Buying, Selling, and Valuing Financial Practices E-Book

David Grau

• Herausgeber: John Wiley & Sons
• Kategorie: Fachliteratur
• Serie: Wiley Finance Editions
• Sprache: Englisch

Seitenzahl: 572

Veröffentlichungsjahr: 2016

Beschreibung

The Authoritative M&A Guide for Financial Advisors Buying, Selling, & Valuing Financial Practices shows you how to complete a sale or acquisition of a financial advisory practice and have both the buyer and seller walk away with the best possible terms. From the first pages of this unique book, buyers and sellers and merger partners will find detailed information that separately addresses each of their needs, issues and concerns. From bestselling author and industry influencer David Grau Sr. JD, this masterful guide takes you from the important basics of valuation to the finer points of deal structuring, due diligence, and legal matters, with a depth of coverage and strategic guidance that puts you in another league when you enter the M&A space. Complete with valuable tools, worksheets, and checklists on a companion website, no other resource enables you to: * Master the concepts of value and valuation and take this issue "off the table" early in the negotiation process * Utilize advanced deal structuring techniques including seller and bank financing strategies * Understand how to acquire a book, practice or business based on how it was built, and what it is capable of delivering in the years to come * Navigate the complexities of this highly-regulated profession to achieve consistently great results whether buying, selling, or merging Buying, Selling, & Valuing Financial Practices will ensure that you manage your M&A transaction properly and professionally, aided with the most powerful set of tools available anywhere in the industry, all designed to create a transaction where everyone wins--buyer, seller, and clients.

Leseprobe

Praise for Buying, Selling, and Valuing Financial Practices

David Grau Sr. has been listening attentively and working effectively with financial advisors since founding FP Transitions. This book reflects his profound understanding of our profession and what it requires to exit one's business with purpose, clarity, and effectiveness. Just as we don't believe there is a one-size-fits-all approach to financial planning, David does not believe there is only one way to approach your exit plan, and that is what sets him apart. The sooner you read the book the better.

Elizabeth Jetton, CFP®, Former President of the FPA; Cofounder, TurningPoint Vision

As the leader of one of America's largest independent advisor groups, I have known David Grau Sr. and FP Transitions for the better part of 15 years. I have great respect for their vision, knowledge, and insight into the world of practice mergers and acquisitions. Once again, David Sr. and FP Transitions have published a book that every advisor should read.

At some point, every advisor will either be a buyer or a seller. This clear, practical, and expertly written book will help tremendously no matter what side of the table you are on. While reading the book alone will not prepare you for the complexity of constructing a thorough and appropriate deal, it is the best first step.

Bill J. Williams, Executive Vice President, Ameriprise Financial

David Grau Sr. and FP Transitions have written the consummate M&A guide for the financial services profession. Coupled with their first book on succession planning and building a sustainable business, this second book provides advisors with a set of bookends that provide a range of great options as advisors consider their future and plan accordingly. Advisors interested in buying, selling, or merging their practices now have a clear road map for developing and executing their plans. This is a practical, step-by-step guide that provides detailed insights on value and valuation, due diligence and documentation, even the financial tools for executing an M&A strategy such as acquisition loans and acceleration options. A must-read for those committed to mastering the process of buying, selling, or merging an advisory practice!

Chip Mahan, Founder and Chairman, Live Oak Bank

David Grau Sr. has written yet another outstanding book. He has a unique way of taking ideas that typically scare investment professionals away and capture their attention. So many in our industry wait until it is too late to develop succession plans and/or exit strategies. Grau does a great job of being blunt to get a professional's attention and then thoroughly educating them as to what they should consider doing. Succession planning, exit strategies, and M&A work is a detailed, thoughtful exercise. This book gives a professional the tools, language, and knowledge to begin the dive into that process.

Chris McAlpin, Senior Advisor, MBA, CMFC, Sound Financial Strategies Group Inc.

David Grau Sr. and FP Transitions comprise one of the advisor industry's most skilled and sought-after matchmakers, bringing buyers and sellers together for more than two decades. In his new book, Buying, Selling, and Valuing Financial Practices, David manages to take the complex and often intimidating topic of mergers and acquisitions and deliver a powerful, yet simplified guide for advisors at every stage in their businesses. Whether in the market to acquire or sell a practice, advisors will benefit from David's insights on the buying basics, valuation fundamentals, and making the deal.

TD Ameritrade Institutional has worked with David and FP Transitions for more than a decade, and we've seen advisors put these ideas into action with great success. David goes beyond theory and provides advisors with a proven process and methods that have been tested in the trenches. This book is a must-read for any advisor who has ever said to themselves, “I know I need an exit strategy and I want to do what's best for my clients, but I don't know where to start.”

Tom Nally, President, TD Ameritrade Institutional

The ability for financial advisors to successfully sell or transition their business (arguably their largest financial asset) is a huge challenge that the industry faces. Rather than just admiring this issue, David Grau Sr. and FP Transitions have evaluated the different causes of this problem and identified how advisors can apply these findings and solutions to their own firms, while recognizing that there's no one-size-fits-all approach to buying, selling, or valuing a financial practice.

Wayne Withrow, Executive Vice President, Head of SEI Advisor Network

The “go-to playbook” for financial services professionals who are looking to grow through M&A activity.

John W. Smith, ChFC®, CLU®, CASL®, MBA, Managing Partner, Cardinal Pointe Financial Group

This book describes everything you need to know for buying, selling, and valuing an advisory practice. A powerful read with many tools.

Jonathon L. Myers, CFP®, ChFC®, CLTC, MBA, CASL®, Private Wealth Advisor, Jon L. Myers and Associates

The Wiley Finance series contains books written specifically for finance and investment professionals as well as sophisticated individual investors and their financial advisors. Book topics range from portfolio management to e-commerce, risk management, financial engineering, valuation and financial instrument analysis, as well as much more. For a list of available titles, visit our Web site at www.WileyFinance.com.

Founded in 1807, John Wiley & Sons is the oldest independent publishing company in the United States. With offices in North America, Europe, Australia and Asia, Wiley is globally committed to developing and marketing print and electronic products and services for our customers' professional and personal knowledge and understanding.

