Questions to ask yourself when growing through acquisition.

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The last few years have generally been very good times for financial advisers. Many of you have grown significantly through your own efforts and those of your team. However there are many of you who have looked to turbo charge this growth through acquisition, either of a book of business or indeed through buying another advice business – lock, stock and barrel. Done well, this can help you significantly increase your growth potential. However if you don’t think it through carefully, an acquisition can result in many headaches and lower than expected results.

So what are some of the questions you should ask yourself before stepping into the market place and looking to buy?

 

Why?

First of all, be crystal clear about why you are actually in the market to buy a book or another practice. What is the strategic rationale for the acquisition? Are you seriously in growth mode, or have you simply run out of ideas in terms of developing your existing business? Maybe instead of spending your money, it’s time to really unpick your own client value proposition, get crystal clear on the type of business you are and then look at all of the potential means to grow your business. There may be better alternatives to going into the market for an acquisition.

 

What?

What are you actually looking to buy? Have you run out of opportunities in your existing business and need an injection of potential clients? Are you looking to buy a book of clients hoping you will unlock a few nuggets in the belief that your advice approach is superior to that of a selling broker? Or are you looking to buy a very well developed business that is going to lift your own business onto a new level through bringing better processes and opportunities than those that exist within your own business? The challenge in the latter situation here is to ensure you actually extract these opportunities, rather than letting the business you are buying fall back to the levels of your existing business.

Who?

So you’ve decided that the strategic rationale justifies a purchase. The question now is which book or business to actually buy. This is where you need to carry out careful due diligence to really understand what you buying: the quality of the clients, the processes, the client propositions and of course the advice that has been provided to their clients. After all, poor advice given in the past could result in a whole host of headaches for you into the future.

Are the clients that you are buying going to increase your recurring income stream over the long term, or are they going to fall away over the coming years through no relationship and loyalty to you? Are they going to really help you to gain a foothold in your target market? At the end of the day, are they going to be worth more or less than the “sum of the parts”?

The people that will come with a business (if any) will of course also be a tremendous asset or liability going forwards. You need to make clear and educated decisions as to whether they are a good fit for your business or not. Bringing in a strong group of people could really help you to drive your business to the next level.


How?

So you’ve found your purchase target. If you’re simply buying a book of business, the chances are this is going to be a fairly straightforward transaction based on a multiple of the income stream. However if you are actually buying the entire business, there are many other factors to consider.

Are the existing owners remaining involved and if so, in what capacity? Are they going to be part owners of your newly enlarged business, keeping them with “skin in the game”? If they are remaining as shareholders, they are much more likely to stay committed to growing the business. On the other hand, if they are remaining in the business simply to help the transition, you should be looking to build in clear earn-out targets. This will ensure that you reap the rewards of their ongoing involvement, as they will be financially incentivised to help you transition the clients into your business.

You should also examine closely the profitability of the business you are buying. If they were struggling to make meaningful money, how are you now going to do it? Can you see cumbersome administration practices that you can immediately replace with your own well-developed processes, extracting immediate savings? Can you see savings to be made in terms of people – maybe you don’t need all of their staff? And possibly you can see opportunities to broaden the proposition that was offered to their clients, increasing the revenue potential. Any of these factors will help you realise more profit potential.

These are just some of the questions that you should ask yourself before you step into the market to buy another firm. Buying a business is a big step – take your time, ask yourself the hard questions and do careful due diligence in order to seriously enhance your prospects for success.

How do you improve the value of your practice?

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We wrote last month about the different ways in which a potential buyer will look to value your business. This is a follow-up piece about how you might increase the value of your business, to ensure you extract the very best price possible. Obviously your recurring income is a crucial starting point. However a good business is about a lot more than a simple multiple of your recurring income. There are a number of ways ways that you can demonstrate additional value in your business, which will allow you drive up the price.

 

Work through all the valuation methods yourself

As set out last month, financial advice businesses can be valued using a number of different methods. The oldest (and simplest) model is the multiple of revenue model. However this is being replaced today in some cases by buyers using a multiple of the profitability of the business (usually excluding the business owner’s earnings) as this takes account of both revenues and costs within the business.

It is really important that you consider all of the potential valuation methods, as a purchaser most likely will do so! If a particular valuation method is proving very difficult in justifying the value of your business, are there changes that you can make that will improve the picture? Doing the calculations yourself and being prepared are really important to achieving the price that you want.

