Category: Invesco Fundamentals

[Eight-part series, current to publication date only]
1 – Why and how do we prepare
2 – Finding the right buyer
3 – Getting the best price
4 – Tax issues overview
5 – Incorporation issues overview
6 – Caveats and limitations
7 – Selling when incorporated vs. unincorporated?
8 – Ways to get paid

2 – Finding the right buyer

Last time, we looked at the main tax and legal issues advisors should consider when selling their books. This article will review questions about your book you should be prepared to answer. 

Key criteria

Your book isn’t simply an accounting entry, though eventually it will become a dollar figure (which we’ll discuss further next month when we look at valuation). 

It takes effort and skill to monetize your book’s inherent value, which is its ability to produce income. Seldom will a potential buyer’s capabilities match up perfectly with the practice he or she is looking at buying. Sometimes this will simply mean either you or the buyer will have to make adjustments, whether minor or major. In other cases, there may be such a gap that the value cannot be sufficiently harvested (possibly affecting both buyer and seller); worse, the acquisition could negatively impacts the buyer’s existing operations. 

Here are some questions that can help both parties determine whether there is a true fit:

Product array:

• What proportion of the book is in direct securities, mutual funds, ETFs? 
• Does the seller use model portfolios, ad hoc recommendations or a custom approach?
• To what extent does the seller use balanced funds and funds of funds, and in what circumstances? 
• How many product suppliers are represented in the book? 
• What is the historical buying pattern across suppliers? 
• For any supplier changes, why did they occur and how was the change communicated to clients?

Investment style: 

• Does the seller lean toward a particular style (e.g., value, growth)? 
• Do portfolios have a geographic or sector slant? 
• What is the seller’s perspective on contributing to RRSPs and drawing down RRIFs?
• Does the investment approach differ from registered to taxable accounts? 
• How often are portfolios rebalanced, and what are the key prompts for doing so? 
• When was the last rebalancing for the majority of the book? 
• To what extent is leverage used in the practice?

Licensing:

• What product licensing does the seller carry currently? 
• Has the seller added, dropped or changed licensing recently? 

Client service:

• How was the original clientele established, and what is the source of continued client growth? 
• Is there a set communications schedule? 
• Who is the primary office contact for clients? 
• How, where and how often are reviews conducted? 
• Does the seller hold client gatherings with business content? 
• Are there non-business/social events for individuals, or small or large groups? 
• What is the seller’s birthday/holiday card and gifting practice? 

Client demographics:

• What is the income profile of clients? 
• How many clients are served, and what are the assets per household? 
• How many multiple-generation families does the advisor serve? 
• What is the age profile of clients? 
• What is the annual mandatory RRIF draw? 
• Is there a generational, social or ethnic connection between the seller and the clientele? 
• What is the ratio of registered to taxable accounts? 
• How many business owners are in the book? 

Geography:

• Where are clients located? 
• How often do clients come to the office? 
• Does the seller meet clients in their homes or off-site? 
• What amenities does the seller’s office have, such as parking and handicap access? 
• Where is the seller’s office relative to the buyer’s? 

Business model:

• How is income earned? Transactional, AUM fees or fee-for-service? 
• What additional services (e.g., tax preparation) does the advisor offer? 
• If there’s been a change in the business model, how recently did that occur and what has been the client reaction? 

Compliance record:

• Are all KYCs up-to-date?
• Are there any current claims, and if so, what kind have there been?
• Are there past claims that have resulted in formal sanctions? 
• Are there past claims that have been settled informally, perhaps with the dealer’s intervention? 

Key personnel:

• Does the buyer intend to retain some or all employees? 
• Do the employees intend to stay on? 
• Are there employment contracts in place, and do they formally address confidentiality and use of business assets? 
• How long have the employees been with the seller? 
• What role have the employees played in client acquisition and retention?  

Office systems:

• Are processes well documented? 
• How up-to-date is the technology and equipment? 
• How easily can this integrate into the buyer’s operations? 
• Will the integration force the buyer to consider an upgrade? 

Other important factors can’t be measured, personality being the prime example. The buyer may be unable to sustain some parts of the practice attributable to the seller’s special skills, or may be able to develop untapped prospects. So, beyond hard financial analysis there are unique considerations that defy easy quantification but demand careful examination. 

Next instalment, we’ll look at valuation and negotiation.

[Eight-part series, current to publication date only]
1 – Why and how do we prepare
2 – Finding the right buyer
3 – Getting the best price
4 – Tax issues overview
5 – Incorporation issues overview
6 – Caveats and limitations
7 – Selling when incorporated vs. unincorporated?
8 – Ways to get paid

1 – Why and how do we prepare

The average age of the financial advisory population is rising. At the same time, all advisors face increasing compliance requirements. Together, these demographic and regulatory trends may lead more advisors to sell their books.