Buying, Selling, and Valuing Financial Practices

The FP Transitions M&A Guide

DAVID GRAU SR., JD

Cover image: Alex Moan, FP Transitions Cover design: Wiley

Copyright © 2016 by FP Transitions, LLC. All rights reserved.

Published by John Wiley & Sons, Inc., Hoboken, New Jersey. Published simultaneously in Canada.

No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, scanning, or otherwise, except as permitted under Section 107 or 108 of the 1976 United States Copyright Act, without either the prior written permission of the Publisher, or authorization through payment of the appropriate per-copy fee to the Copyright Clearance Center, Inc., 222 Rosewood Drive, Danvers, MA 01923, [phone], fax [phone], or on the Web at www.copyright.com. Requests to the Publisher for permission should be addressed to the Permissions Department, John Wiley & Sons, Inc., 111 River Street, Hoboken, NJ 07030, [phone], fax [phone], or online at http://www.wiley.com/go/permissions.

Limit of Liability/Disclaimer of Warranty: While the publisher and author have used their best efforts in preparing this book, they make no representations or warranties with respect to the accuracy or completeness of the contents of this book and specifically disclaim any implied warranties of merchantability or fitness for a particular purpose. No warranty may be created or extended by sales representatives or written sales materials. The advice and strategies contained herein may not be suitable for your situation. You should consult with a professional where appropriate. Neither the publisher nor author shall be liable for any loss of profit or any other commercial damages, including but not limited to special, incidental, consequential, or other damages.

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Library of Congress Cataloging-in-Publication Data:

Names: Grau, David, Sr., author.

Title: Buying, selling, and valuing financial practices: the FP transitions M&A guide / David Grau, Sr.

Description: Hoboken : Wiley, 2016. | Series: Wiley finance | Includes index.

Identifiers: LCCN 2016015333| ISBN 978-1-119-20737-5 (hardback) | ISBN 978-1-119-20739-9 (Adobe PDF) | ISBN 978-1-119-20738-2 (epub) | ISBN 978-1-119-20740-5 (obook)

Subjects: LCSH: Selling. | Purchasing.

Classification: LCC HF5438.25 .G723 2016 | DDC 332.6068/1—dc23 LC record available at https://lccn.loc.gov/2016015333

To Oscar

CONTENTS

Foreword

Preface

For Sellers

For Buyers

Acknowledgments

Chapter 1: The Basics You Need to Know

Avoiding the Critical Mistakes

Valuation: The Great Debate

Assessing What You Have Built (or Are Acquiring)

Who Is Selling? Transition Strategies by Ownership Level

Overcoming Attrition: Public Enemy No. 1

What Is Being Sold?

Organizing the Marketplace

Exit Plans versus Succession Plans versus Continuity Plans

The Planning Continuum

Chapter 2: Value and Valuation Fundamentals

An Overview

What Creates Value?

Standards of Value

Valuation Approaches and Methods

The Rule of Thumb Method of Valuation

Application of Standards and Approaches

Making Sense of It All

Who Is Qualified? (To Offer an Opinion of Value)

Valuations for Bank Financing

Notes

Chapter 3: Solving Valuation

The

Blue Book

Standard

Lessons Learned

A Value Calculation

How It Works

Recurring versus Nonrecurring Revenue

Assessing Transition Risk

Measuring Cash Flow Quality

Fixing the Fracture Lines

The Profitability Issue

Chapter 4: Building and Preserving Value toward the End of Your Career

Chapter 5: Preparing to Sell

What’s Your Plan?

Finding the Very Best Match

When to Sell: Timing That Final Step

In a Nutshell: How to Sell Your Book, Practice, or Business

The Listing Process

Making a Quick Decision to Sell

When Selling Isn’t Selling

Ten Things Buyers Will Want to Know

Handling Key Employees during the Selling/Listing Process

Letting Go

Chapter 6: The Buyer’s Perspective

A New Direction

If at First You Don’t Succeed . . .

Build a Base for Acquisition

What Sellers Will Want to Know

Understanding the AUDITION Process

Are You a Buyer or a Prospect?

Nontraditional Acquisition Strategies

Chapter 7: Deal Structuring: Payment Terms, Taxes, and Financing

Seller Financing

The Shared-Risk/Shared-Reward Concept

Performance-Based Promissory Notes

Earn-Out Arrangements

Revenue Sharing or Fee Splitting Arrangements

Earnest-Money Deposits

Down Payments

Basic Tax Strategies

Installment Sales

Asset-Based Sales/Acquisitions

Stock-Based Sales/Acquisitions

Bank Financing

The Mechanics of the Process

Blending Seller and Bank Financing Together

Acceleration Options

Working Capital Loans

Chapter 8: Due Diligence and Documentation

Conducting Due Diligence

Assembling and Managing Your Team

Advocacy versus Nonadvocacy Approach

Documenting the Transaction

Chapter 9: Key Legal Issues in the M&A Process

What Exactly Is “Boilerplate”?

Reps and Warranties

Covenants and Conditions

Indemnification and Hold Harmless Clauses

Protections against Death or Disability

Default Provisions

Resolution of Conflicts

Basic (but Not Trivial) Legal Issues

Chapter 10: The Transition Plan

Regulatory Issues

Transferring Fee-Based Accounts

Setting Up for the Post-Closing Transition

E&O Insurance (Tail Coverage)

