For advisors looking to expand a practice quickly, purchasing a book of clients was once the most expedient solution. Robert Enright learned the hard way that it isn't necessarily so anymore.
Enright, of the Burton/Enright Group in Walnut Creek, Calif., initially set out to acquire a firm near his firm's home office. He wanted the target company to have a successful business model and a seller whose personality was compatible with others in his firm, and he eventually found a good match — but only after looking at seven candidates over the course of two years.
“It's not easy to match all three of those criteria,” says Enright, whose firm added a few hundred clients and $47 million in client assets via the acquisition. “Particularly because it's a seller's market.”
Indeed, according to FP Transitions, a Portland, Ore.-based broker for financial advisory practices, there are currently about 30 buyers for every practice seller. Those numbers mean advisors on the prowl for an acquisition must be prepared for competition. It also means they need to define upfront what sort of acquisition they are looking for and what compromises they are willing to make if the ideal target does not materialize.
Bob Lyman, an advisor with Sequoia Financial Network in Hoffman Estates, Ill., recently spent six months competing for a practice against “three to five” other bidders, only to lose out to someone willing to pay most of the deal in cash upfront, instead of arranging for a payout over time. His is a common tale. Bidders on practices increasingly include banks, trust companies and other deep-pocketed players. Add to this the uncertainty that a seller's clients will stick around after a merger and the possibility that the practice you purchase will be full of land mines, and it's a wonder anyone ever buys a practice. The reason advisors are willing to weather all this is simple: Do an acquisition right, and the payoff is big.
A case in point: Three years ago, Robby Harfst, an advisor with Raymond James in Ashland, Ore., was running a practice in Illinois and looking to move out west. “I wanted to grow my practice, but I was tired of seminars and referrals,” he says. “I wanted to move to a small community where I could put down roots and raise a family.” He wound up buying a well-established firm in Ashland, with $80 million in assets under management and 400 clients. Instant satisfaction.
Why Buy?
Before you go chasing that dream, however, you have to decide exactly why it is you want to buy a practice. While it may seem like an obvious move, making an acquisition isn't always the right step.
“Think strategically,” says Philip Palaveev, senior manager with Moss Adams, a Seattle-based accounting firm specializing in financial advisories. “Bigger does not necessarily mean better.” In other words, decide whether or not your objectives can be best met through an acquisition. Common reasons for acquisition: improving economies of scale in a back office, improving the quality of a client base and expanding a practice to another location.
Another increasingly common goal: increasing the value of a practice with an eye towards selling the expanded business down the line. This was Michael Dorvillier's intention. An advisor with LPL in La Jolla, Calif., Dorvillier decided three years ago that he needed to bulk up his practice so he could eventually sell to a bank or another large institution.
“You've got to have $1 billion in assets, a diversified, well-oiled machine if you want to sell to these people,” he says. He subsequently made what he hopes would be the first of many acquisitions — a 25-year-old practice with $200 million in assets under management, run by a fellow LPL advisor.
A good rule of thumb is to buy what you know. If you do mostly commission-based business, go for a commission-oriented acquisition. If you're fee-only, look for a similarly structured firm. “You're going to take on a lot of clients in a very short period of time,” says David Grau, president of Business Transitions, which owns FP Transitions. “This is not the time to learn a new niche.” Dorvillier, whose practice is fee-based, followed this advice, and focused on firms with a matching approach.
There are varying degrees of good matches. James Barnette, an advisor with Raymond James Financial Services in Sterling, Va., made the last of three acquisitions about six months ago and chose a commission-based firm, even though he is fee-based. Given the seller's preponderance of C-based shares, “I felt I could easily move clients into a fee-based program, because they could get out without paying any fees,” he says.
My Momma Told You…
How to find the best deals? It's not always people who are actively shopping who find the best bargains. In fact, says Palaveev, “most people who buy a practice stumbled across someone and took advantage of the opportunity.”
Monte Marti, an advisor with Personal Financial Management in Cedar Rapids, Iowa, is typical in this regard. Eight years ago, he got to know an advisor from a different broker/dealer while they were giving seminars run by the same organization. Eventually, the older man, who was thinking about retiring, started suggesting Marti buy him out. A few years later, Marti switched to the same b/d and began renting space from his acquaintance, who owned his own building. Two years ago, Marti struck a deal to buy the practice.
But waiting for serendipitous circumstances to emerge is hardly the only approach to deal hunting. For serious shoppers, there are brokers, like FP Transitions, who connect buyers and sellers. Another prospecting trick: Ask wholesalers you work with for names of advisors who might be looking to sell. Enright, for his part, met his seller at an investment conference. In some cases, your b/d might help. Dorvillier, for example, made a point of alerting headquarters at LPL about his intention to buy a practice. It was someone there who told him about the business he eventually bought. In fact, b/ds may go out of their way to let you know about a practice that's for sale within the firm — especially when it's a successful concern they want to keep within the fold.