 

Drive up trail & other recurring incomes

Obviously there is no point just a year or two before you want to sell up, to really start trying to make the switch from upfront commissions to the flatter income structures that are far more prevalent today. A purchaser will want to see a steady and increasing recurring income stream over a prolonged period. If a sale of your business is on the horizon at all, now is the time to start making that shift to increase your recurring income stream, so bring this objective through in every area of your business and right across the team.

 

The persistency of business is crucial

Of course the size of your business is a main factor. But so equally is the persistency of your revenue. Lapse rates have become a major issue for life companies and advice firms alike, so obviously persistency will significantly impact the price someone is willing to pay for your business. There is little value in a firm that can’t demonstrate an ability to build up a durable revenue stream.

There are a number of steps that you can take to help address any purchaser concerns in this area. Preparing the ground for an effective “earn-out” period will really increase the confidence of a potential buyer – one of their concerns will be your commitment in this area. Also reducing the reliance of clients who seek to deal exclusively with you will also help. If you can demonstrate that clients deal with your business rather than just you, a buyer will feel more confident about those clients staying with the business.

It is also worth looking at the remaining advisers in your business. Having them tied into solid contracts with clear non-compete clauses should they leave, will again help you in your negotiations with a buyer.

 

Have a winning business proposition

A buyer will want to believe that he or she is getting more than their money’s worth when running the rule over your business. A very compelling business proposition will help to provide this comfort. For example, this may be strengthening the buyer’s position in their chosen market or indeed giving them access to a new market. It may be a unique expertise that your business offers or strength in attracting a particular target group of clients. A strong position within a niche market can be a very attractive proposition! If you own a brand that is really well known in an attractive target market, this is a very valuable asset. However on the other hand, if you’re not clear about what’s unique about your business and be able to demonstrate this, you cannot expect a prospective buyer to see this potential.

A buyer will also want to be purchasing clients who are engaged by and committed to your organisation, and are likely to stay with the firm going forwards. To achieve this, you’ll need to ensure that your processes for ongoing client engagement really stand up to scrutiny.

 

Your service and compliance systems are very important

Potential purchasers also want to minimise the headaches involved in a purchase. They want to buy a well-run business that looks after its clients in a professional and engaging way and is compliant in everything that they do. In fact better still, they want to buy a business with potentially better processes and systems than their own, that they can then leverage for their now expanded business. There’s a real opportunity to make your business more attractive to a buyer through utilising excellent business processes.

 

Your people are the heartbeat…

While your clients are at the core of your business, your own people are the heartbeat of it. They have the strong relationships with your clients, the expert skills that potentially are sought by a buyer and the capability to deliver brilliant service to attract and retain your clients and valuable income stream. A highly skilled, cohesive team is an enormous asset when selling.

 

These are just some of the factors you might think about as you prepare your business for a potential sale. If you have any comments in relation to the above or indeed can identify any other factors, please leave your thoughts below.

What’s your advice business worth (to someone else)?

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This is the first in a two part-series of articles that examines the sale of financial advice firms. In this initial article, we consider the various valuation methods that can be used to place a value on your business. Next month we’ll take a look at some of the ways that you can (positively) influence that value.

How to value your business

There are many methods that are used to value businesses, however the most common methods are,

  1. A multiple of recurring income
  2. A multiple of EBITDA

We’ll examine both of these in turn.

 

A multiple of recurring income

This is still the most widely used valuation method, and it is certainly the one used in casual conversations among advisers. This is the basis that is quoted in relation to any “buy back” agreements in place in the market. This basis is popular because of its simplicity, and also because a potential purchaser will be satisfied that they are buying a future income stream. The value of the business is not skewed by a huge uplift in new business sales (and attaching initial commissions) in the year or two before the sale of the business.

Of course the next question is – what’s the multiple! And that’s really where the negotiations start. This will be determined by a whole range of elements including;

  • The business retention strategy in place and the actual retention record of the business. This is a critical factor for would-be purchasers.
  • The compliance profile of the business – are the systems in place robust or is it all a bit lacklustre, with potentially significant hidden problems down the road?
  • The synergy between the seller’s business and that of the purchaser. This includes target markets, systems and the ability to easily integrate the two firms. These factors may make one potential purchase a better prospect than others, as the purchaser may gain more from synergies and be willing to pay a higher price.

 

Multiple of EBITDA  

The simple calculation based on recurring income is not deemed sufficient in all situations. For larger firms, a more refined calculation method is often deemed necessary, and this is where the multiple of EBITDA (Earnings before interest, tax, depreciation and amortisation) comes in, as this takes a much broader view of the business as a whole and looks at the actual profitability of the business.

