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November 19, 2018 at 03:35 PM
As interest among independent financial advisors in growing through acquisitions continues to grow, one question that has increasingly been asked is, “Can I afford to take out a loan to purchase another independent wealth management practice?”
When it comes to making acquisitions with bank financing, the ability of advisors to scale borrowing to buy one, two, three or more practices depends on the acquirer’s practice and personal cash flow, all of which can be improved meaningfully by targeting cash-flow rich acquisitions.
Overleveraging Is Uncommon
First, some background: Traditionally, financing extended to advisors for the purpose of acquiring other independent practices has been minimal at best, and most lenders remain skittish overall on the independent wealth management space. Consequently, lending capacity remains untapped.
For example, we recently worked with a prospective seller of a successful independent advisory practice who approached us to determine how much bank financing was available for prospective buyers of her practice, based solely on her practice’s financials. Until that point, she had not collateralized the practice, which had robust free cash flows.
Initially, this advisor had planned on listing her practice for $2.5 million. Our cash flow analysis supported a $3 million valuation, especially factoring in a further increase in cash flows that could be expected after a sale, with the departure of the owner and her corresponding compensation.
The advisor increased her asking price, and was able to negotiate a $2.8 million sale via bank financing.
Although the seller’s practice supported the sale price, the funding bank also collateralized the transaction with the purchaser’s practice. The aggregate free cash flows and substantial enterprise value from both practices assuaged reluctant bankers, enabling deal financing — and the transaction — to happen smoothly.
Maximize Borrowing Scale
Having established that independent advisors can afford to take out loans to make acquisitions when purchasing cash-flow rich practices, the question becomes: How can advisors maximize borrowing scale to accelerate a growth acquisition strategy?
The commercial real estate (CRE) developer provides an excellent example of maximizing borrowing scale. Real estate developers are speculating that the value of the underlying property they acquire will increase over time, much like advisors with the value of their practice.
