Let’s say you’ve been carefully planning your exit from the business over several years — and then suddenly the investing landscape shifts, clients cash out of equities, and your revenue stream drops 20, 30 or 40%. Or maybe you’ve been thinking about expanding your practice through an acquisition but have been watching the market roller-coaster and aren’t sure when to jump in. What do you do?
There’s no question both sellers and buyers are feeling the impact of volatility keenly — but many who may have been sitting on the sidelines for a couple of months, waiting for signs of stability, are beginning to make their moves. At least that’s what Owen Dahl has been seeing. The partner at Moss Adams LLP in Seattle says the phones stopped ringing from potential buyers between early September and mid-November as advisors focused more on business preservation than business growth. But, over the past few weeks, the first tentative calls have started coming in from interested buyers attracted by the prospect of bargain prices for good practices.
In Portland, Oregon-based FP Transitions’ database, the buyer-to-seller ratio has held steady at about 40-to-one and has actually risen in some markets, says marketing director David Grau Jr. “The buyers we’ve spoken to have said that acquisition has become priority number one,” he observes, explaining that buying a book of business now outranks more traditional business building strategies, such as seminars and marketing, which have become a tough sell in today’s markets.
“It’s much, much harder to grow organically,” Grau says. “Acquisition — transitioning over an existing block of business with the seller’s assistance — is the only way they’re going to double in size in the next couple of years.”
That’s not to say recent declines in the values of client portfolios haven’t had an impact on book prices and the way deals are structured. Dahl points out that prices based on multiples of trailing 12-month revenues are a reliable measure of valuation only in stable or growing markets. He anticipates that new pricing structures will emerge to take into account recent market volatility while providing prices that are fair to both the buyer and the seller.
Grau observes that so far, sellers’ lower revenue streams have largely been offset by higher multiples offered by buyers — leading to valuations that aren’t very different from what they were a year ago. But, he adds, “something has to give.”
After all, he says, “You can’t have less revenue and pay the same price because, ultimately, it does come down to cash flow from a buyer’s perspective. So sellers, who are financing 99% of these deals, have been extending the financing and financing more of the purchase price contingently, using things like earn-outs and work-outs. They’re willing to wait for the upside potential over the next couple of years.”
Sales perks
In an environment in which revenues have dropped, multiples have risen and payout terms have lengthened, what can a seller do to get the best price for a practice?
According to David Burnie, CFP, principal and resident partner at Ryan Lamontagne Inc. in Ottawa, who has watched several colleagues go through purchase and sale transactions, one important strategy is to put the business — rather than a book of business — on the auction block.
“A book of business is a customer list more than anything,” he says. “Those can be found pretty cheaply.” He points to an advisor he knows who has purchased insurance books of business for as little as 1 or 1.25 times annual revenue. But selling a business — with all of its processes, staff, clients, revenues and a comprehensive financial planning approach — can generate much more. “We’ve had people in the past offer us up to six times revenue,” he says, though he is quick to add that his business is not currently for sale.
Dahl says key contributors to a higher bottom line for the seller include a strong and diversified client base, limited reliance on just a few big clients, diversified portfolios and a large number of longer-term client relationships. And he emphasizes that sellers shouldn’t get too worried about short-term market volatility. “If you’ve done the right things, you’ll ride it out,” he says. “Focus on your clients, and you’ll maintain a transferable asset.”
A “turnkey operation” is the most attractive to buyers, according to Grau. That means a business that an advisor can step right into, with good technological infrastructure and sound customer relationship management and portfolio management systems in place. He says it helps if the seller has trimmed accounts that don’t fit the business’s core target audience through a partial book sale or transfer to a junior associate.
Julie Littlechild, president of Advisor Impact, says practices that have certain core strengths will be attractive to buyers no matter what current market conditions might be. “The things that will enhance value, and therefore price, are the same in a turbulent market as in a good market — although good markets seem to mask the need for some of these fundamentals,” she says. “[Sellers] need to focus on minimizing the risk for the buyer, and that means focusing on retention and demonstrating real potential.”
Higher retention rates through and beyond a sale come from satisfied clients, she says. It helps to be able to show buyers that your book of business has untapped cross-selling opportunities. And it’s important to be able to prove that clients value the team as a whole, rather than only an individual advisor. Littlechild suggests that systematically collecting client feedback can go a long way toward quantifying subjective aspects of client relationships and convincing buyers that you’ve done everything you can to lower the likelihood that clients will walk away from your practice.
Buyer beware?
Advisors who are preaching “buy low, sell high” to their clients should consider that the same holds true for buyers of financial services practices, says Grau. “You’re probably not going to get practices more cost-effectively than right now,” he points out.
But Dahl adds a cautionary note: Many firms see volatility as a good opportunity to attract dissatisfied clients, so buyers have to work harder than ever to retain a new book of business. And because retention is essential to maximize the value of a purchased book, he recommends that buyers do due diligence on opportunities that seem too good to be true. Fire-sale prices should be carefully evaluated, especially when they’re offered by younger advisors who may be anxious to leave unsuccessful practices and who, at any rate, may not have cultivated the strong, long-term relationships with clients that facilitate retention.
Buyers depend on the seller’s wholehearted commitment to making a strong case for the transition to clients, particularly if they’re not leaving the practice to retire. To ensure that clients naturally move from one advisor to the other, Littlechild suggests implementing a documented transition process with a great deal of clear communication. The transition plan, she notes, should include the compensation/buyout method, valuation method, client transition process, due diligence process, client transition timeline and staff transition/retention plan.
In addition, the buyer must tread carefully and lightly to maximize retention. “You can’t walk in on day one and be critical of what someone else has done for the last five years, because they had trust in that person,” says Douglas Lamb, CFP, principal and senior financial advisor with Spera Financial/Dundee Private Investors Inc. in Toronto.
Lamb learned this lesson even though he bought a book of business in kinder, gentler market times. “You aren’t just the old advisor in new clothing. You have to treat it as if that’s a new client, gain their confidence and find ways of building that relationship. The best way to do that is to get to know them and make an emotional connection with them.”
In a well-structured transition, Grau estimates that buyers can expect average retention rates of 90% to 95% even in volatile markets — though that figure will vary depending on the type of practice and type of clients. Transactional practices with little client contact may have rates that are significantly lower, he suggests, while fee-only businesses with a great deal of client contact can achieve rates as high as 100%.
Grau adds that the current trend toward making more of the purchase price contingent on performance and involving the seller in the transition for a longer period of time could help to offset the risk that a greater number of clients may walk away during turbulent times.
“Buyers historically have always liked to use performance-based payment methods because it guaranteed they were going to get the best efforts of the seller,” he points out. “Now, all of a sudden, the sellers are back on board with that strategy, saying, ‘OK, I will wait over the next three to five years and take my money contingently, because with my assistance I know the clients will like you.'”
For both seller and buyer, Grau says a successful sale boils down to detailed planning well in advance, and he offers advice that you probably regularly give to your clients: “It’s all about understanding where you are at today, and then setting goals for where you want to be.”
That’s a message that holds true in any market.
(12/09/08)