Sample Client Letters

Conclusion

Appendix: Sample Documents

About the Author

About the Website

Index

Advert

EULA

List of Tables

Chapter 2

Table 2.1

Table 2.2

Table 2.3

Chapter 7

Table 7.1

Table 7.2

Table 7.3

Table 7.4

List of Illustrations

Chapter 1

Figure 1.1

Structural Elements of an Independent Financial Services/Advisory Model

Figure 1.2

Industry Segmentation

Figure 1.3

Transition Strategy by Ownership Level

Figure 1.4

End of Career Transition Strategies for Independent Advisors

Figure 1.5

Most Advisors Focus on Revenue Strength Elements

Figure 1.6

The Goal: A Balance between Revenue Strength and Enterprise Strength

Figure 1.7

Exit Planning Strategies

Figure 1.8

A Succession Plan

Figure 1.9

A Continuity Plan

Chapter 2

Figure 2.1

Gross Revenue Multiple by Revenue Type

Figure 2.2

Valuation Considerations: Purpose, Standard, Approach, and Method

Figure 2.3

Valuation Credentials

Chapter 3

Figure 3.1

A Summary of Valuation Indexes

Figure 3.2

Identifying the Presence of Fracture Lines

Chapter 5

Figure 5.1

Exit Plan Options and Paths

Figure 5.2

Basic Exit Planning Process

Figure 5.3

Workweek Trajectory

Figure 5.4

The 30-Hour Threshold

Figure 5.5

A Sample External Exit Strategy

Figure 5.6

A Sample Internal Exit Strategy

Figure 5.7

The Open Market System

Chapter 6

Figure 6.1

A Statutory Merger

Chapter 7

Figure 7.1

Seller-Financed Payment Structure

Figure 7.2

Tax Allocation—Average Payment Structure

Figure 7.3

An Example of the Structure of Bank Financing

Figure 7.4

Payment Structure with 70% Bank Financing

Figure 7.5

Payment Structure with 55% Bank Financing

Chapter 8

Figure 8.1

The Harbor Master’s Flag with Two Red Flags, Letting People Know That Severe Storms Are on the Way

Guide

Cover

Table of Contents

Preface

Pages

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xix

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31

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75

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283

Foreword

About 20 years ago, FP Transitions launched the open market concept for finding and matching the best of many interested and qualified buyers with one particular seller, confidentially, and everything changed.

Back then, we often introduced ourselves at speaking events around the country as “eHarmony for financial advisors,” smiling as we said it. But today there is a 50-to-1 buyer-to-seller ratio. The high level of demand has resulted in not only a better value proposition for sellers, but also their ability to select the best of a large auditioning group of interested buyers to step in and take care of a loyal and trusting client base. That’s turned out to be a great benefit for the entire industry—it has even increased the value of the buyers’ practices as a result. Effectively, we empowered sellers to transfer their duties and responsibilities to someone else at the end of their career, and then created the systems and processes to help them do exactly that.

Fifteen years ago, we completed one of the first acquisitions in this industry that was funded entirely with an SBA-guaranteed bank loan, and today, we’re working to help modernize and institutionalize the bank financing process that may yet again change the value proposition, and the payment structures, for an entire industry of independent owners. This could be a significant improvement in the mergers and acquisitions (M&A) space if together with our buyers and sellers we can make it work well from the clients’ perspective.

Payment terms and tax structures in this industry have continued to improve as we honed our craft. We introduced the concept of a “shared-risk/shared-reward” payment structure to protect buyers and sellers, and to ensure that the post-closing “economic marriage” adequately supported cooperative and motivated parties to look after the clients who have always been the real focus of this M&A process. Ninety-five percent–plus long-term client retention rates and 2% default rates tell the rest of the story.

As we grew, our service offerings became broader because the business model we envisioned was expanding past what a small three- or four-person consulting practice could ever hope to offer. Like you, we wanted to make a difference. I was brought in about 10 years ago based on my experience as the COO of an international business brokerage firm that had valued and sold more than 2,000 practices and businesses every year of all types, all over the world. Together, we put the wrenches and hammers to a stagnant M&A market and a valuation system that wasn’t adapting or evolving very effectively, even as the independent industry changed all around it, and continues to do so.

Ten years ago, it was obvious that buyers and sellers were struggling with a valuation problem as they sought to measure what they’d built, or sought to acquire at market value, and to precisely determine their next steps. There was simply no affordable, accurate, and practical method by which to make a value calculation for M&A purposes. At one end of the valuation spectrum was a multiple of gross revenue (GRM), which worked just fine for very small books with transactional revenue sold through an earn-out arrangement, but not much else. At the other end of the valuation spectrum was a full appraisal, such as the discounted cash flow (DCF) method, which was perfect for a courtroom setting or large, multiowner firms. But at $5,000 to $50,000 per valuation, only the largest and most motivated sellers could afford, were interested in, or had need of, this respected academic approach.

The independent industry needed another choice, a better choice, so our first order of business was to create the Comprehensive Valuation Report, an accurate and affordable value calculation that relied on FP Transitions’ large and growing private database of comparable, closed transactions—without which this approach would have no credibility. It’s all about the data! After eight years of closings (at the time), we had the “comps” to do the job right. Eight thousand valuations later, the handwriting is on the wall, so to speak, and along the way, the industry vernacular began to regularly borrow our valuation terms like “cash flow quality” and “transition risk.” Answering one simple question—What would a competitive, strategic buyer pay for a specific revenue stream given standard and reasonable payment terms?—made all the sense in the world to most of the entrepreneurs in this industry.

But as it turned out, not everyone wanted to sell. Many advisors enjoyed what they did and wanted to sustain their lifestyle practices for as long as possible. Some advisors even had the temerity to want to create a legacy model, to build an enduring and transferable business that could outlive them and serve their clients and their clients’ children and grandchildren. So we launched the concept of “equity management” in a white paper published in 2008 by Pershing, LLC, and championed the term “continuity planning” as separate and distinct from “exit planning.” The related terms “revenue-strength” and “enterprise-strength” that we first shared in our work with Fidelity in 2009 have become common parlance in describing how practices or businesses are built and structured.

Along the way, FP Transitions led the shift from using basic revenue-sharing agreements, to earn-out arrangements, to today’s use of a more sophisticated performance-based promissory note structure. We shared our concepts and thinking with hundreds, maybe thousands of practice management personnel at the various independent broker-dealer (IBDs) and custodians, sometimes gratefully, sometimes not. It turns out that independence is often more important during the recruitment process than upon an advisor’s retirement, but we’re going to champion the cause of the independent selling owner because in the long run, that’s what is best for the clients who support this industry.

