27/10/2010

“Practices for Sale – get ‘em while they’re hot”.  That seems to be the message recently.

Apparently there are a number of reasons – the ageing demographic of advisers, pressures on profitability (particularly with the move from commissions to fees), the desire of the big boys to get bigger the fastest way they know how, the greater complexity of financial advice and the seemingly ever-increasing liability of advisers, to name just a few.

Whatever the reason, if you’re thinking of buying a financial advisory practice there are a number of things you might want to think about carefully – synergy, culture, revenue-spread, value, files, staff and the role of the vendor.

Synergy.  Why precisely are you buying the practice and therefore does it meet your needs and goals?  Is your purpose to increase adviser income, diversify income sources, establish some volume cost savings or simply provide some opportunities for cross-selling? How will the new business achieve your purpose?

And does the new client base use the sort of products and investment structures that you are comfortable and experienced in working with?  Does the practice focus on things like wrap accounts, SMA’s, direct shares, direct property or SMSFs?  Are you able to meet the needs of the clients in these areas?  Don’t, whatever you do, assume that you will be able to convert a large client base to new investments or structures in the short term.  That kind of substantial shift in attitude, especially by older investors, takes considerable time.

Culture.  What sort of clients does the new practice have and are you comfortable and experienced in dealing with that type of client?  What is their socio-economic demographic, their industry/professional demographic and their age demographic?  Are they used to highly personal service or more of an institutional-style approach? Do they value the brand name of their current AFS Licencee or is it only their adviser they value? 

Many large companies have come undone by not understanding the culture of smaller operations and meeting that culture. 

Revenue Spread.  The 80/20 rule suggests that 80% of the revenue will come from only 20% of the clients.  Whilst this does not necessarily hold for every practice a buyer should be aware of whether any particular clients account for a significant percentage of the practice revenue.  Clearly the greater the concentration of revenue in a small number of clients the greater the impact for serious damage if one of those clients leaves.

Is revenue based on a particular type of work and how stable is that type of work likely to be in the future? 

Are there some major referrers to the practice who account for a large amount of revenue and will those referrers continue to refer to new owners? 

What is the ratio of ongoing business revenue to new business revenue?  Too much of the former means that the business is not attracting new clients while too much of the latter suggests the business may not be keeping clients.

Value.   The current value method for financial planning practices has been the subject of some debate recently with at least one major player announcing that practices are currently over-valued.  With the move to fee-based revenue, planning practices can be more closely compared with, say, accounting practices.  Generally accounting practices in a major city sell for 0.9 times last year’s revenue.  Yet planning practices ask 3 to 3.5 times that revenue – applying the same multiple that used to apply to “recurring revenue” in the old days of commissions.  Is the difference sustainable?

Regardless of whether that asking price is reasonable or not, the fact seems to be that buyers are around at that price and so the market is dictating the price not the theorists. 

Two other matters for buyers to consider when the issue of the price of a practice is negotiated – the retention (if any) and the prospect for time payment.  The former refers to the practice of retaining between 10% and 20% of the agreed purchase price for a period of 1-2 years to allow the buyer to be assured of delivery of the practice ie to ensure revenue for that period matches the promises made by the vendor.  The second is the prospect of paying for the practice over time, effectively using the practice’s revenue to pay for itself.  With small business finance harder to come by currently, vendors may well need to consider ways to assist the buyer to finance the purchase.

Files. The state of the practice files is often a window into the quality of the practice.   Are they well kept, accessible, accurate and detailed?  Do they indicate that regular reviews are being done for clients?  How will they be viewed by the buyer’s Licensee?  What are the computer issues? Should the files be reviewed by a compliance expert?

Staff.  How important are the staff to the ongoing and seamless continuity of the practice? Have they been working in the practice for a long time, have good relationships with the clients and know much useful information that the buyer could use?  If so, then will they stay if the practice is sold and on what terms? 

More importantly, if they left could they take clients with them?  Are they bound by a restraint in their employment agreement?  What right would the buyer have to force the vendor to take action if the employee acted unlawfully?

Role of the Vendor.  The sale of a practice creates uncertainty in the mind of clients and almost inevitably some clients will take the opportunity to move. It is therefore important to present the sale as not a major change but rather as a natural development for the business. 

The vendor should remain in the business for a substantial time after settlement thereby giving the impression of continuity and certainty.  They should also actively sell the attributes of the buyer and be charged with convincing the clients to stay.

Whether your purchase of a financial advisory practice is worthwhile depends on how well you handle the purchase process.

If you have any questions in regard to this article, please contact TOWNSENDS BUSINESS & CORPORATE LAWYERS on (02) 8296 6222.