From the June 2009 issue of Wealth Manager Web • Subscribe!

A Re-Done Deal

Yet even in the most uncertain and difficult situations, it is clear that the dialogue between the affected parties will have to begin today. Delaying or deferring the discussion only exacerbates the problem. Ultimately, a compromise will have to be reached because it is clear that the worst-case scenario is for the practice to fall into disrepair between a reluctant buyer and lack of capital. A compromise is possible, and with some creativity, at least the original intent of the deal can be preserved.

The first question to answer, of course, is which deals should be redone and when should we stick to "a contract is a contract"? These are my criteria:

1. Is the deal still financially viable AFTER we pay the current buyer some fair compensation for their labor? Notice that it is critical that we pay the buyer some amount of compensation before we calculate whether there is enough cash to pay the seller. In many situations, the advisors operating the practice have to forgo all or substantially all of their income in order to make the payments to an acquirer or a retired advisor. In many cases, junior partners have to devote all of their income to the buy-in in order to make the payments. In all of these cases, the situation is not sustainable. If the advisors are not able to pay their personal bills, they will leave the practice or, worse, they will make disastrous decisions in an effort to make ends meet.

2. Was the deal's intention for one side to bear the market risk or was the intention to share in the outcome? If at the time of the deal it was intended that both parties will be in the same boat and will grow and prosper together, then it is only fair to share in some of the downside--even if the deal was not exactly designed that way. This is usually the case with new partner buy-ins and most of the consolidation deals. Succession deals on the other hand, where one advisor is retiring, often are meant to get the advisor completely out of the practice as well as the risk of running it.

3. How much time is left? In the case of "a deal is a deal," it is probably a single year of payments; five more years of payments are clearly a case of sitting down and discussing the options.

4. Was the price fair? This is the thinnest of ice. It is very difficult to argue what is a high price and what is too high a price on an arms-length agreement. Assuming both parties were sober at the time, a mutually agreed upon price is the right price. Still, especially in succession deals, emotional considerations were affecting the judgment of those involved. It is difficult to haggle on price with your mentor, with your father, with your teacher--yet these are usually the retiring advisors who are selling their practices to successors. In some cases they grossly overpriced the deal, and in other cases they grossly underpriced it. In some cases they thought they were grossly underpricing, while in reality they were asking for too much.

5. Do you still have to work together and/or have a relationship? If the affected parties will continue to rely on each other and act as partners in the future, then clearly something needs to be done. If the deal was between "strangers," then it is easier to insist on sticking to what was signed.

It is important to remember why we are revising a perfectly legal and binding contract: The reason is that one of the parties can usually walk away, abandon the practice and let the other party recover what they can. Furthermore, through compromise, the seller can still collect better consideration in a revised deal than in a salvage operation. Last but not least, the people who are stuck on the short end of the stick are usually those who are meant to lead the recovery--younger partners and consolidated firms.

What tools are available to make changing the deal a reality?

1. Extending payments over a longer period of time to mitigate the cash flow drain, or even deferring some payments for a period of time - This is a very straightforward option that is used in all kinds of consumer loans. Simply restructuring the payments from, say, a five-year term to a seven-year term can reduce the size of the payment and help the buyer enough to be able to maintain the rest of the deal.

2. Converting from one form of payment to another, giving the seller more upside potential in exchange for lower payments -There are many possibilities under this heading, and most of them involve converting payments from fixed to variable, tied to the real results from the practice.

3. Changing the parties altogether - Sometimes when one party won't negotiate, it may be better to look for a replacement. In some situations, it may be possible to raise capital from a private equity firm to buy out the existing contract, and then restructure the balance with the private equity firm.

4. Reversing the transaction - In some cases it is possible to reverse the transaction or at least to partially reverse it, for example by buying back its equity.

5. Revaluing the firm - Finally, the can of worms! Sometimes we have no choice but to write off our losses and move on. It is quite possible that we were all overvaluing advisory firms back in 2007 and early 2008. Getting some money for the practice rather than trying to recoup what's left of the deal through court battles may be the best course of action. Having some sympathy for the remaining successors is a factor here, too. Sometimes the valuation was just not fair to begin with, and it is time to face the music.

There is nothing easy about renegotiating a signed agreement. It will be extremely difficult for the sellers to accept different terms or even different valuations and not feel as if they have not been treated fairly. However, these are extraordinary times. You have to remember that even Madoff's victims were asked to send their last six months of "profits" back to the court-appointed trustee since the gains turned out to be fictitious. "Fair" is sometimes difficult to agree on. "Practical" is sometimes easier to search for.

In the long term, we may find that the entire industry had its deal redone. It is quite possible that we were overvaluing advisory firms based on unrealistic expectations about growth and profitability and not pricing in the possibility of a crisis. It is also possible that we will have fewer buyers, both internal and external, going forward and thus, as demand declines prices will follow. It is possible that as an industry we may have to extend more credit to the young advisors, change the terms of their career path and their equity plans to be more favorable, and perhaps start working earlier on our succession.

The deal may change some, but fundamentally, the principles guiding it will stay the same--value is created by cash flow and growth. The equity of an independent firm is its most valuable currency, and we need to be able to create a "market" for it in order for any professional to be able to capitalize on what they have created. That may require some flexibility, but bending is better than breaking.

Philip Palaveev is President of Fusion Advisor Network. He can be reached at
ppalaveev@fusionadvisornetwork.com.

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