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Succession Resource Group is a boutique succession consulting firm based in the Pacific Northwest, serving clients across the country. SRG was founded by David Grau Jr., MBA in 2012 after nearly a decade of helping advisors with valuation and succession planning. SRG's team of experts leverage their industry expertise, combined with best-in-class resources, to help advisors, agents, and accountants manage the equity in their businesses...

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10 min read

Selling a Book of Business for Financial Advisors

Jun 29, 2021 11:08:20 AM

Stack of Books

There are multiple reasons to believe that the number of mergers and acquisitions in the wealth management space will be high in the next five to ten years. To start with, over 50% of active financial advisors are over age fifty. Many of them will be looking for an exit strategy. Combine that with the fact that very few advisors have a succession plan and the increased deal volume year-over-year recently and it is reasonable to expect more consolidation short and long-term.

Other factors include increased competition, likely higher tax rates, interest rates climbing, more compliance (think Reg BI), increased reliance on technology, and compressed fee structures. These all add up to potential loss of revenue or increased stress (or both), which will drive many advisors to reactively seek firms looking to buy their existing book of business. The combination of deals prompted due to the aforementioned reasons and the normal amount of advisors retiring each year, sellers will be numerous.

Successfully selling your book of business to the right person, and for the right price, is a complicated process that requires multiple steps and considerations. Assessing how much the firm is worth is one of the first to establish reasonable expectations. Finding the right buyer is another critical step. Then the deal terms need to be agreed upon. And do not forget the tax implications. They will have to be dealt with as well.

To assist you in this endeavor, we have compiled some questions and answers to review before and during the selling process. We have also added some tips for after the sale is closed. The relationships with clients will not just end when you sell. There is a transition process.

When is the Right Time to Sell Your Book of Business?

Personal circumstances are rarely in proper alignment with market conditions. Simply “wanting out” does not necessarily mean that it is time to sell your book of business. If your revenue is declining, you just lost your largest client, or made any major internal changes, you may not get the value you are hoping for or expecting.

Retirement is an easier scenario. If you set a target date a few years into the future, you can take the necessary steps to ensure you have maximized the value of your business and positioned yourself to attract the best suitors.

Another priority for those last few years may be prospecting and on-boarding younger clients if you want to create an internal transition plan. Advisors who have worked in the industry long enough to be considering retirement generally have aging clients, specifically clients over the age of 70. While buyers expect an older clientele when buying a business from a retiring advisor, the specific age of clients and the concentration of assets with those older clients can have a detrimental impact if no multi-generational planning is happening.

The key is to understand your book of business and the demographic early enough that you can do something about it. Beginning to do more generational planning with clients will not be an overnight success, but with time and focused effort, advisors have the ability to mitigate one of the primary concerns any buyer will have. It is also a good idea to find the technology you need to be able to track and show the age of your clients, which are engaged in multi-generational planning, what assets those clients have, and any potential roll-overs or new money that could come into the practice.

What is Your Book of Business Worth?

The two most common valuation methods for financial service businesses is either a market-based valuation using comparable transaction data, or an income-based valuation that focuses on the business’s ability to generate profits. Neither of these are the correct solution 100% of the time; determining which method is most appropriate is dependent on the circumstances and size of the parties involved. But, the valuation of a financial advisor book of business can be estimated using a revenue multiplier of trailing twelve-month revenue. The industry standard for RIAs or advisors with recurring revenue is generally between 1.6 and 4.4, but when buyers outnumber sellers by a factor of 75:1 in 2020, it is common to see a well-positioned practice that has been prepped for sale, to exceed 3.0x on their recurring revenue.

Another method used for estimating value is an earnings multiplier (e.g., multiple of EBITDA, EBOC, EBIT, SDE, etc.). Serious buyers will want to conduct an actual valuation as well as take a deep dive into operational costs and profit margins. Even solo advisors have expenses, but the question remains, will you be assuming those expenses? If you will be assuming the seller’s overhead, and it is more reasonable to use a valuation method that focuses on profitability versus a value of the top-line revenue. When using this method, the industry standard for valuation is 4 to 8 times the annual earnings, including reasonable owner’s compensation.