A few years back, FP Transitions literally wrote the book on building an enduring business and formally defined “succession planning” for this unique group of professionals for the very first time. Every year, we now help to create hundreds of new, first-time, “30-year-old” owners who are investing their money and their careers to build on top of an existing practice—to form a “successor team.” We coined the terms “G-1, G-2, and G-3” to set up a succession strategy for next-generation advisors. Our original work with many of the large IBDs and custodians led to terms and concepts that are now commonly used throughout the industry. To do all this, we led the use of entity structures to create a chassis that is designed to last, and to serve well beyond the founder’s career—a cutting-edge strategy in this industry. That’s exciting and important work. And we continue to push the boundaries every day in order to keep advisory practices thriving and serving their client base for generations to come.

As this book is sent to the publisher, we have 40 staff members whose skill-sets include five JDs (lawyers), two CVAs (Certified Valuation Analyst), one of whom has also earned the designations of an ASA (Accredited Senior Appraiser) and MCBA (Master Certified Business Appraiser), ABAR (Accredited in Business Appraisal Review by the Institute of Business Appraisers), and MAFF (Master Analyst in Financial Forensics), and a CFA (Certified Financial Analyst) with several more CFA candidates in the wings. We also have compliance and regulatory skills to augment these credentials, important in this highly regulated industry. And along the way, we’re building our own enduring, multigenerational ownership structure.

Today, there is no question that an advisory practice has value, but it doesn’t seem that long ago that they didn’t. Yesterday, we argued with industry “experts” and “pundits” fighting to establish that an advisory practice had any value at all.

The M&A space for the independent financial services and advisory industry has come a long, long way in a very short time because of great ideas like these and because of a really smart group of financial advisors/entrepreneurs who seem determined and destined to lead the professional services ranks in terms of value, transaction terms, and satisfied clients. And together, we’re only just getting started!

Brad Bueermann, CEO, FP Transitions

Preface

For Sellers

Rule No. 1: You get only one chance to do this right.

In our experience, sellers tend to be at a distinct disadvantage in the M&A process. That might sound strange given that there is, and has been over the past 20 years or so, a strong seller’s market in the financial services and advisory industry. With a 50+-to-1 buyer-to-seller ratio, how can sellers not have the upper hand? The fundamental truths are these: (1) buyers tend to be more skilled in the M&A process, and; (2) the deck is usually stacked against a seller.

Advisors can buy many times, but selling tends to happen just once in a career, and unfortunately it often happens without a solid plan and without accurate and reliable information upon which to base any plan. It is hard to master a concept that you get to do only one time, especially if you learn mostly by word of mouth. Sellers have the advantage of scarcity, but buyers have the advantage of being able to repeat the acquisition process over and over again until they get it right. Buyers also have the support of their broker-dealers and custodians, whose goals align much more closely with those who stay than those who leave. Sellers, please read that last sentence over and over again.

For all these reasons, sellers need to pay very careful attention to the strategies in this book. Sellers need to understand that, while in the “driver’s seat,” they are not in control unless and until they command the entire transition process, from valuation to listing to documentation to taxation to closing, and then being able to deliver the clients—an overall process that often starts at least three to five years before most advisors think it does. Too often, sellers sit in the driver’s seat full of confidence, but fail to understand that they’re actually sitting atop a car-carrier and being driven along by someone else who knows where they’re going and what they’re doing. Sellers, be mindful of where you get your information and who appears to be helping you. Free information is usually worth just that, but it can sometimes cost a fortune.

Being prepared means planning ahead and relying on accurate, occasionally blunt information and data sources; do not make the mistake of relying on stories told by advisors who have gone through the M&A process one time as a seller and came out relatively unscathed, or by a practice management person at your broker-dealer or custodian whose job it is to make sure your clients/assets aren’t lost to a competing broker-dealer, no matter what. Learn the basic facts and decide for yourself—but do the math.

Finally, sellers have a duty to place their clients’ financial futures in the hands of the best person they can find, not the first person to walk through the door. Selling to a friend or someone who makes the process seem so easy is tempting, but stop and ask yourself this question: Am I doing what is best for my clients? The advantage of a seller’s market does not lie simply in higher values; it lies in being able to find the very best match for your trusting clients. The goal is to find the perfect buyer, the perfect advisor to take over, which, in the end, creates and supports a fair value proposition for all. Starting with a one-to-one buyer-to-seller ratio, though, is rarely, if ever, the best way to achieve that goal.

Rest assured that buyers are reading this same material and are studying the very systems and processes that you’re now learning. That’s okay. You can always choose to keep working, at your pace, and not sell. In fact, trading in your exit plan for a long-term succession plan is a great idea if you start early enough and have the time and energy. This book is designed to put you in control of your future and to level a playing field now dominated by buyers of independent financial advisory practices. A level playing field is good for your buyers, too! But sellers, you need a plan and you need to execute it in a professional and learned manner.

And no matter what you choose to do in the end, don’t forget Rule No. 1.

For Buyers

Rule No. 2: Do it right—the value and terms you agree to pay as a part of today’s M&A activity will affect the value and terms you’ll receive tomorrow.

There is a lot of competition to acquire a financial advisory practice. Recognizing that acquisition allows you to substantially increase the size of your practice or business in about 90 days, paying for at least two-thirds or more of the acquisition out of the acquired cash flow over the next three to five years, there should be no surprise that there is a 50-to-1 buyer-to-seller ratio. But this book isn’t just about how to fight your way to the front of that long line of interested buyers—it is also about how to avoid that line altogether by planning ahead and knowing exactly what you’re doing and how to get the job done correctly.

In this book, you’ll learn the basics of acquisition, including the legal, regulatory, payment structures, and tax aspects of the process. You’ll learn how to look at sellers in a different way and how to sculpt your offer to reflect what the seller is selling and how they’ve assembled the pieces. You’ll learn that there is no one single, formulaic method by which to value, construct, and complete every acquisition. You’ll learn that in some instances, using a multiple of revenue is a perfectly acceptable method for valuing the book you’re buying, and in other cases, that’s about the worst thing you could possibly do. It all depends on what you’re buying, and how the seller is constructed.

You’ll also learn the difference between cash flow and equity value. For those of you reading this book that came from or learned the most important lessons in your professional life from the wirehouse side of the industry, there is a difference. Cash flow is obviously important and, day to day, captures the attention of every practice owner. But if you’re going to build a business, or acquire a practice (and there is a difference between a business and a practice), you’ll need to master and implement the concept of equity. This book will help you understand what it means to build a practice versus a business versus a firm. As a buyer, you need to know the differences because a successful acquisition strategy will depend on it.

