Mergers are a lot like weddings—on a certain date you say “yes” and share half of everything you own with somebody else, hoping for a long future together. Sometimes it works and you can’t imagine ever being alone. Sometimes you pay a ton of money to attorneys to get you out of this thing as fast as possible, and you are happy if you still own a car and a checking account afterward.

The quiet and deep current of mergers is shaping our industry much more than the highly heralded acquisitions and consolidations. Hundreds of mergers are under way at present, creating larger firms with more resources to compete and deeper pools of talent. Many of those firms will be the dominant competitors of the future. But then again, maybe half of those advisors will be joining the classes of miserable people complaining every evening about their business partners.

Which one you become depends on how much you know what you are looking for and how you find the right partners to pursue your vision.

Defining Mergers
An investment banker once told me, “There is no such thing as a merger—one party is always the acquirer and the other is always the disappearing acquired.” Perhaps that is true, but investment bankers tend to be a little cynical. So in an effort to be more positive, I still believe a merger is an act of “joining forces.”

For this article, I will define a merger as a “cashless” transaction where two businesses come together, pooling their profits, resources and equity to create a joint strategy and pursue a joint vision. There is no “buyout.” Instead, both parties come together to assume all the risks and rewards together.

The Power of Mergers
The power of mergers comes from two parties’ ability to combine resources and energy and mix complementary skills and talents. The combination of resources creates larger firms, and larger firms have significant advantages. They generate higher income per partner. They also make their people more productive and attract larger clients. In fact, industry surveys such as the one done by Investment News and Moss Adams demonstrate that the largest firms have as much as three times the income per partner that the average firm in the industry does. What’s more, they tend to grow faster—to some extent because of mergers. That’s why two marrying firms have great potential.

The most powerful effect of a merger, however, comes from the new company’s ability to recruit, train and develop people. For example, a firm with $300 million in assets under management and $2.5 million in revenue is not a very compelling employer for the average CFA, MBA or CFP. Such a firm, while it is a good size by industry standards, appears rather small to someone who just graduated and does not have a lot of experience in the industry. Now assume that the firm doubles in size through a merger and you have a visibly large organization with more than $5 million in revenue and the critical mass to hire many bright young people.

Often, advisors seek economies of scale in mergers, and this is where they will be disappointed—larger firms do not usually experience lower overhead. Economies of scale are very elusive in our industry, and are only enjoyed over a short period. The leverage of one system is often offset by the need to create or expand another system as the firm grows and perhaps operates multiple offices. The real leverage comes from training and developing people and from solving succession and capacity issues. This is why mergers are on the rise today.

Mergers On The Rise?
While I have no statistics to support this claim, I believe there are more discussions going on everywhere. I asked 25 firms belonging to Fusion Advisor Networks (a boutique advisor “club” affiliated with NFP Advisor Services Group) about their merger plans and found that at least a quarter of them were in active discussions with other parties. Another quarter were interested in starting a dialogue with a fitting candidate. I believe those numbers would hold true for the entire industry.

Mergers have also contributed to the growth of many of the top firms in the country. Firms such as Aspiriant, Private Ocean and Moss Adams Wealth Advisors went through mergers in their growth path. Modera Wealth Management and Back Bay Financial Group Inc. completed a merger in 2011. Savant Capital and the Monitor Group merged in 2012. But such deals are not the exclusive domain of large firms—every day, solo advisors come together to form partnerships and ensemble firms.

Sometimes, these firms don’t even call it a merger. If they’ve brought in outside partners, they may think of it only as “recruiting.” Still, all the elements of a merger are there: They are joining forces and exchanging equity.
This trend, rather than acquisitions, may turn out to be the most powerful force for consolidation in our industry—as it was in the CPA industry. Though consolidators such as Century Business Systems and American Express bought many small CPA firms, such consolidators came and went, and meanwhile large CPA firms like PwC and big regionals like Moss Adams patiently merged with one group of partners after another to become the dominant competitors of today.

Merger Structures
Typically in a merger, two firms combine their equity and their financial interest to form a new company that will execute a joint business plan. Again, in our definition there is usually no cash exchanging hands, so the real question is not, “How much?” but rather, “What percent?” Sometimes, one party is larger and will survive the change, while two firms of equal size will form a new entity they operate together.

Ultimately, the merger is defined by several variables:
• Is equity exchanged for equity? How much and what kind?

• Are positions being changed? What will be the role and title of the partners in the new firm?

• What is the compensation? In the new entity, the partners’ compensation is a key part of the deal.

• What is the operating structure? What level of autonomy does each practice preserve to operate as it did, or to what degree will both firms change?

There is a growing trend of older professionals merging their practices into “younger” firms as a step toward retirement. Such mergers allow both parties to spend time integrating and knowing each other and also allow the retiring advisors to continue practicing for quite a lot longer than they could on their own. The new firms that emerge from those deals have their successors ready and locked in (as buyers), so there is much less a sense of urgency about when or how the older advisors will retire. This strategy has been very successful; in fact, there are many large RIAs that are aggressively seeking such deals with aging wirehouse advisors and independents.

