Top Tips for Buying a Financial Advisory Practice

It’s a rather grim statistic: in a study completed last year, only about a quarter of financial advisory firms reported being “very satisfied” by acquiring another’s advisory business.

Sponsored by NFP Advisor Services and conducted by the Aite Group, the white paper — Alpha Acquisitions: Maximizing the Return on your Practice Investment — indicated that client retention proved to be the biggest obstacle during an acquisition. While a 76% average retention rate sounds perfectly respectable, keep in mind that's only for the cream of the crop — the most successful acquisitions that fell under what the survey deemed “alpha acquisitions.”

To ensure that your acquisition places you squarely in the "alpha" category, it’s essential to stick to a proactive, rather than reactive, strategy — and to know what potentially fatal missteps to avoid.

The company you acquire will likely have a markedly different work culture from the one you currently run. As you review potential acquisitions, it’s tempting to make a cursory appraisal of how a new company’s already established culture will mesh with yours. Keep in mind that appearances can be deceiving, and the internal culture of a company will always be more complex than meets the eye. (For more, see: FAs Should Factor Clients Into Succession Plans.)

Yet how you avoid a culture clash? Take pains to integrate new employees from the acquired company into your firm’s culture: it won’t happen automatically. The fact that many employees making the jump may not have desired, or even foreseen, the change can mean unspoken resentments. Keep in mind that numbers never tell the whole story: take time to debrief with your new employees to hear their insider’s take on their existing business culture. Be proactive in giving those employees a voice for their concerns, as well as sufficient opportunities for leadership and collaboration in your firm’s new organizational structure.

According to the Aite Group survey, personal contacts between both parties dramatically increased the chances for the acquisition’s success. In fact, a previous personal connection between two people existed in more than half of all successful deals. Brokering the deal directly proved also fortuitous: external consulting firms were used in only 10% of successful deals.

From the client end, don’t assume that new clients will necessarily embrace the kind of service model you traditionally provide. Ask plenty of questions, and don’t make jump to conclusions: what do your new clients want, and what do they expect? If you’re used to conducting planning meetings on the phone, and most clients in a new firm are accustomed to coming into the office this is something you’ll want to gauge in advance. The same goes for communicating updates and information to your clients: are they accustomed to being contacted by phone, while your firm’s standard mode of communication is email? When it comes to client interaction, face-to-face time might be imperative in setting the right town with the new client base that you inherit. (For related reading, see: Management Tips from Top Financial Advisors.)

The Aite survey points to patience as a virtue: among the firms polled, many of the successful acquisitions were the result of a long vetting process lasting several years. When seeking out a partner, don’t rush: spending looking for a good match statistically pays off in the end. (For more, see: Key Steps to Building a Great Financial Planning Practice.)

It may seem like an obvious question to consider when debating the merits of an acquisition: how does the revenue of the parent company compare to the revenue of the potential target company? While acquiring a new firm is a perfect opportunity to inject new lifeblood, and new sources of revenue, into the system, consider how big a risk you can safely take. An acquisition that represents more than a quarter of your current revenue means that your operations and financial balance sheet will be significantly impacted if the transition goes less than smoothly. New prospects that would total than 20% of your total revenue stream are likely simpler — and safer — bets. (For more, see: How Advisors Can Fill the Talent Gap.)

It’s unlikely you stiff the server at the restaurant you regularly frequent — or if you do, you’ll expect to receive less than stellar service. A similar rule applies to acquisitions: bargaining down to bottom dollar will rarely yield a deal with a top-notch practice. Even if you shop around for a firm that might be willing to strike a deal, beware: it’s not worth acquiring a mediocre firm even if the price is right.

So, what are the essential factors in strategically pricing an acquisition? Expect to pay along a formula that measures market worth plus revenue. Among top factors to consider, business longevity is one: how long has the firm been around, and what is their reputation? Other factors to look at include the client services model and the revenue mix. In terms of assets, make sure to look at both total assets under management as well as the cash flow from operations. (For related reading, see: How Financial Advisors can Adjust to Robo-Advisors.)

In the long run, paying more might ultimately pay off: the Aite survey actually revealed a strong correlation between satisfaction and paying more for an acquisition. In fact, the 25% of those who reported highest satisfaction with their acquirers who paid more those who reported being the most satisfied with their acquisitions also reported paying more. Just what does “paying more” entail? Rather than a dollar figure, it all comes down to multiples. In the survey, the average acquisition amounted to 1.36 times revenue, while alpha acquisitions — the most satisfied — clocked in at 1.55 times revenue.

Don’t put a second mortgage on your house to cough up enough funds for an acquisition. Perhaps unsurprisingly, there’s found a high correlation between dissatisfaction with an acquisition and taking out a personal loan. In the Aite survey, among acquirers who expressed a lack of satisfaction, 73% had taken out a personal loan. (For related reading, see: How Financial Advisors are Leveraging Social Media.)

While the cause and effect of these numbers aren’t transparent, it's worth mulling over whether going into debt is a reasonable risk on both the business front and in your personal life.

When it comes to merging a client base after an acquisition, time is not on your side. Before you strike a deal, be proactive in establishing a plan to quickly and smoothly transition clients from one practice to the other.

While a need for speed is imperative when it comes to merging a new acquisition, be prudent when it comes to the human side of the transition. If the acquired companies comes with organizational or personnel issues that require action such as project shut-downs, layoffs, or redistribution of roles. (For more, see: Growth Strategies for Financial Advisors.)

When negotiating the complex and sensitive nature of an acquisition, don't try to defy the basic laws of physics. For every action, there's a reaction: this is especially true when dealing with major personnel and organizational changes. Then there's Newton's First Law of Motion, which states that every object in a state of uniform motion tends to remain in that state of motion unless an external force is applied to it. In an acquisition context, that means that the speed and success of merging two companies depends entirely on swift, proactive measures. Inertia is your enemy: don't risk maintaining the status quo and hope that two disparate company cultures and organizational structures will magically merge. (For more, see: How To Create A Business Succession Plan.)