Buyers, this book will also help you get ready for the next acquisition opportunity. Being prepared doesn’t mean being very excited and willing to jump into the ring on a moment’s notice when an M&A bout is about to begin. It means planning and building and valuing your own business ahead of time. Smart sellers can tell the difference between a well-prepared buyer and a mildly interested participant who thinks they can figure it out as they go and prevail through good intentions, enthusiasm, and even force of will.

Understand this simple fact: larger, stronger, durable businesses tend to acquire smaller, one-generational practices, books, or jobs. Where do you fit in this food chain? You need to know how things work in this industry and you need a strategy to succeed if you’re serious about building a business designed for the sudden and explosive growth that accompanies an acquisition strategy. Your broker-dealer or custodian will gladly support your efforts to acquire and retain the clients and assets of every seller in their network. But will they help you first build a business model specifically designed for this purpose?

Today, you’re the buyer. One day, too soon, you’ll be the seller and will be dependent on the marketplace and values you’re helping to develop, even the network you’re working within. Plan and execute accordingly.

Acknowledgments

Writing a book is hard work. Most people probably intuitively understand that aspect of the process, but few have firsthand knowledge of what it actually takes—and the many people whose inputs and guidance are invaluable.

Of the many contributors, first, thanks must go to the clients who let us assist them, building and reshaping their practices, and sometimes calling it a day and selling or merging what they’d spent a lifetime building. The daily contact and connection with independent advisors, young and old, building and/or selling, is the lifeblood of a book like this. Not a night went by in the year of writing it that something learned by day didn’t make its way into the manuscript. This daily connection is what separates a book based on theory and a book based on fact and observation—our goal has clearly been the latter.

The downside of writing through such a connection, on top of a day job, is that the book writing is mostly done at nights and on weekends, and that is why (along with three complete drafts) it took so long to complete. My wife, Penny, gave up all those weekends and gave me the endless quiet time to do what I needed to do. I’d like to say that she knew what she was getting into when she married an English major who became a lawyer who became a businessman who yearned to write, but most of us don’t plan that far in advance. We just make the best of the world we find ourselves in the midst of, and she has done that without complaint.

I also had a great business team without whom this book would not exist. My longtime business partner and our company’s CEO, Brad Bueermann, guided gently and patiently, telling me the truth whether I wanted to hear it or not. Laura Bueermann served as my personal editor and labored through draft after draft with me. It turns out that Stanford people are really smart. Laura saw things that I didn’t and had the ability to add that one perfect word or two to each sentence and paragraph she touched, and the book is the better for it.

FP Transitions’ valuation experts, Warren Burkholder, ASA, MCBA, ABAR, MAFF, CVA, and Ryan Grau, CVA, were incredible in helping shape the text and the messages in Chapters 2 and 3 on value and valuation, the most difficult chapters in this book to write. Eric Leeper, CFA, helped me think through the logic of various sections and double-checked the math throughout. As an English major, I have a lot of respect for our team of math majors.

Jeanie O’Reilly Northcutt, our longtime Listings Director, and Aaron Wells, Transactions Coordinator, serve as the anchors of our transactions section and helped maintain a steady flow of information from the daily activity of our buyers and sellers and contributed to the accuracy and strength of Chapters 5 and 6.

FP Transitions has assembled its own law firm over the years, and Rod Boutin, JD, our General Counsel, and Ericka Langone, JD, Assistant General Counsel, both contributed to the final draft, making sure that all the “t’s” were crossed and the “i’s” dotted. Rod and his entire team, in particular, helped shape Chapters 8, 9, and 10 and the forms in the Appendix.

Christine Sjolin, our Operations Manager, and Marcus Hagood, our head of EMS (our Equity Management System), each applied their special and gentle touches to various sections and helped keep me on track as earlier drafts occasionally wandered a bit . . . or a lot.

And last but not least, our marketing department, comprised of Elise Rogers, Marketing Director, Rachel Beckwith, Senior Marketing Strategist, and Alex Moan, Video Marketing Specialist, gets credit for everything artistic about this book from the cover to the graphs and illustrations.1

Building a great business is about surrounding yourself with great people, and in that I have certainly succeeded. I am honored to work with those listed here as well as all of our many loyal and hardworking staff members every day of the week.

Chapter 1The Basics You Need to Know

Avoiding the Critical Mistakes

There are two critical and common mistakes that independent financial advisors make in the mergers and acquisitions (M&A) space. One is to treat every sale or acquisition target the same way: applying the same valuation approach, the same set of documents, and a common set of payment terms or financing elements, regardless of the size or structure or sophistication of the opportunity. The second mistake is to equate exit planning with succession planning—the two concepts are completely different and advisors must understand the differences if they are to succeed in this arena and correctly structure a transaction, whether as seller or buyer.

The specific purpose of this book is to help advisors understand how to sell what they’ve built to someone else for maximum value and at optimum tax rates, and/or to successfully complete an acquisition and become someone’s exit strategy, on the best possible terms, with minimum risk, writing off the entire purchase price over time. These are not disparate goals; they are connected in every way and part of a win-win-win strategy that must be the ultimate goal for the buyer and seller, the good of this industry, and the client base that serves as judge and jury over the outcome of the M&A process.

For most independent financial advisors, their book or practice or business is easily the largest and most valuable asset they own. Critical mistakes cannot be allowed to happen. The process of sorting out the issues, learning the basics, and then mastering the more complicated aspects starts right here, right now.

Exit planning results in a transaction with either an external buyer or an internal buyer, but the commonality is that the process is completed in one step—usually not suddenly, just completely. External buyers usually have a very similar practice model but are often much larger than the seller in terms of size and value, while an internal buyer is someone you’ve hired, know, and trust (maybe even a son or daughter), but who is often without the financial resources and the experience of the external buyer.

A succession plan is quite different; it is designed to build on top of an existing practice or business and to gradually and seamlessly transition ownership and leadership internally to the next generation of advisors. The founding owner in a succession plan is not a “seller”—they’re a business partner or a shareholder, and long-term, sustainable growth powered by multiple generations of collaborative ownership is the number one goal. This book is not about succession planning. If that topic is of interest to you, please consider reading our first book, Succession Planning for Financial Advisors: Building an Enduring Business.

