Buyer’s Remorse

How old is the average client? The demographics of the client base are probably the single most important element to evaluate in an advisory firm purchase: Demographics dictate the longevity of a firm. An abundance of older clients in or approaching the withdrawal phase requires the advisory firm to replenish those assets with new clients more proactively and aggressively.

What is the firm's growth engine?  When most advisory firms get to a certain size they become more passive and responsive to business development opportunities, rather than assertive and creative. When the principals sell out of their stakes they often lose interest in finding new business. While a buyer may include performance targets in the final purchase price, these only work if enough of the purchase price is on the table to be earned by the seller and if the seller still wants to work hard. Whatever the scenario, older advisors usually sell out so they can get some cash and slow down to focus on the things they like to do. Oftentimes, unfortunately, they not only failed to develop younger associates to step up, but also neglected to brand and market the firm to drive new opportunities to the practice.

What role will the selling shareholders have after the deal? Many advisory firms rely heavily on the principals. In fact, often the firm must sell because successors have not been developed. With the transaction completed, are sellers expected to continue working with clients? Is a plan in place to transition those relationships to others in the firm? Does the firm have qualified staff that can actually handle those responsibilities?

How will the younger staff, particularly advisors, feel about the deal?  Forget the culture challenges that come with reporting to passive owners who are more interested in financial returns than client service; we are dealing in an environment where there is an acute talent shortage. This means that quality advisors have options. When the business is sold and the buyers take a preferred distribution of the cash flow, how long will advisors wish to continue working hard to keep and grow clients? Will they be offered an ownership stake, and will the benefits of that stake (dividends, buy-out price, etc.) be enough to induce them to remain with the firm? Or will the sale motivate the firm's advisors to look for better situations elsewhere or to start their own firms?

How will the clients feel about the deal? While it is unfair to characterize financially motivated buyers as not being interested in having clients served well, there is a risk that a passive financial buyer will make decisions to produce a better return, such as cutting costs, raising fees or changing the service experience. Further, by the nature of the transaction, the buyer may find it necessary to recruit other talent to replace the selling shareholders. These new people will have to connect with clients to keep them in the fold. Typically, serial buyers or private equity firms seek a liquidity event such as an IPO within five years of the first investment. This goal dictates a more intense focus on quarterly earnings, which could force a change in the way the advisors want to work and the clients want to be served.

Consider every angle of a deal and share concerns with the potential buyer. Serial buyers usually aim to consolidate firms quickly. What will create the synergy or common link among those firms? Acquiring a financial advisory business is not quite like buying a manufacturing company or a bunch of muffler shops. Advisory firms depend on professional, credentialed individuals. In the event of defection by the current staff, a limited talent pool exists to draw from. While buyers wish to retain clients and ensure the continuity of the income stream, they need capable staff to serve those clients.

As a prospective seller to private equity investors or consolidators, it is in your best interest to make sure that prospective buyers understand the risks and how they can be mitigated. Once the practice is sold, you never want to take it back (and that happened a number of times in the past few years). The buyer—whether just another advisor or a moneyed firm like a consolidator—must thoroughly understand the challenges. If the deal falters, not only is the amount paid at risk, so too is your reputation with ex-clients whom you respect and regard as friends.