From the September 2010 issue of Investment Advisor • Subscribe!

Formulas For Success: Soul Mates, or Marriage of Convenience?

When considering a merger, get to know your potential partner

Do you ever speculate as to what attracted a seemingly incompatible couple to each other and what compels them to stay together? It's a tasteless exercise that many of us indulge in; sometimes we just can't help imagining how such opposites attract. I often wonder the same thing about advisory firm partnerships, especially those that result from mergers. It's not uncommon to see one advisor practicing financial planning for middle income pre-retirees while the other handles sophisticated investment management for high-net-worth clients. Or one specializing in the suddenly wealthy while the other counsels 401(k) plan trustees. One has worked alone all his life, the other has always leveraged staff. What draws these odd couples into each other's orbit?

It's a big decision to join with another firm. In addition to complementary business models, the advisors' personality types must be compatible. In some cases, opposites can set off epic battles for influence over how things should get done. In others, where the partners are more secure, opposites can create wonderful, harmonious environments. The alchemy of an extrovert and an introvert can yield a dynamic business where one partner focuses on the outside and the other on the inside; one on sales, the other on service.

In the first glow of courtship, the charms of a possible mate may seem irresistible. Whatever the initial allure, take some time to think things through. The bigger question centers on how prospective merger partners can build a strong and enduring relationship.

Ritual Sniffing

As a business consultant since the 1970s, I have worked with literally hundreds of advisory firms on matters related to succession, mergers and acquisition. Now, as the leader of an RIA custodial platform, I often find myself discussing the opportunities and pitfalls of such transactions with advisors who are seeking new ways to drive growth and ensure continuity. Often the first question to emerge is, "what's the multiple?" While that subject is interesting and ultimately relevant, it is almost always premature.

In the beginning, prospective partners should be trying to figure out what makes the other tick: what kind of culture they have created, how they do business, and how they relate to their employees and clients. Learn the fundamentals of the firm's business practices, who they perceive to be their optimal client and how they deliver their services to the market. Discover what their competitors and centers of influence say about them (discreetly, of course), and uncover their weaknesses.

For some, these extra steps seem too hard, too complex and too boring to engage in. Far too many advisors want a quick fix, a rule of thumb, a predesigned form. They would rather jump into a relationship believing that their charm will prevail, and trusting that the logic of the deal is too compelling for it to fail. And it all can be done with little cost in time and money! Regrettably, these same merger partners spend years trying to undo the damage that was done by being so eager, if not rash. It is a depressing moment when they realize they now must painfully repair or divest of a marriage that never should have taken place.

Unfortunately, annulments of these relationships do not come easily. In addition to the legal challenges, partners must unravel complicated issues related to technology, staffing, client responsibility and finances. Further, corporate divorces are embarrassing to the principals and consume every last dollop of energy left to firm owners who have spent years trying to serve and generate clients.

So the first lesson in merger discussions is this: Don't focus on the size of the dowry, but rather on determining if the partnership is based on an underlying compatibility that will endure and flourish.

Do You Really Want a Partner?

Advisors contemplating a merger should first be clear about what they aim to accomplish. There are many compelling reasons to merge with other firms, especially in this environment. The desire to create scale and attract talent is high on the list. So too is the opportunity to have a bigger presence in the market and the resources to serve clients more completely. Mergers can also facilitate an orderly transition of the business when the principals begin executing their succession plan.

But advisors are a lot like people. They have emotions. They have likes and dislikes. They have their own approach to doing business and a way of living life that is unique to them. They have philosophies about how to spend money and exhibit their personal values.

So even when a prospective partner's client profile fits well and advice is rendered in a consistent manner, dig deeper. Mergers require due diligence around personal characteristics and beliefs that will be tested in the early phases of the partnership--and beyond.

As appealing as a merger may be, are you really ready to commit? The demands of a union can be especially challenging for small practices or solo firms where owners have never had to share decision making before. We all have the potential to grow and adapt, but many entrepreneurs are not hard-wired to share authority or glory with others. It's helpful to know thyself before engaging in the work of combining forces to build a greater enterprise.

So What Do You Do?

As advisors know, it's always best to begin with a plan. Start with the goal. Then evaluate the present. What is the gap between your vision for the future and the current reality? Is it people, scale, technology, expertise, brand, market presence, energy, business development capability? Knowing what you seek to accomplish through a merger goes a long way towards informing your strategy.

With this goal in mind, create a framework for your search. Outline a profile of your ideal match and, like speed dating, quickly narrow the field. Identify a front runner from a short list of candidates who have exactly what you are looking for.

Then begin the process of getting to know the other firm and its people. This should be done over the course of months, not days. And it should happen before you engage too deeply on the financial terms of any transaction. Take your time, keep your eyes and ears open, and think things through.

When you're ready, go into the merger discussion with a series of "deal-makers" instead of "deal-killers." Deal-makers are those elements that you believe would make the combination a winner.

Deal makers could include:

1. Will the merger be beneficial for both firms?

2. Will it create better opportunities for our staff?

3. Will it enhance the experience or advice we give to clients?

4. Will it build income for the principals?

5. Will it result in greater overall value for the enterprise?

Till Death Do Ye Part

As with prenuptial agreements, it's best to negotiate the terms of a buy/sell agreement while all parties are still friendly and able. For example, what will happen in the case of the death of a firm advisor? Not everybody has an agreement that informs the estate or heirs how to dispose of the ownership interest, and under what specific terms, should something tragic occur. In many cases where buy/sell agreements do exist, they are often between two advisors operating their own practices. This carries some obvious risk, such as leaving the advisor who takes over the practice drowning in new clients while trying to tend to his own business.

A more common triggering event for a breakup is the retirement or departure of an owner. Buy/sell agreements should specifically state how the valuation will be determined, what the relevant date of the valuation will be and how the payments will be made. The agreement should have clauses for how the person leaves--whether voluntarily or involuntarily--and whether the departure might cause damage to the firm. It should provide protection to the remaining owners should a group of owners leave en masse.

Running a business is not easy. Bringing a new partner into the mix can complicate the task. Nonetheless, firms with multiple partners usually grow faster, last longer and serve clients better than their resource-strapped counterparts--but only when the partnership is based on a shared vision, a mutual respect and a compatible way of doing business and making decisions.

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