As part of exploring the various exit strategy options and how to structure those transactions, this book will also explain the different value and valuation techniques and their applicability given various situations. You’ll learn the difference between an asset-based deal structure and a stock-based deal structure, as well as how to employ various financing methods such as a promissory note, performance-based or adjustable notes, revenue-splitting or revenue-sharing arrangements, and earn-outs. The element of bank financing will also be carefully considered because this is a powerful tool when used correctly. We’ll also evolve beyond the basic concept of silos versus ensembles in the process toward a more sophisticated and accurate classification system.

One of the fundamental tenets of this book is to not treat all advisors the same as though one approach to valuation, contracts, payment terms, and contingencies fits all situations, sizes, and revenue models across the spectrum. In fact, there is no one single method, one single view of this unique industry that works every time for every buyer or seller. It depends on what you’ve built and how you’ve built it. Using your specific vantage point, our goal is to explain what works and what doesn’t work, and how to do the job right, whether you’re a buyer or a seller. In the end, we all need the best buyer to prevail, not the first on the scene or the one with the most money.

If you approach all M&A opportunities in this unique industry with one set of tools, one set formula, and just one valuation approach or method to be applied in every instance—the way most writers, consultants, and practice management personnel recommend—your view of the world will always be partly right, but mostly wrong, not unlike the blind men and the elephant from the Indian folktale told in a poem by John Godfrey Saxe:

The Blind Men and the Elephant

It was six men of Indostan To learning much inclined, Who went to see the Elephant (Though all of them were blind), That each by observation Might satisfy his mind.

The First approach’d the Elephant, And happening to fall Against his broad and sturdy side, At once began to bawl: “God bless me! but the Elephant Is very like a wall!”

The Second, feeling of the tusk, Cried, “Ho! What have we here So very round and smooth and sharp? To me ’tis mighty clear This wonder of an Elephant Is very like a spear!”

The Third approached the animal, And happening to take The squirming trunk within his hands, Thus boldly up and spake: “I see,” quoth he, “the Elephant Is very like a snake!”

The Fourth reached out his eager hand, And felt about the knee. “What most this wondrous beast is like Is mighty plain,” quoth he, “’Tis clear enough the Elephant Is very like a tree!”

The Fifth, who chanced to touch the ear, Said: “E’en the blindest man Can tell what this resembles most; Deny the fact who can, This marvel of an Elephant Is very like a fan!”

The Sixth no sooner had begun About the beast to grope, Then, seizing on the swinging tail That fell within his scope, “I see,” quoth he, “the Elephant Is very like a rope!”

And so these men of Indostan Disputed loud and long, Each in his own opinion Exceeding stiff and strong, Though each was partly in the right, And all were in the wrong!

Valuation: The Great Debate

There is a lot of debate in the financial services industry as to the best approach and method to apply when valuing a financial services practice. Some feel an income approach (focused on earnings or profitability as espoused by the discounted economic cash flow method) is best. Others prefer to use a direct market data method that relies on market “comps” or comparable transactions between buyers and sellers of similarly structured practices or businesses within the same industry. Some buyers prefer a much simpler valuation approach, applying basic revenue splitting, revenue sharing, or earn-out payment terms to measure actual success over a period of years—a wait-and-see approach. Some buyers insist on using a multiple of top-line revenue or adjusted bottom-line earnings.

Buyers tend to use the one method that they understand, or a method that has worked well for them in the past, regardless of the size and structure of the acquisition opportunity. Sellers are often embarking on the valuation trek for the first time and sometimes have only a limited understanding of this crucial topic. Practice management personnel at the various broker-dealers and custodians have their own agenda and weigh in on the valuation debate with their own preferences. Each party to the process has a goal, and the goal really isn’t about finding the right answer; the goal too often is to find the answer each party needs to be true to advance their own cause. As a result, there is a lot of unnecessary and unjustified confusion about how to value a financial services practice or business for M&A purposes.

The goal of valuation, aligned with the proper approach and method, should be to bring the parties together, not to serve as a wedge and to bludgeon the other side with an argument about who is right or wrong and why one party’s approach is superior to the other’s. Valuation in the financial services industry has become the single most divisive issue in the M&A process. Valuation disputes stop most deals before they even start. Let’s end the debate with the goal of completing more transactions and taking better care of the clients who have placed their trust in an independent advisor.

The place to start is to fundamentally understand that there is no right or wrong answer to the question, “What is my practice worth?” The answer will vary depending on what is being bought or sold (a book or a business, assets or stock, a minority interest or a controlling interest, etc.), who the buyer is, why the valuation is being performed, the motivations of the parties, and even who’s performing it. When the time comes for you to sell your practice, the first question shouldn’t focus on which approach to use to arrive at a proper value. The appropriate series of questions leading to a valuation solution should be:

What am I selling and why am I valuing my practice?

If you’re a buyer, the focus should be on this question:

What am I buying and why am I buying it?

Purpose Informs Value

In other words, you need to know what you are trying to solve for before you attempt to answer the question as to how to solve it. No one single valuation approach and method solves every problem, every time. There are many tools in the valuation toolbox, and as a buyer or a seller, you need to know at least the basics of how to use them and when to apply them, or at the very least, when to call for help and what questions to ask.

Of course, selling a relationship-based practice or business isn’t like selling a fast-food franchise in which you hand over the keys and a How-to-Run-It Manual. In this M&A space, the clients get a vote, and most sellers care about what their clients think of their final act—something that buyers need to understand as well. Best price and terms should always take a backseat to “best match,” another consistent theme in this book.