Regardless of the calculation used to determine valuation, buyers will also factor in future cash flow projections, client retention rates, current fee structure, and the estimated valuation of closest competitors. Solid numbers in each of these areas could increase the sale price.

How do you Maximize the Value of a Book of Business?

Selling Books to Financial Advisors

Multipliers do not tell the entire story. Granted, revenue and profits are the most relevant variables in calculating the value of a book of business, but there are other actions the financial advisor can take to boost (or diminish) the asking price.

A few of the key performance indicators that advisors have the ability to influence and should therefore monitor are as follows:

  1. Revenue mix - The most valuable revenue sources are those that are consistent and recurring, such as fees, trails, 12-b1s, renewals, and financial planning. While a simple fee-only RIA is certainly attractive and simple for a buyer to acquire, more diversified revenue sources often result in higher overall values paid. The most valuable of the recurring income sources are usually third-party managed assets, given the recurring nature of the revenue and how scalable it is.
  2. Growth rate - Buyer will pay a premium for businesses that are not only growing but have sustainable growth sources even after the founder's retirement. Focus on ensuring your growth can be sustained when you retire.
  3. Profitability - Focus on creating a business that looks as efficient on paper (your P&L for example) as it is in reality. Many firms fail to do any internal housekeeping prior to selling, which can be detrimental to the value.
  4. Age of clients - You cannot make your clients any younger, but you can be aware of the age of clients and work to mitigate this perceived negative by a buyer through multi-generational planning.
  5. Key Ratios (revenue/assets per client, households-per-professional, etc.) - Understand the current ratios in your practice relative to what is “normal” to ensure when you are ready to sell, you have taken steps to ensure your practice attracts the best successors and will garner the highest value.
  6. Your client service model(s) - Clearly define your client service model for your A clients, your B clients, etc. Having the service model defined will not only make you more efficient and consistent with delivery, but it will also provide greater confidence to a buyer, which translates to a higher value.
  7. Repeatable systems and processes - Buyers are focused on scale, they are not looking to take on another 40 hours worth of work every week. So, focus on defining your processes and leveraging workflows within your office.

How do you Build Transitional Value for the Buyer?

Selling the book of business is not complete when the deal is closed. Those clients have relationships with the seller. There needs to be a transition plan in place so that they stay with the new firm. Buyers want assurances that this will happen as a way to mitigate risk, often including a clawback/retention clause in the deal, or wanting the seller to remain involved in some reduced capacity post-sale.

Financial advisors can mitigate perceived buyer risk, and therefore build transitional value, by starting the process early enough they can remain involved post-sale on a part-time basis for a few years, and/or crafting/contemplating the actions needed to create a smooth handoff from seller to buyer, and possibly creating a strategy based on each client segment, whereby you may do more for your biggest/best clients. This often involves a combination of letters, personal phone calls or virtual meetings, client appreciation events, social media posts, and face-to-face meetings (when appropriate). While it is important to create this type of plan prior to closing, it is rare to share or begin any of this with clients until after the deal has closed and the down payment has been funded.

What are the Tax Implications of the Sale?

Taxes are similar to the price and payment terms, what is good for the seller is bad for the buyer, and vice versa. Sellers want to pay little or no taxes, and buyers want to write the entire purchase price off as they pay it. But, the answer is usually somewhere in the middle. The initial consideration is whether the deal can/should be structured as an asset or stock sale. For independent RIAs, or those operating as a hybrid, either option (or both in many cases) may be appropriate and viable, whereas those operating under a corporate RIA or independent broker-dealer may find that the asset sale is the only/best option. Structured correctly, and depending on the circumstances, a seller can obtain long-term capital gains, while still allowing the buyer to amortize the entire purchase price.

Timing of payments is another tax-related consideration that more and more selling advisors need to consider since there is bank financing now available for buyers, resulting in many sellers receiving all or most of their purchase price at closing. While a large cash payment upfront is attractive, many sellers are now considering how they can spread the payments out over multiple years to stay at a lower tax rate. However, when payments are made over time, the seller can expect to pay their taxes at whatever the prevailing rate is at that time. So, while he/she may structure the payments to stay at a lower capital gains rate for example, changes in the tax code could/will quickly undo all the creative tax planning done prior to closing.

