid how? Will you have profit centers or will you operate a combined P&L? What will be your titles? How will you make decisions? How will you use or distribute/contribute capital? What are the future risks and how will you deal with them?

6. Deal. What are the valuations or formulas for combining? Will there be an exchange of equity? What obligations to retiring and retired partners exist now? How will you “divorce” if something doesn’t work?

Again, it is very tempting to jump to the valuation discussion, but if this is truly a merger it is difficult to begin there. Since in a typical merger there is little or no cash changing hands, the valuations are a bit more abstract than they would be in a cash deal. What usually matters the most is the “exchange rate”—the rate at which one company exchanges shares for the equity of another. This gives rise to many complex questions of valuation and financial analysis that should be considered carefully. Valuation experts can certainly help here, but both firms also need to carefully educate themselves about the methodology and logic of the reports and carefully discuss the data and results with the experts.

The valuation is often not where the rubber meets the road. Often, what’s more important is the income to the owners after the firms’ integration.
The structure of the merger and the size difference between the firms may mean an immediate drop in income for one or more owners. The trade-off may force some decisions and a dose of reality. For example, if you really believe the merger will grow the firm quickly, are you willing to give up income to achieve that?

Who Should Be Thinking About Mergers?

It seems most advisory firms are already intrigued by mergers. After all, close to half of all firms are already discussing them. My advice would be that mergers are all about finding a good partner. If you find that partner, you should very much consider joining forces and achieving your vision together. On the other hand, if you are not convinced you have the right partner, there are no industry conditions or competitive dynamics that will make a merger a good idea.

The same applies to succession. If you have found a firm that you trust with your clients and your people, then a merger may be the right way to solve the problem. However, if you can’t trust the other firm completely, what are you achieving by combining your problems?

Many mergers may very well be dressed up acquisitions, but even the desire to signal collaboration is important. After all, if you examine the history of the accounting industry, this is how the Big 4 and even regional firms came to prominence—they were built through mergers, not acquisitions.


Philip Palaveev is the CEO of the Ensemble Practice LLC. Philip is an industry consultant, author of the book The Ensemble Practice and the lead faculty member for The Ensemble Institute.