Hurley: What’s going through the seller’s head during the process?
Frieden: Every seller has a reason. Some are selling because they have taken a business as far as they can—grown it as much as they are capable of growing it. They are selling at what they believe is peak value for that business. They could continue to run the business but have chosen to sell instead to maximize value.
Some are sellers because they don’t have a succession plan or they are 70 years old and are out of gas and just want to retire. That subset of people is selling because they want liquidity and to go off into the sunset and be done.
Another subset includes people who are selling because they know they’ve got a broken widget and they want to sell it before it really falls apart. Some of these firms may have a disproportionately old client base, personnel [or] advisor or [have] compliance problems that will take time to fix and have decided to sell rather than fixing the problems.
Even more do not know they have the broken widget or are in denial about it. They’ve been clipping coupons and feel good, but they are not looking at it from the standpoint of somebody who’s buying those cash flows and expects to collect them for the next 20 years. Buyer due diligence often turns up these problems, which may then lead to a reduction in purchase price or the parties walking away. A seller who loses a deal over diligence problems may find it much harder to do a deal down the road as well.
Hurley: What are the biggest mistakes by sellers?
Frieden: Owners who think that they are ready to sell, but they are not. They are not over the Rubicon. They want to get paid and are tired of coming to work every day. But when somebody else starts telling them what they’re going to do with their business they don’t like that, and they’re unwilling to turn over the reins.
Hurley: Do those deals ever get done?
Frieden: No. [These kinds of owners] decide they want to sell and start a process. However, they over-negotiate everything and end up blowing up the deal. Every point evolves into a price negotiation. They want a zero-risk sale, at 10 times earnings, and they want it in cash at closing with no deal protections for the buyer.
The first thing I try to find out is whether they really are a seller and why they’re selling. That is critical. Next is to understand whether they have a franchise that could be appealing to buyers. If you have to sell, you don’t have a whole lot of leverage. If you have a company that has some successors, a decent client base, and no compliance problems, you have choices.
Hurley: And buyers’ mistakes?
Frieden: Many target companies have real problems—clients aren’t sticky, there are compliance or personnel problems. I think the buyers who are going to be successful are going to be able to scope out the difference between real problems and the ghosts. They are going to do enough diligence to avoid real pitfalls but, at the same time, they are going to have some tolerance. They understand that all firms have problems.
Hurley: What should a buyer be looking for in a seller?
Frieden: You want selling owners who want liquidity bad enough that they want to move along and not be there forever. They also have a good enough relationship with the next [generation] so they can get everybody else across the Rubicon to get the deal done.
Hurley: That’s often a big problem.
Frieden: Yes. There are a finite number of dollars or shares or units that a buyer is willing to dole out to get the deal done. And they are being split between the founders—who are leaving—and the successors who want a bigger share of the pie.
A buyer is potentially dealing with a four-headed monster. It has a capital source as well as other buyer shareholders to which it must convey why this is a good acquisition. On the other side of the table, it must deal with founding sellers who want as many dollars as possible and next gen people who it is relying on going forward who are focused on their personal economics. It must persuade the latter of the unknown—that their upside in this going-forward venture is greater than they have now so that they want to paddle hard alongside the buyer going forward.
Founding owners also often do not care a whole lot about the culture of the acquiring firm or its personalities. They don’t have to live with it for 20 years, and although they sincerely care about their clients and employees, it doesn’t cost them dollars and cents if the [acquirer] turns out to not be what they thought.
On the other hand, the next gen are in bed with the buyer potentially for the rest of their career. They are being asked to “trust” a buyer with whom they may have little background. They also are going to be party to a shareholders’ agreement that may be less accommodating than what they currently have, and they also may have to agree to more restrictive non-competes.
This all points back to the importance of being a seasoned acquirer. Because they have done deals, they have credibility and the seller’s successors can talk with people at the firms that they have acquired, which often helps with the “trust me” factor.
Hurley: Do buyers generally pay about the same?
Frieden: I don’t think it’s an exactly efficient market, but it’s pretty close.
Hurley: What then determines the winner?
Frieden: Several things. Sellers want and need to look credible to their clients and employees—the deal and the buyer must make sense. Dating is also involved. Convincing somebody to sell to you is hand-holding at the right times to make them feel good about the process.
Hurley: And the role of a pre-existing relationship?
Frieden: If you have a trusted relationship with somebody who’s selling, it will be a much easier transaction for them. They’re going to feel more comfortable.
Hurley: What’s the most surprising thing you’ve seen happen in the industry over the last decade?
Frieden: The evolution of companies into having real value. It’s great for the owners; they have something to sell. But not just that, it’s good for the employees. These people may have a significant opportunity going forward; they can build a career and personal wealth rather than just having a job. It’s good for the clients, too. They have a place to stay for generations.
Hurley: What will be the biggest surprise in the industry over the next 10 years?
Frieden: Client demands are going to change. [Wealth managers] currently are trying to figure out who their clients are. Am I catering to ultra-high-net-worth, high-net-worth, mass affluent? The demands of those clients and what they’re willing to pay is going to change. It will be hard for wealth managers to deal with, particularly at scale.
Also, as more people and money flows into the industry, larger numbers of regulators and plaintiffs’ attorneys will start to show up. If you look at the banking industry, compliance is your A-number-one risk, or the first box that you’re going to check if you’re looking at a deal.
Hurley: Thank you.
Frieden: Thank you.