In the last article we considered the pros and cons of achieving revenue growth through acquisition. In this blog we examine the options to accelerate growth through selling your firm. But before we do, an overview of the M&A landscape may be helpful.
The number of M&A deals increased annually over the past 5 years as reported by DeVoe and Company and Echelon Partners who track M&A of firms whose AUM is $100 million or greater. DeVoe’s Fourth Quarter 2017 Deal Book reported 153 deals in 2017 and Echelon’s reported 168. As there is no central reporting of M&A deals we can assume these numbers are an under-representation of total deals.
To put the number of deals in perspective, according to Cerulli, there are 18,225 retail-focused RIAs in the US, meaning 1% of advisory firms changed hands last year based on the reported numbers. Even estimating unreported deals, the total number of deals as a percentage of total firms is extremely low.
RIAs with more than $1 billion in assets mimic smaller broker/dealers in their scale and brand recognition as they now hold more than half the RIA channel’s assets. Cerulli reports that just 4% of RIAs control 60% of the assets in the space. RIAs with at least $1billion in AUM employ more than 32% of the channel’s workforce at the end of 2016. (Cerulli)
However, 70% of advisors have less than $100 million in AUM and most are lifestyle practices where the firm’s identity is linked completely to the partner or partners of the firm. On the other end of the spectrum, an enterprise firm’s identity is linked to the firm. Many lifestyle practices have enviable profit margins and ownership income, afford the advisor flexibility and control over her schedule, and provide satisfaction of long-time client relationships.
These aging innate entrepreneurs struggle to give up control of a great gig despite gritting through the complexities of compliance, the commoditization of investment advice and the demands and costs of advancing technologies. Some solo practitioners would rather shutter their firm than lose control at the cost of capturing the value of their life’s work. Others identify internal successors but question the successor’s level of entrepreneurial hutzpah. Some successors hesitate to pay the firm’s sales price based on an unrealistic owner’s valuation. Consequently, and despite the clickable industry headlines, the number of advisory firm sellers is meager with the buyer to seller ratio proving out at 50 to 1.
An unexpected illness or flat out fatigue are the sudden impetus of some sellers. The looming SEC requirement for succession plans may move others. But advisors should consider a sale not out of fear but out of choice. Before determining your firm’s value or identifying a successor, you should take the time to analyze what you want for the legacy of your firm and the next phase of your life. Yogi Berra’s quote “If you don’t know where you are going, you’ll end up someplace else,” speaks to this challenge.
Pro #1: A liquidity event will make it possible to diversify the concentration of your assets . Just as you counsel executives of publicly traded companies with a high concentration of their employer’s stock to spread the risk, you too should follow your own advice.
Pro #2: A negotiation driven by the owner will receive a higher price for a firm in versus the fire sale price wrangled by a spouse unfamiliar with the details.
Pro #3: The synergy of joining forces with another successful company will bring your firm forward, improving the services and pricing offer to your clients. The new energy and effort will engage your clients who may have additional assets and referrals for a growing advisory firm.
Pro #4: The systems and procedures of an acquiring firm can be wind at your sails . They may have more advanced technology, better workflows or a larger staff than your firm. Use these resources to take your firm, now a division, to a level of growth previously unobtainable.
Pro #5: As part of a larger firm you will benefit from a regional or national presence and your profile lifted as the larger firm’s marketing and brand broadens your reach.
Pro #6: Less time managing the business allows for more time with existing clients and client development . You became an advisor because you gain satisfaction from helping people navigate the complexities to secure their financial future. You did not become an advisor to manage an advisory business. Now you have time to focus on clients and growth again.
Con #1: Loss of control. If you sell your company, you will either remain through integration and then exit or you will stay indefinitely maybe as a managing director but also as an employee. Loss of control is the single biggest hurdle sellers face.
Con #2: Change. You will abdicate power to the executive team of the acquirer. The physical office and potentially some of your staff may go. If you remain past the integration, you will need to conform to another firm’s systems and procedures, and the inevitable adjustments to financial planning and investment management methodology.
Con #3: Risk of Losing Clients. One of the biggest concerns voiced by advisors is the risk of losing clients. Articulating your conviction and the specific benefits to the clients of the change is effective. You are moving them into the future as investment management and financial planning progresses. They will be grateful for this. Clients are stickier than you think, client loss less likely than you fear. Studies have shown that up to 90% of clients move with the advisor.
Answering the Who, What, When and How questions as you move through discussions and negotiations will help you stay focused. Keep notes to more easily observe the evolution of your thoughts and decisions.
What are you trying to accomplish, growth or an exit? What is the value proposition of the potential acquirer? Do both you and your clients meaningfully benefit from the value proposition?
To Whom do you sell? Cultural alignment, fair compensation, staff considerations, and your future role will drive your choice. Concessions are inevitable; mutual trust essential.
How: Tax considerations, financing capacity and size differential between the two firms will influence the terms and legal structure of the sale. Legal counsel is required.
When: This is the toughest question. From a quantitative perspective, look to revenue growth to as a guide. If your P/E is trending higher you are in a strong negotiating position. If your revenues are flat or declining and aging client’s net withdrawals are increasing your negotiating power is waning and time is ticking. From a qualitative perspective, you will struggle with the prospect of selling your firm absent an urgent issue unless your next act is clearly defined.
I’ll write about envisioning your future in the upcoming article.