Caveat vendor, caveat merger

Alex Cook

There are many good reasons for an effective succession plan. For one thing, the Financial Services Board mandates it, in order to protect the interests of clients. But it also makes sense for the broker or advisor because it is a way to capitalise their years of hard work to provide a retirement income.

The obvious triggers for putting a succession plan in place would include death, disability or retirement. Less obvious would be a desire to protect declining margins by shedding some of the burdens of compliance and administration. It might also be a way to free up a broker or advisor to spend more time with clients and less time running the business.

Certain pitfalls

For most people, the obvious way to provide continuity for clients, to create a more pleasant working environment and to realise the value of the business, is to sell it to a larger company, perhaps staying on for some time. While a merger certainly is a viable strategy, there are certain pitfalls that should be avoided. Based on many years of helping independent brokers and financial advisors to negotiate a successful merger, the main issues are:

• Selling/ merging at the wrong time: This is particularly pertinent for advisers with a predominantly life-based business. Because such a business has low annuity income and a high potential for clawback, vendors will typically offer a low multiple of revenue for its book. As a result, the capital sum realised will not generate enough income to replace the business’s revenue.
  A much better approach would be to work with a partner who can unlock the inherent value of the life book by converting the clients to investment clients. If the adviser is nearing retirement age, it’s likely that his or her clients are too – making them likely to be thinking of retirement themselves.

• Selling to a big corporate: Getting under Big Brother’s wing can seem like a good idea for all sorts of reasons, but I have seen things go horribly wrong. One pitfall is that some corporates only buy a portion of the business, say 25%. Typically they value the business generously and pay out top dollar for their stake, but the contract is cleverly worded to give them 25% of the revenue rather than the profits, which can leave the original owner actually netting a small fraction of his or her former income.
  Such deals often don’t include any administrative support or office space, so overheads can remain high while the business owner finds him- or herself tied to a partner who seems less and less attractive. Such a deal makes it all but impossible to achieve a total exit later.

• Selling to a firm of similar size: Another option is to merge with a firm of a similar size. This usually involves valuing both businesses, and then taking out life policies on each of the principals.

  In the event of death, the survivor uses the insurance pay-out to buy the deceased’s business from his or her estate. All well and good, but it’s a strategy that covers only death, and the likelihood is that the lump sum realised would not generate enough income for the heirs.

  But there are other weaknesses to this approach, such as the sale does not guarantee that the clients of the acquired company will remain loyal. And if the survivor’s business suddenly acquires a substantial number of new clients, it is unlikely to have the capacity, systems or processes to service them.

In conclusion, then, while selling or merging your independent business may look like a good way to ensure continuity for your clients and financial security for yourself or your heirs, it all depends on how the transaction is structured – and with whom. Unlocking the value of an independent broker’s or financial advisor’s book is not straight forward, and the right partner is essential to achieve it.