So what does all this have to do with elephants and blind men? Last year, I sat on a four-person panel where we were asked to discuss the intricacies of value and valuation as applied to independent advisors who were interested in acquisition or selling. Two of the panelists were practice management specialists, one with a large independent broker-dealer (IBD) and the other from a custodian. The other panelist was an investment banker. The investment banker was adamant that the discounted cash flow method his firm produced and sold was the single best way to perform a valuation in this industry, every time—anything else was just silly and a wild guess. Another panelist opined that for most of the thousand-plus advisors in his IBD, what worked best on a daily basis was a simple rule of thumb, or a multiple of revenue or earnings. Over the length of his career, this method had proven to be practical, affordable, and good enough to do the job in most cases. The other panelist thought that it was simply a matter of “wait and see,” paying value for what a buyer actually received using an earn-out arrangement or a basic revenue sharing approach; in his opinion, formal valuations or appraisals, even multiples of revenue, weren’t even called for.

Each panelist was partly in the right, and all were in the wrong, but these points of view reflect what we hear and experience every day. There is no single valuation methodology adequately suited to the range of revenue streams and structural components now represented in this fast-growing and rapidly evolving industry. That is why buyers and sellers need to adjust and elevate their level of understanding and thinking about how to buy, sell, and value a financial services or advisory practice or business. On that note, another of our goals in this book is to help you understand not only how to determine value, but how to apply the payment terms so as to motivate a seller and to protect a buyer in order to ensure that the clients’ best interests are never overlooked in the process of realizing or paying that value.

Assessing What You Have Built (or Are Acquiring)

There’s a clever use of terms and concepts in this industry. One good example is describing the organizational structures of independent financial practices as “silos” or “ensembles.” The basic notion is that a silo is a single “book of business.” The term “ensemble” is reserved for a business with multiple professionals who truly work together as a team, pooling their resources and cash flows, creating a bottom line, and then distributing profits to the owners of that business. These terms are certainly relevant in this industry, but they do not form a complete system to use in assessing what an advisor has built or seeks to acquire.

This binary system of categorizing all financial advisors as either a silo or an ensemble model does accurately reflect one critical element about this industry—the importance of organizational structure. For this contribution, we are indebted to our predecessors Mark Tibergien and Philip Palaveev, authors of Practice Made Perfect and The Ensemble Practice, respectively.

But the evolution continues and structural issues go well beyond just organizational elements and must include the choice of an entity (such as a C corporation, an S corporation, or a limited liability company), or not, as with a sole proprietorship, and the ownership level compensation system, which directly affects and supports growth rates and the underlying profit structure. These foundational elements, or the lack thereof, affect every advisor, broker-dealer, and custodian in this industry. More to the point, these basic foundational elements, whether weak or strong, dictate the structure, success, and value of every M&A transaction (Figure 1.1).

Figure 1.1 Structural Elements of an Independent Financial Services/Advisory Model

As you study and master the concepts and strategies in this book and begin to consider your exit plan or acquisition strategy, start with these basic questions:

“What have you built and are considering selling?” or,

“What exactly is it that you want to acquire?”

The answers to these questions require more descriptive and precise terms than just “silo” or “ensemble.” We suggest you consider the following terms for classifying the levels of independent ownership in the financial services and advisory industry, which, in turn, accurately reflect how each level of ownership is built and operated:

A job (or a book)

A practice

A business

A firm

These descriptive terms, within the context of this M&A guide, also reflect how each level will likely be acquired, grown, or disassembled. These terms and the working definitions that follow form very practical tools that we have developed and use on a daily basis and contribute to help advisors understand the impact of the various structural elements of their transition plans. In other words, if or when you’re thinking of selling, what you’ve built, and how you’ve built it, will often determine how you sell it and what you sell it for.

A job, often and appropriately called a book, exists as long as the advisor or financial professional does the work. Job or book owners are independent and “own” what they do, for the most part. W-2 or 1099, registered rep or investment advisor or insurance professional—it makes no difference—they can all fit equally well in this category. But when a job or book owner stops working and someone else starts, it becomes the new advisor’s job; the cash flow attached to that job belongs in whole or in substantial part to the person doing the job. Of course it is about production; in fact, it is about nothing else. A job owner works under someone else’s roof, owns none of the infrastructure, and has no real obligations to the business other than to produce and get paid while taking care of his or her client base. This is the basic definition of being independent.

The “value” of a job/book is tied almost entirely to how much money the producer or advisor takes home every year. Think in terms of gross revenues, or GDC, of less than $200,000 a year (although we do see cases of the “super producer,” described in more detail in our first book on succession planning—that group has much higher production- or revenue-generation capabilities, but all other aspects still fit this defined category). In this industry, by our watch, about 70% of advisors are owners of a job or a book (Figure 1.2). Jobs or books are most likely to sell at the lowest price, and on the worst terms with the worst tax structure—at least when compared to practices, businesses, or firms.

Figure 1.2 Industry Segmentation

A practice is more than just a job or a book, often involving support staff around the practitioner and the ownership of at least some basic infrastructure (phone system, computers, CRM system, desks and chairs, and so forth) usually within an S corporation or an LLC. But like a job, a practice exists only as long as the practitioner can individually provide the services and expertise. Practices are limited to one generation of ownership, after which someone else takes over. The practice may be sold outright, transferred through a revenue-splitting arrangement, or be dissolved with the clients finding their own way to another advisor. Practices have one owner, but often encompass one or more additional producers (usually categorized as owners of a job or a book) with whom they share time, expenses, and support. About 25% of the advisors in this industry fall into this category.

Jobs/books and practices are “strongly held,” a term we employ to reflect a single owner who dictates direction and results—the typical founder and entrepreneur. The focus for job or practice owners is entirely on revenue strength. There is little need for enterprise strength at these levels. There is also no significant “bottom line” or profitability at these levels (yes, we’re talking about 90% to 95% of the industry at this level and below) and there doesn’t need to be. No one invests in these models, at least in terms of becoming a formal shareholder or partner. Earnings are mostly paid out as compensation to the producers through some form of an eat-what-you-kill (EWYK) system or a salary/bonus structure tied in some way to top-line production, as opposed to actual profit distributions or dividends. None of this is written in stone—many practices have the ability to do much more, as is the case with jobs or books. It is simply that, historically, the advisor/owner takes home what was produced, a legacy of the wirehouse-brokerage model.

The more valuable practices tend to sell using a formal documentation process that creates and supports long-term capital gains tax treatment for the seller and write-offs for the buyer. Practices have a stronger value proposition than jobs/books, providing the owner with more options, a higher sales price on better terms and at better tax rates, and tend to have lower transition risk (see Chapter 3 for more information), an important element for buyers to consider.

