I don’t know about you, but it troubles me that advisors who would rather get an anesthesia-free root canal than work for a bank get seduced by a “perceived” large purchase price from a bank. We’ve all heard people brag about acquisition offers from banks ranging anywhere from three to five times annual revenues. Yet when we look into these deals, we usually find that up to half of the purchase price is held back and tied to future performance. What’s more, often the currency that is being used is bank stock, not cash. Stock, especially if it is restricted or closely-held, should be discounted by as much as 50% from its stated value when being considered as part of the buyout.

In recent years, some of the most active buyers of advisory firms have been banks. There are big bank deals like Harris Bank acquiring Sullivan, Bruyette, Speros & Blayney, Inc. in McLean, Virginia, and MyCFO in California, and little bank deals like South Umpqua Bank in Oregon buying Carter & Carter in Eugene, Oregon. Sometimes, financial institutions will pay a premium for such acquisitions because they have a strategic motivation to expand their product line and increase their non-interest income. But do these deals work?

The answer is yes. Banks can be a great merger partner, primarily because of the resources that they have the potential of bringing to advisory firms. But sometimes these deals don’t work. When they fail, it’s often because the merging companies fail to address the strategic, cultural, compensation, and integration issues that come with every merger. Ideally, these issues should be addressed prior to consummation of the deal, but at a minimum they should be a priority during the first six months after the merger.

Unfortunately, banks are notorious for following the herd. When they see their competitors introduce a new business concept, there is a mad rush to follow. As a result, a bank’s merger with an advisory firm may be more reactive than strategic, and it’s important that you validate the bank’s motivation before you proceed.

In our experience consulting with banks that have entered into the financial advisory business, we have found some common institutional problems:

o Their financial planning operations often lack critical mass. Because the advisory business is so foreign to bank leadership, the tendency is to start small. For instance, they might first acquire a solo or small practice to manage their risk. However, many of these practices are already at capacity, without resources to respond to bank leads, or even develop internal relationships that are key to growing revenues.

o They often try to be their own broker/dealer. Most firms that merge into a bank are regulated by the NASD, which presents the bank with an unfamiliar set of issues. For one thing, NASD prohibits corporate contracts (for reasons that escape me); for the bank to legally receive a distribution of income, they must form a broker/dealer to process the transactions. Often we refer a bank to a broker/dealer that is willing to provide private-label services, which reduces costs, but still leaves them with the issue of oversight.

o They have no plan or feedback loop to translate bank clients into financial advisory clients. Is there true compatibility between bank customers and the target clients that advisors seek? Would those customers be comfortable asking for financial advice from the bank or its subsidiaries? Once compatibility is determined, both sides need to develop an action plan, accountability, and a process for pursuing and managing relationships, as well as determining who gets paid for what.

Planner, Plan

Whenever we have been engaged to assist a bank or an advisor in a merger transition, we generally recommend that the leadership of both organizations devote time for organized strategic planning. They must resolve questions about the clients they’ll serve and why, and the products and services they’ll offer and why. They will need to agree on goals and identify resource gaps that will be hurdles to achieving those goals. They will need to agree upon the steps to be taken over the subsequent 12 months to move them incrementally closer to their goals, decide who will be responsible to take those steps, and determine how success will be evaluated. It can take up to three years for a merger to meet the expectations of both parties; without a joint business and strategic plan, it will take far longer.

Perhaps the biggest strategic issue that the bank and the advisor must resolve is defining success. Is it expansion of services to existing bank customers? Is it building a new financial services brand in the market? Is it return on equity or increased share of wallet? From the advisor’s side, is it liquidity, market presence, management, or leads? Defining success will help both parties to direct the right resources to ensure a happy relationship.

Another major bugaboo is compensation. Compensation conflicts often arise when newly acquired advisor ends up earning more than the president of the bank. Whether it’s ego or pay equity that gets in the way, the advisor’s pay is frequently a cause of friction. More commonly, the tension revolves around what the advisor and his team are getting paid for. Is it for producing? Giving advice? Providing portfolio management?

