Advisors are smart about many financial matters, but when it comes to selling their own firm, many are surprised about how much more there is to know. That was sage advice at the Summit delivered by Investment Advisor editor-at-large (and former editor-in-chief) Bob Clark, who counts among his own consulting clients FP Transitions.
FP Transitions matches buyers and sellers of advisory practices and has a feature on its Web site (www.fptransitions.com) where firms can list themselves if they are looking to buy or sell. The company publishes a yearly "Practice Transitions Report" which includes data about what makes a practice valuable, and that could be useful to an advisor who wants help placing the correct valuation on her firm, and is interested in learning more about who the buyers are. It is a "vibrant, robust marketplace," says Clark, reporting that FP Transitions typically has about 200 firms for sale and about 4,000 or 5,000 buyers on its Web site. He says FP does about 100 deals in a year, taking a fee of 7% split between the buyer and seller. Deals usually close in about three months. The firm, he said flatly, has created an "independent marketplace" for advisors.
All deals are not equal, however, and the one that appears at first blush to be the highest bid for a firm might not pan out that way, Clark cautioned; it is important to look below the surface. There are different types of buyers: Institutional buyers include strategic buyers like banks and insurance companies; and consolidators, which roll up smaller firms under their umbrella, Clark explains. Advisors who want to quickly build assets by acquiring other advisors constitute a third type of buyer. In the case of one advisor buying another, the profitability of the target firm may not matter as much as with an institutional buyer or a consolidator because the advisor buyer presumably knows how to run a firm profitably; here the primary attractions for the buyer are the target firm's clients and assets under management. But institutional buyers often have their own agendas, and their own investment bankers may show up with numbers that may at first look great--much more than what another advisor is willing to pay--though this is where some sellers can wind up in hot water.
"Size matters," says Clark, referring to the revenues of a seller's firm, and also to the size of the buyer--and so does who is buying. He cautions against leaping to sell to the highest bidder: "Why would a practice be worth more to a bank than to an advisor just like you down the street?" Smaller firms may be attractive to a large bank or insurance firm or consolidator. But what do they want with that smaller firm? Clients--not necessarily talent. Corporate buyers' investment bankers, Clark argues, "know a lot more about this than you do," he notes, "they make their living on deal terms." While they may offer high valuations, watch out for bad deal terms, private--instead of public--equity, lower compensation for principals who would be contractually obligated to stay for some period, and the requirement that acquired advisors sell their proprietary products--products, he drily notes, advisors would probably already recommend if they thought they were such great investments.
Correct valuation matters too. Smaller firms, with less than $2 million or $3 million in revenues, are generally sold on the basis of gross revenues, but where the revenue comes from is very important: Are they from commissions or fees? Commission revenue is considered much less valuable than fee revenue because fees are recurring, while commission revenue is not. Fee revenue is considered about twice as valuable as commission revenue, says Clark, referring to the FP Transitions data. What to do? Convert your clients to fees before selling your practice, he suggests.
There are other variables to consider as well in the valuation of a firm. Are the selling advisors looking to retire? What is the age of the clients? Older advisors and older clients are worth less, in advisory firm valuation terms, than younger advisors and clients.
Then there are taxes: The way taxes are treated on the deal itself makes a big difference in how profitable it is, and there are compelling reasons for both sides to want the terms of the deal to be very different, to make the tax treatment favorable to themselves, so tax advice is a critical component of evaluating any deal.
In this seller's market, profits don't matter, but revenues and deal terms do matter. "In very, very few cases" do practices sell to the highest bidder. More often it is a match between "like philosophies and like clients," Clark notes. "Sellers have a vested interest to sell to the buyer who has the highest likelihood of retaining clients."