Obviously, it is important to consult with a tax professional before making any financial moves, particularly one as large as selling an entire book of business. Do this in the exploratory stages to avoid any last-minute surprises when in the midst of negotiating.

How do you Find the Right Buyer?

If you need medical advice, you go to a doctor. When you need tax advice, you go to a CPA (even though you MIGHT be able to figure it out on your own). When planning a sale or acquisition, it is a good idea to seek help from an M&A specialist. Experts in the field can go over the available options, some of which we have covered here, help evaluate and match sellers with buyers, as well as negotiate the sale, provide relevant industry advice, and other critical resources such as due diligence materials and purchase and sale agreements.

A common but far less successful strategy to “get the word out” is to network with other advisory firms and talk to your custodian or broker-dealer. Even worse is simply selling to a colleague without evaluating other potential candidates and/or offers. Selling a book of business is a common topic among financial professionals. It is the way that larger firms achieve rapid growth, so it is possible there may be a buyer that the advisor looking to sell is already connected to. However, connecting with potential buyers is only the tip of the iceberg, and it is the easy part. It is still highly recommended that sellers contact an M&A expert who knows the industry, even if there seems to be an obvious buyer in the picture. Appearing too eager, not having enough suitors, or not knowing what to ask for or how to get the buyers to say “yes” will negatively affect negotiations. Lack of knowledge could jeopardize the deal or could cause the seller to leave money on the table.

Online “matching making” forums are not the right place to search for buyers or to post a financial services practice. These sites often serve as the “clearance bin” of practices for sale that could not find a better solution elsewhere. A serious financial advisor who values client relationships does not shop them around online. Legitimate firms that are looking to buy a book of business do not go there for sellers.

What Happens After the Deal is Closed?

Bestsellers Book Sign

An advisor retiring from a firm where there are partners and associates to manage client relationships can simply sail off into the sunset with little effort. It does not work that way when an outside firm purchases a book of business. There is a transition process that needs attending to, whether the seller plans to remain involved for a short period, or over many years.

In some cases, purchasing a book of business means buying an entire firm. The primary advisor may step away, but there is still an existing infrastructure in place. Even in these cases, people are part of that infrastructure and need direction. What will their role be if the firm is acquired?

Priority number one is taking care of the clients. As an independent financial advisor, the obligations are clear, which means facilitating a smooth transition. Contact each client and let them know how excited you are to have found the perfect successor, and talk about the lengths you went to in an effort to find the right partner. Reassure them that they will be taken care of and ensure they know you will not be suddenly disappearing, but that you will gradually be slowing down gradually over time.

Once the initial contacts have been made, stay available to both the acquiring firm and the clients. It is most common for sellers to remain available for 12-18 months post sale, providing on average 300-500 hours of transition-related support. As a “former” advisor, the role changes to more of a mentor and guide post-sale. But, it is becoming more and more common, for a seller to remain involved in some capacity for 3-5 years. Selling earlier generally results in less attrition and more growth, and as a result, usually a higher sale price.

When Should You Start Building a Succession Plan?

Most advisors think of a succession plan as something you do when you are ready to retire. If you wait that long, you may not get what your business is or could have been worth with just a little bit of advanced planning. Succession involves more than just naming someone to take over. It is about ensuring you have a plan to transition the business and clients you spent decades creating. While a transition can happen in as little as 6-12 months, many find the process more enjoyable when they sell a few years prior to wanting to completely step away from the business, giving themselves and the clients more time to get acclimated.

The time to create a succession plan is right now. Begin with the end in mind. You can never start thinking about succession too early. You may not take active steps when you are in your 40s and 50s, but knowing where you want to end up at the end of your career will help you run a better firm in the meantime and have an exit event that is so gradual almost no one notices. Maybe you want to build your business and have your children or other family members take it over, maybe you want to find the best candidates and sell to the highest bidder as part of your own retirement plan. The key is to have an idea before your clients start asking. Contact Succession Research Group (SRG) today for assistance. Our team has experience with helping advisors increase the net worth of their practice and creating succession and acquisition strategies to guarantee profitability.

David Grau Jr.

Written by David Grau Jr.

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