When this calculation method is used in relation to smaller firms and where the business owner’s salary is the main overhead, EBITDA is often adjusted by removing the owner’s salary from the calculation as this can often significantly skew the EBITDA figure. With the salary excluded from overheads, a prospective purchaser can get a clearer picture of the real profitability of the business.

 

Payment Terms

Usually when an advice business is sold, there is a handover period where the previous owner remains with the business for a year or two to ensure a professional handover of the clients to the buyer, and to assist in the retention of those clients.

As a result, the payment terms usually include some of the purchase price to be deferred – maybe with half paid up front and the remainder paid in tranches over the following two years. There will typically be penalty clauses if the retention turns out to be lower than anticipated. These terms are really important, as they align the interests of both the buyer and seller towards a smooth handover with high retention rates.

 

Make the process easy

Due diligence before a sale is key. Once any confidentiality agreements are in place, it is really important that the required information is easily accessible to a prospective purchaser. If they feel they have to drag the information from you, they will wonder what you are hiding. So make sure you are capable of providing the required information before you start seeking out a buyer.

Equally, be realistic in your price expectations. While of course you may not choose to take the first offer that comes your way, don’t hold out forever for that elusive windfall sale price.

 

These are thoughts solely on the financial side of selling your business. In a follow-up article, I’ll look at steps you can take to actually increase the value (and more importantly the price!) of your business.

What’s the right charging structure for you?

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Trail commission. Is it the silver bullet that enables Financial Brokers to be paid for the value they add, to build value in their businesses and eventually sell the business at a healthy multiple? Or is it a somewhat opaque way for advisers to be paid, sometimes with very tenuous links between the value provided by the adviser and the payment received?

Trail commission is far and away the most popular method of being paid today. First of all it’s relatively easily explained. Clients understand it. And of course trail is very easily collected. Clients don’t have to write another cheque, which is always a potential hurdle. Clients also see a level of alignment of interest – if the portfolio sees strong growth, both the client and the adviser win. Also there is no VAT payable on trail commission, that will apply to retainers and fees if the adviser’s fee based turnover threshold for VAT is exceeded. This is good news for personal clients.

For the adviser, trail makes a lot of sense. It’s the most used factor in advice firm value calculations and trail tends to naturally increase each year in line with portfolio growth, and as new contributions are paid into investments and pension policies. Very importantly too, it doesn’t tend to dominate review meeting conversations. Many advisers have moved to Modular AUM-based Pricing, which is where prices are linked to AUM, but then varied based on the level of service. This has become very popular in Ireland, as the focus of the conversation shifts from the price paid to the value added.

But trail is not perfect. As we see asset management fees fall dramatically in some markets, trail levels will come under a lot more scrutiny. In any case, some advisers (and/or their clients) already baulk at the idea of their remuneration being based on the client’s asset levels rather than the value provided. This might be where fees come in.

 

How do you structure a fee?

I am often asked this question by advisers who have decided to go down the fees route, usually just for a segment of their clients, but on occasion for their business as a whole.

There are of course many different ways of structuring fees – below are listed some of the most common structures used in Ireland and/or in other markets. Of course each of them has their merits and drawbacks, but hopefully this list will help you identify one or more structures that suit you and your business. First of all, the most common structures are,

  • A fixed rate for each service (plan preparation, annual review service etc.). These rates can differ for different levels of complexity associated with different clients.
  • The “McDonalds Menu” approach of bundling services together into service packages, and then charging different fixed fee levels for different service packages.
  • A monthly retainer

Some advisers are now combining one or more of these, including combining them with trail commission. The most often used combination is a fixed fee for preparation of a financial plan alongside modular based trail commission or a retainer for ongoing services.

Other less often used structures include,

  • Hourly charging – rates are quoted by lots of advisers here, but few actually end up using this basis…
  • A model used by advisers in some markets aimed at millennials and others with low asset levels but often high incomes, is advice fees linked to the client’s income and net worth, instead of to AUM.
  • A subscription model based on client preference and personality. A client who is a “delegator” pays more than a client who is simply looking for validation of their own decisions, who in turn pays more than a DIY client who simply wants help with product execution.

As you can see, there are many different bases that can be used, and often the preferred structure is a combination of different structures. The challenge for you is to identify the model that fits best with your own client proposition and that reflects the value that you are adding.