If a practice is to grow and evolve into a business, it will need to enhance and bolster its organization, compensation, and profit structures along the way in order to facilitate a new generation of owners/advisors. Businesses and firms have or are implementing a compensation system that supports strong growth and sustainable profitability. Books and practices often have strong growth rates as well, but almost always at the expense of profitability, arguably irrelevant in a one-owner model. Revenue sharing or other EWYK compensation systems accomplish only the production and cash flow goals, leaving profitability and equity unattended to. In the end, these elements signal the divide between a job/book or practice on one side, and a business or a firm on the other side. We’ll continue to build on these concepts and expand the thinking around revenue strength and enterprise strength later in this chapter because it effects every aspect of the M&A process.

A business has certain foundational elements in place, such as an entity structure, a proper equity-centric (or ensemble) organizational structure, and a compensation system that gives it the ability to attract and retain talent while generating a sufficient profit margin (i.e., 30%+) to reward and attract a multigenerational ownership structure. The revenue stream may be singular or diversified, but usually about 75% or more is fee-based. The business is built to be enduring and transferable from one generation to the next. It operates from a bottom line approach and earnings are used to reward ownership and encourage investment in the business. The ownership-level compensation system shifts to a base salary plus profit distributions. Continuity agreements are a given and take the form of a Shareholder Agreement or a Buy-Sell Agreement. A business gains its momentum and cash flow from revenue strength and its durability and staying power from its enterprise strength. Businesses tend to have a much stronger value proposition than practices, affording an owner a range of options, including retiring on the job, selling at maximum value with the best overall tax structure possible, or building a legacy, all with little to no transition risk. About 4% of independent advisors presently fall into this category, though this group is growing rapidly.

A firm is an established, multiowner, multigenerational business, and it got there through proper succession planning. It is built with a strong foundation of ownership and leadership by recruiting and retaining the very best people in the industry. It operates primarily from a bottom-line approach and earnings are the measure of success, at least as important as production and growth rates. Again, the revenue stream may be singular or diversified, but about 90% or more is usually fee-based. Continuity agreements aren’t just a safety measure. They are a means of internal growth and strength. Anticipating the loss of one generation means planning for the success of the next generation. Collaboration among owners and staff is the rule. In a firm, the goal isn’t to have the best professionals, but rather to have the best firm. Firms offer the best value proposition and are almost always supported with a strong internal succession plan that provides a culture of ownership, attracting and retaining the best advisors, who attend to multiple generations of clients. About 1% of today’s independent advisors are owners of a firm and we expect this group to double in size in the coming years.

In this book, from this point forward, we will use the terms “job/book,” “practice,” “business,” and “firm” very specifically and within the context of the preceding definitions. Depending on whether you are selling or buying a job/book, a practice, a business, or a firm, your choice of valuation methodology, financing, payment structuring, transfer mechanism (assets or stock), and even the paperwork to complete the transaction is often tied to the seller’s level of ownership and what they’ve built—even how they’ve built it. This conclusion is reflected in the following section showing how advisors tend to leave or retire from each level of ownership.

Special Note: The ownership level of a firm tends to sell internally through a formal succession plan. As such, this book focuses on firms only with respect to their role in acquiring smaller businesses and practices and omits use of the term “firms” in most instances, including selling through an exit plan.

Who Is Selling? Transition Strategies by Ownership Level

So, who is selling? Where are the sellers? As a buyer, it is important to know where to look, and what to look for to make acquisition a reliable and profitable growth strategy. The numbers tell an interesting tale, one most advisors don’t understand (Figure 1.3). What a seller has built, and how they built it, greatly influences their eventual transition strategy.

Figure 1.3 Transition Strategy by Ownership Level

Each year, FP Transitions performs formal valuations on over a thousand advisors’ jobs or books, practices, businesses and firms, a process that fuels a large and deep database. What advisors do next—once they know with greater certainty the value of what they’ve built—is simply a matter of observation. The data is clear. Across all ownership levels, we’re seeing that about one in 10 advisors sell externally (to a third party), but the numbers vary significantly by ownership level. Perhaps the real story lies in what more than 8 out of 10 advisors do if they aren’t going to sell.

Currently, the primary exit strategy for job/book and practice owners is attrition. Independent owners at these levels don’t sell as a first choice, certainly not as often as they should. This is a surprising choice given that, for most advisors, their books or practices are usually the most valuable asset they own. Under the attrition route, these advisors enjoy their income streams for as long as they can while gradually working less and less, spending fewer days in the office and less time and energy on marketing and technology and then, one day, when there is nothing much left to sell, they call it a day. The work just dwindles to an end, and the remaining clients are given a few referrals to peers or friends and that’s it. No cymbals clanging, no bells ringing. It just ends quietly.

This outcome is bad for the industry, and especially for the clients who look to their independent advisor for professional financial advice and mistakenly assume that their advisor will be serving them on a timeline tied to their lives and needs, not their advisor’s planned (or unplanned) career length. And this really needs to change. But it would be equally incorrect to conclude that every job/book or practice owner needs or should attempt to create a succession plan.

Most books and many practices are not capable of generating a qualified internal successor because of how they are assembled. The primary culprit is the use of wirehouse-style employee-based compensation and reward systems that make production and sales achievements the pinnacle of a career. Durability and profitability are not the goals of book owners and most practice owners. As a result, it is far more likely that independent advisors will build one-generational books as opposed to an enduring business.

Think about it for a moment before we continue our discussion on transition strategies by ownership level. What would it take to prompt at least half of the job/book and practice owners (about 95% of the industry by our headcount) to either build an enduring business or, worst case, to sell their work at peak value to a business or a growing practice that could serve those acquired clients for generations to come? More knowledge of the M&A process? A better value proposition? Better payment terms, with a larger down payment and shorter or no seller financing? Could bank financing be the answer, allowing sellers to cash out more quickly and completely and with less risk? Would one or more of these things make the difference? We’re about to find out because this industry is changing rapidly—whether it changes for the better, or worse, or just stays the present course, will be decided in large part by today’s buyers and sellers and builders.