Transferring a practice is often the largest business deal a financial advisor will oversee. And it’s often also the advisor’s largest personal financial transaction. On the buy side, it can be a monumental financial obligation and personal commitment; on the sell side, it is the culmination of many years of invested time, effort, resources and emotion.  

In the past, young advisors would be lining up with cheques in hand. The future may not be quite so predictable. When it comes to negotiations, while the top-line purchase price may be top of mind, it is the bottom-line figure that matters most: the after-tax take-home cash for the seller. 

Over the next year, we’ll present a series of articles aimed at assisting advisors in negotiating with those tax concerns in mind. We’ll start with a high-level look at the parties’ preparation, key evaluation criteria, valuation approaches, and how negotiations build toward a contract. We’ll then turn to tax considerations, determining what is being sold, how payments are structured, and what actions may be taken to mitigate tax concerns.

This article will discuss the timeline and preparations for selling.

Strategic planning

An advisor who has a clear vision of what her practice stands for and where it is headed — often called a career or practice plan — will be able to command a higher price than an advisor who doesn’t.  

To obtain anticipated value, a selling advisor will need to emphasize what is desirable about her practice, and may need to adapt the practice to meet the market’s requirements. 

The timeline for strategic planning varies, but to qualify as strategic, a plan should last a minimum of two to three years. Market cycles could affect potential buying and selling opportunities, extending the vision out to almost a decade. In practice, and to keep planning within measurable reach, a five-year outlook would be a manageable target, ideally with a rolling annual review. 

Due diligence

Due diligence is the process whereby contracting parties confirm their understanding of the transaction they may be entering. Initial impressions developed during informal interactions are confirmed or adjusted through more formal discussions, detailed disclosures and first-hand data and document reviews. Entering into a due diligence process has costs, since the process takes time and attention away from income-producing activities and management responsibilities. 

The more complex the transaction, the longer the due diligence usually takes. For an advisor with little or no experience looking at other advisors’ operations, it can take time to decide what to look at, and what to look for. Having an existing practice plan (both as a buyer and as a seller) can help focus in both respects.

For the seller, opening the books can be a sensitive matter. Without reasonable access, however, a potential buyer may be unwilling to proceed. Operationally, it can be disruptive to have another person reviewing papers and accessing digital files. Beyond that, the seller wants to be certain that the acquiring party will be able to complete the financial terms of the agreement, and that the seller’s reputation will be in good hands after closing. And whether or not the deal closes, privacy, confidentiality and the integrity of the practice must be protected. (Later in this series we will touch on non-disclosure agreements and other negotiating tools.)  

The depth and timeframe of due diligence may be minimal, whether by intention or simply due to lack of planning. In other cases, particularly where a mentor relationship has developed, informal talks may extend over years. As a transfer of client assets generally supports the value of a practice, the process should span at least one series of client review meetings. This could mean formal due diligence might run from a few months to a year or more.

Closing

The closing date is when the legal rights transfer between the parties. Sometimes, the entire practice is transferred on that date. In other cases, a selling advisor may decide to parcel out the practice over time, possibly in separate processes involving different buyers. 

Post-closing

The parties may intend a clean break at closing; but, formal or otherwise, there can be a continuing relationship for a number of years. For example, the buyer’s payments may be periodic following closing, whether or not the amount of payments relate to performance. Commonly, this will be a couple or a few years, but generally no more than five (in part for tax reasons, which we’ll discuss in a future instalment).

On the other hand, the buyer may want the seller to be present for client hand-offs. Usually, this takes one to two years.

Whatever the intentions, it’s critical that the parties document in their agreement if, how, and for how long they’ll continue to work together. 

Risks

Here are the main risks in a buy-sell transaction:  

• Missed opportunity: The possibility that a high-potential buyer or seller does not come to a party’s attention, or that that potential is not recognized at the relevant time. A well-considered and documented strategic plan should minimize this risk.
• Unrealized value: It’s important to understand the value of the practice from one’s own perspective and from the other side. Without this, a bad bargain may be struck (for at least one party, maybe both).
• Imprudent venture: An ill-prepared advisor may enter into an unadvisable deal, possibly for the simple reason that a long-awaited counterparty has materialized. Having an understanding of oneself and one’s future plan can help protect against this pitfall. 
• Practice disruption: Pursuing, evaluating and concluding the sale of a practice can be time-consuming, even if the deal does not close. Both parties need to guard against false starts, balance strategic activities against continuing obligations, and conduct negotiations efficiently.
• Reputation/liability: Possibly the greatest proportion of a practice’s value lies in the advisor’s goodwill with clients, which in turn rests on reputation. If you’ve entered a deal with an advisor who later behaves badly, you may incur legal liability for his actions (though that’s unlikely). More likely is that you incur reputational liability by association. 
• Return on investment: This is a business deal. Parties must apply their analytical skills dispassionately to arrive at a fair value, structure manageable payment terms, and conscientiously monitor and fulfill obligations at and after closing, all with taxes playing a central role in the result. 

Next instalment, we’ll discuss finding the right buyer for your book.