How To Negotiate A Merger
Advisors spend too much time worrying about the legal, financial and tax structures of their mergers and not enough time on more substantive issues—specifically, knowing what they are going to be doing with their new partners and who will be responsible for what. I frequently advise clients to break down the negotiation into four stages and try to focus the discussions at each one:

1. Establish a shared vision and strategy. The first discussion with a potential merger partner should be focused on what the two of you are trying to achieve together. Before getting in the car together, ask each other where you are planning on going. What do you see the business evolving into after the merger? What would it look like 10 years later? What do you expect to do in the new business? How will each of you contribute? What will make the combination work strategically?

2. Get to know the person and the business. If you will operate day after day, side by side with another advisor, you should make sure that your communication and decision-making styles are compatible. That does not mean you have to be identical or even similar—very often the combination of different personalities is more powerful. You just need to understand and know the other person. Spend some time socially together—go play golf, tennis or box against each other (nothing compares to hitting your partners as a relationship builder —though don’t do it if you are not a boxer). It also helps to include spouses in your social events and even conversations. As much as I am a proponent of keeping clear lines between personal and business matters, this is a time when you really want to know the other person. He does not have to be your friend, but you have to be comfortable with him being your business partner. I read somewhere that couples who experience conflict early on have better relationships. That’s very true for partnerships too. Don’t avoid early friction—face it and see what it tells you about how you will work together when things don’t go well.

3. The devil is in the details. Sometimes the compatibility is there, but the operational details can still sink the ship. Consider important questions, such as whether you will combine offices. Where will the new office be? What tasks will different staff members take on? Will you change broker/dealers or custodians? Will you change systems? What about service and pricing? The list goes on and on, and this is a step that is worth spending two to three months on.

4. Deal with the financial and legal structure. Finally, it is time to deal with legal and financial issues, and this is where you should bring your attorneys and accountants. Some businesses obtain valuations and that allows them to determine the combined percentages. Others simply go with the contribution of AUM or revenue. There are benefits to both approaches, and the discussion is more detailed than we can get into. That said, you are not selling the business; you are doing this to enable a shared vision, not to capture the value of what you created in the past.

Due Diligence
Greg Friedman, the founder of Junxure and PrivateOcean (a firm created through a merger), has taught me that no matter how much due diligence you do, there will always be surprises once you merge two firms. He says you must focus your due diligence on items that can reasonably be examined without disrupting both businesses. Then you must let trust develop between you and your merger partner, because when the surprises arrive, trust will help you overcome them.

The due diligence process should focus on:

1. The clients and the services. You must try to fully understand the other business, who its clients are, what the accounts look like, what is the investment approach, what kind of plans they create, who their venders are, etc. Perhaps ask them to treat you as a client and take you through their process.

2. The people and compensation. Ask questions such as these: What are the job descriptions? How closely do they match reality? What is the performance of each individual? What is the other staff like to work with? What is the current and past compensation? What bonuses have been paid? What benefits are covered and what is the cost? And so forth …

3. The operations and technology. As we mentioned, the devil is always in the details. You will need to understand who the other firm’s custodians are and what contracts they have. What broker-dealer contracts are there, if any? Will accounts need to be transitioned, and if so, how will it be done? What is the cost of moving assets and accounts if necessary? What technology is used and where does the data reside? What is the other firm’s compatibility with your technology and what transitions are possible? What does the lease say and how is the office set up? How is security handled for electronic and physical records?

4. Financial record. You will need to obtain and understand all financial statements for the last few years, including balance sheets. You must also examine the pricing and bill runs, any credit agreements or notes due, any covenants attached to such agreements, etc.

5. Legal and regulatory items. We are not a law firm or accounting firm, and it is highly advisable to involve your attorneys and CPAs in this process. They will guide you through issues such as the operating agreement of the other firm, its tax history, its regulatory registrations and history, its privacy policies and how those affect you, the firm’s legal contracts, including those with clients, etc.

The Wedding Day
At some point, you will have made up your mind and you will be ready to make a move. When that moment arrives, it is time to start bringing other people into the merger plan. Think of your employees in terms of concentric circles—the key people you are very close to may need to be part of the process from the beginning, or at least early on. Others on the periphery of decision-making may be included only after the deal is finalized.

When you tell employees, you have to be sensitive to their perspective and know the questions likely swirling through their minds: “Will I still have a job?” “Will I have a new boss?” “Are we moving the office?” “Is parking paid for?” “Will I have to learn new software?” Don’t dismiss such little details—addressing them early will allow your staff to build enthusiasm and encourage their collaboration.

The clients are a different matter. There should be no discussion with them about the pending merger until the deal is final and signed. I have seen many advisors tell clients about a pending merger, introduce the new partner to them and speak at length about the plan, only to see the entire deal come apart when the client sees irreconcilable differences. Client communication is important, but don’t tell everybody about the deal until you sign it.

A merger can double the size of your revenues, the access to talent and the budgets and resources you have. More important, a merger can give you colleagues and partners who will help you retain your energy, will give you new ideas and help you through difficult times.

A merger could also disrupt and destroy your firm if there are partner conflicts and internal bickering. Chances are, if you read this far, you are either considering a merger or anticipating a merger conversation with somebody. As you progress through the negotiations, keep asking yourself, “What can we do together that I cannot do alone?” A good answer to that question will likely bring you to a good deal with a great chance of success. 

Philip Palaveev is the CEO of the Ensemble Practice LLC. Palaveev is an industry consultant, author of the book The Ensemble Practice and the lead faculty for the Ensemble Institutes. For more information, visit Interested advisors may also participate there in Moss Adams’ Survey of Compensation.