No matter the source of your lead, due diligence on a prospective acquisition is a must. At a minimum, this includes looking over key tax returns and other documents. But it doesn't hurt to go deeper. When Enright conducted Q&A sessions with prospects, he discovered “quite a few skeletons in the closets,” including shady real estate deals and instances in which advisors charged high surrender fees that he suspected they had not disclosed to clients. “That made me pretty nervous,” he says.
Still, striking a balance between expedience and care is important, since deals are coming together more quickly than ever. According to Grau, the median time to close a deal is now 2.6 months, down from seven months three years ago.
Price of Entry
Purchasers typically pay around 2.1 times the last 12-months recurring revenue stream or up to about 1 times gross annual revenues for a nonrecurring stream, according to Grau. Further, conventional wisdom says that fee-only practices go for more than commission-based ones, though Palaveev notes this isn't necessarily a smart way to value a practice. “The present value of future cash flow is the only true indicator of what the true value is,” he says.
The fee-based premium doesn't take into consideration the question of how other costs will affect the bottom line — for example, whether you have to close down an office or maintain two locations. If you're buying a practice affiliated with a different b/d, you'll also face conversion costs there, as well. It's important to make sure new expenses don't overshadow the gains in an acquisition. One way to keep acquisition-related expenses down is to stick with a practice affiliated with your same b/d. Barnette, for example, has only bought practices associated with his b/d. He saw his expenses rise about 15 percent after his most recent acquisitions, but because revenues shot up 50 percent, “there's been a relatively insignificant effect on the bottom line,” he says,
Of course, not everyone is willing to pay a premium for fee-based businesses. Dorvillier, for one, says it's “crazy” to do so, and he figured out a way to pay less than 1 times revenue, with no money down over a 10-year period. The deal required letting the seller stay with the business for as long as he wants and to receive a percentage of gross revenue every month. Last year, according to Dorvillier, that came to around $300,000.
Most of the time, buyers pay one-third the purchase price in cash. The bulk of the payment is made through what amounts to financing by the seller. In these arrangements, the seller accepts payment over a period of time, usually three to five years. During all, or most, of that time, the seller usually stays on to work with clients and help with the transition.
According to some observers, this common practice benefits buyers more than sellers. How so? Take a practice valued at 2 times revenues, or $1 million, with payments of $200,000 to be made over a period of five years and a 5 percent interest rate. According to Palaveev, the net present value of that transaction would really equal $850,000, with a multiple of 1.74, “because we deferred the payments,” he says. If you consider that on the open market the buyer might have had to pay an interest rate more on the order of 10 percent, then the transaction is really worth more like $750,000, or a 1.5 multiple. The result: When you factor in all the risks, “The net present value of the transaction is 40 percent to 50 percent lower than what it appears to be on paper,” says Palaveev.
It's possible to get bank financing, but such loans are hard to come by, because banks generally look at advisory practices as a highly illiquid — and unsatisfactory — type of collateral. In some cases, you might be able to get a loan through the Small Business Administration. Generally, the minimum loan is $100,000, the maximum $1 million, with an interest rate of prime plus 2.2 percent and a seven-year repayment period.
Then, there's also the possibility that your b/d might help out. Marti, for example, made a down payment of one-third of the purchase price and got a loan from his b/d. The b/d's incentive? It wanted to keep the seller's clients. Like Marti, however, you may also have to finance the rest by taking out a second mortgage or by borrowing against other personal assets.
Introductions Necessary
Perhaps the most important part of an acquisition is introducing yourself to the seller's clients — and persuading them to stay put. The best way to meet is obvious: face-to-face. Harfst held three to four client meetings a day with the seller over an 18-month period. There are other ways to make clients stick out the ownership transfer. Dorvillier recently threw a party in honor of the seller, who is still working in the firm. “The soft message is that, some day, he will be gone,” he says. Still, expect it to take a year before clients really start asking for you, instead of the seller.
Also, be prepared to make some other unanticipated adjustments after the sale. Palaveev points to a hands-on-type buyer who purchased a firm with a considerably less thorough client-service model. They ended up deciding not to integrate the new practice into their firm, instead running it almost like another department. After his sale was completed, Marti discovered that the seller typically arrived at work at 6:30 a.m. Though Marti was more of an 8:30 a.m. type, he adjusted his schedule to serve the clients who were used to stopping by the office on the way to work.
Ultimately, remember that when it comes to buying a practice, it's not purely a numbers game. Often, the highest bidder doesn't win out, but rather, the mantle goes to someone whose personality meshes with that of the seller. That's why, for example, Harfst bested about 15 competitors in the race to buy the firm he ultimately acquired.
“We really hit it off,” he says. “And he was really concerned that the buyer plant his feet here and get involved in the community. I was willing to do that.”
