From the October 2007 issue of Investment Advisor • Subscribe!

It's Not All Gold

When buying a practice, don't be distracted by the shiny objects along the way

Is there a buying frenzy going on? These days, it seems as if everyone wants to buy a practice to grow her business. Sometimes an acquisition can be an excellent growth strategy. And, let's face it, the timing is good. Thirty percent of the general population is age 55 or older; 22% is 35 to 49 years old, according the U.S. Census Bureau. Assuming these percentages translate to financial planning and investment management professionals, we can reasonably expect that many boomer-owned practices will come on the market during the next 10 years.

Buying a practice, however, doesn't always purchase you a gold mine. Let's consider two possible cases. In both instances, a seven-figure advisor bought a practice half as large from an advisor who was 20 years older. Each purchased practice was located near the buyer; each was predominantly fee-based and had a similar number of clients. The buyers and sellers were dedicated, hardworking, and ethical; managed portfolios personally; appeared to have solid client relationships; and were affiliated with the same broker/dealer.

In the first case, the transition was completed over two months. Clients were informed via letter, with a follow-up phone call made to schedule an appointment with both the buyer and the seller of the practice. All paperwork was completed efficiently and, several years later, 98% of the transferred clients are still with the buyer. The seller continues to have a role with the firm, working part-time with a small number of clients.

In case two, the seller joined the buyer's firm with the expectation of tapping into a marketing machine and transitioning clients to the buyer. But a combination of factors surprised both the buyer and seller. First, the seller found himself uncomfortable with the day-to-day reality of not running his own business and just couldn't make the transition. Second, the seller was forced to deal with some unexpected health issues, which interfered with the schedule for transitioning clients. Finally, a higher percentage of the seller's clients had only moderate loyalty and did not follow him as anticipated. Ultimately, the seller retired with only about 10% of client assets transitioned to the buyer.

Slow Down--Avoid Buyer's Remorse

Because buyers are eager to purchase a practice and perceive it as a quick and easy way to grow the business, they sometimes go into the due diligence phase of the process wearing rose-colored glasses, injecting into it exactly what they want to see.

Let's say a wonderful opportunity falls in your lap. The planner down the street is selling his practice, and he calls you first. You've known him for a long time and are confident about his ethics and compliance practices. All of your buddies are saying how they want to buy an established financial practice, and they spend time researching and looking at practices that come on the market. Because it's a sellers' market, you are honored to be approached, so your knee-jerk reaction is to strike a deal as soon as possible. You skim over the due diligence aspect of the transaction, and, move quickly to apply industry averages to the deal, arriving at a purchase price and terms agreeable to both you and the seller.

Suddenly, the seller's book is yours, and you realize that your acquisition may not be so lucrative after all. As you begin to set up appointments, you discover that a quarter of the book is made up of clients in their eighties, with estate plans long established and children who live far away and are awaiting an inheritance, and who have their own trusted advisors to manage the assets. A second quarter of the book is clients with minimal assets whom you would never have considered taking on in the past. Still another quarter is widowed women, who usually don't make a move until they check with you first--a style of dependence with which you are unaccustomed and uncomfortable. The final quarter of the clients had only a good-to-moderate relationship with the seller. Their introduction to a new advisor is just the opportunity they have been waiting for to shop around.

Due Diligence and Problems After the Fact

Due diligence is a process--a two-way street, when each party can look at the other's investment philosophy, service model, and orientation to customer service. It's a time for measuring the chemistry between buyer and seller and, perhaps most important, the relationship between the seller and the clients, as well as the potential for a relationship between the buyer and the clients.

Even when you hire a professional dedicated to helping with the due diligence process, there is a tendency to go way outside your business model because you believe that buying a practice is a simple way to grow your business. There are several due diligence lists available to help a buyer investigate the many aspects in determining the stickiness of clients when a practice is transferred. (See "Ask These Questions First" sidebar for a list of essential due diligence questions.)

Even with carefully done due diligence, things can still go wrong. Consider the following:

  • You buy a book of happy clients and the market tanks soon after you take over the accounts; instantly, the happy clients start second-guessing.
  • The staff you inherit just doesn't fit in and is not as good, productive, or computer-savvy as your staff, causing conflict and decreased productivity.
  • The seller remains after the sale to help transition clients, but overstays his purpose.
  • As the ink is drying on the buy/sell agreement, two competitors run compelling ads in the local paper encouraging clients to shop around before they commit to a new planner. A free consultation is encouraged.
  • The clients just don't feel comfortable with you, your staff, your location, and so forth.

Consider this alternative. An advisor seriously talks for a year with another advisor about buying his practice. After researching the practice, the advisor walks--no--runs away. During his year of due diligence and review he discovered that the book was riddled with clients whom the buyer was trying not to take. To get the 50 additional clients he wanted, he would have had to buy 250 others; this would have required him to get more staff and to change his business model. With his long-term outlook and positive reputation in his community, he decided that he would wait and eventually place an ad in the local paper inviting selected clients to join his practice. In other words, he decided not to reinvent his own business just to get the quick hit of acquiring clients by buying another practice.

Doing What's Right for You

Growth is critical to any small business, but buying a book is just one strategy for growth. How far you would be willing to stray from your own business model to acquire a practice is a question whose answer must be carefully considered and thoroughly researched before you enter into a buy/sell agreement. The perceived gold of a purchased book could cost you more in energy and dollars in the long run than the book of clients is worth.

Once you multiply the number of hours it takes to conduct due diligence times the number of firms you have to sift through to find the practice that is worth purchasing, you have to wonder how else the time could have been used. The last thing you need is for your own clients to feel neglected while you are distracted by the process of looking for a business to acquire.

No doubt, buying a practice is a good way to grow if you find a firm that is right for you. But unless you do, don't be sucked into the buying frenzy.


Joni Youngwirth is the vice president of practice management at Commonwealth Financial Network in Waltham, Massachusetts. She can be reached at jyoungwirth@commonwealth.com.

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