Surprisingly, this issue is frequently not resolved until after the price and other terms of the acquisition have been negotiated, or even after the merger has been completed. As you might imagine, the compensation of the advisor, and determining how the profits of this “new” unit will be distributed, can have a substantial impact on the overall economics of the deal. Consequently, the total compensation for all the advisors/principals involved must be incorporated into the financial models from the beginning.

We recommend that after the advisory firm has aligned its organization to fit the agreed upon strategy, the parties set the compensation for each position. Included in this model will be incentive plans, benefit plans, and other factors that normally count towards an employee’s reward.

The bank may also argue for lower levels of compensation to the advisor and his team because of a high purchase price. But this can easily be resolved in the proper context. If the compensation model was incorporated into the valuation analysis, then you can get both parties focused on the right numbers. The bank will measure its return on equity from the income distribution out of the advisory subsidiary, as well as the advisor’s contribution to bank product sales or referrals back to the parent, such as for loans. The question, then, is how to monitor these various revenue streams, and how to reward those who are producing these returns.

The bank will be concerned about paying the advisor so much up front on the acquisition that the advisor will have little incentive to continue to drive the business forward. As most such mergers involve the advisors/principals staying with the firm for a considerable time, they are usually a growth strategy for the advisors, not an exit strategy. Consequently, the bank will likely be careful to include in the net purchase price earn-out clauses based on performance. While such terms are certainly appropriate, an advisor should be careful to distinguish between the total buy-out price and compensation for his labor–after all, an advisor’s future work is adding additional value to the firm, and the should be paid accordingly.

Perhaps the biggest hurdle is conflicting cultures. It’s better, of course, if each side tries to understand the other’s values, but in most cases the advisor will eventually need to adapt to the mother culture of the bank. While it’s possible that the larger entity–the bank in virtually all cases–will adopt some of the best elements of the advisory firm, it’s far more likely that the advisory firm is going to have to do most of the bending.

Part of this bending comes from the fact that large organizations with relatively rigid structures, such as banks, have protocols on how they do everything from who they hire, how they make decisions, and where they focus resources. It is often difficult for independent advisors who were the biggest kids in their own sandbox to find that they have to share their toys with the bigger kids. For instance, the new institutional decision-making process will seem glacial for an advisor with an entrepreneurial background. Issues like this will become even more challenging if their “champion” within the bank–the person pushing hardest for the merger–does not end up being responsible for managing the new advisory affiliate after the merger, or worse yet, leaves the bank.

It would be wise for advisors to spend time talking to principals in other firms who have merged into the bank about their experiences, and talk to folks who have joined the bank from another company. Don’t expect these people, who are now employees of the bank, to share all their dirty laundry. But asking them about their transition experiences and ways the bank compares to their old firm can often be revealing. Your goal is to get a better understanding of how to successfully work within that particular institution.

It is common these days for people to speak derisively about the politics and bureaucracy within larger companies (brilliantly captured in the Dilbert comics). But if you’re going to make a merger with a bank work, you can’t get bogged down in the negatives. In a bigger sense, company politics are also about the art of getting along with your co-workers in any setting–it’s something we all deal with in our personal and professional lives. One’s position and leverage often dictates the person who will prevail when conflicts arise, but in most respectful cultures, there is always opportunity for compromise.

All these problems may seem tactical, but their sources are strategic. Before you merge your firm into a bank, understand its vision for your business, the resources it will commit to realizing this vision, and it’s definition of success. It’s easy to make any merger look good on paper, especially when you have high six or seven figures staring at you; but between the idea and the reality there’s plenty of room for failure.

Mark Tibergien is a nationally recognized specialist in practice management for financial services firms, and partner-in-charge of the Securities & Insurance Niche for Moss Adams LLP, the 10th largest CPA firm in the U.S. He can be reached at mark.tibergien@mossadams.com.