Acquiring a business or client bank can be a great way to expedite growth, but this is not without its challenges, writes Victoria Hicks, managing director of M&A brokers The Exit Partnership.
A successful acquisition is dependent on the integration not just the ability to agree a deal structure and obtain the finance, meaning the shortage of quality talent to ensure the clients are well serviced post purchase can be a stumbling block.
A more recent issue is that of rising interest rates especially where the cost of debt funding linked to the base rate is going to have an impact on margins.
With the noise about where interest rates could peak in the short term, modelling the profitability of any acquisition and stress testing this against potential future interest rates could start to have an impact on the ability of firms to acquire.
The question is will this reduce valuations across the board or will this reduce the ability for those who require debt to purchase to compete?
How big is due diligence (DD) when buying advice firms?
Always longer and more detailed than sellers anticipate and requiring a lot of resource from the buyer across various disciplines to assess the information correctly.
Firstly, we have to consider what is being purchased. Is an acquirer buying the assets, therefore their liability is commencing when the clients are transferred or novated to them or are they buying the shares and the full history of the business.
The DD that is attached to both types of purchase is vastly different. Even with an asset purchase DD is still in-depth with an acquirer wanting to ensure a standard of advice, and confirm they are buying what they believe they are buying. Here there is much more focus on the client demographics and the financials.
With an asset purchase, any staff will have their contracts TUPEd, so an understanding of TUPE (Transfer of Undertakings (Protection of Employment) Regulations)) law is also key. Whilst the inherent liability that comes with acquiring shares is not there, there could still be reputational damage or potential issues in the future due to previous advice provided causing acquirers to walk away.
DD on a share purchase can extend upwards of 500 points and covers regulatory, financial and legal aspects, with regulatory due diligence being the most comprehensive and time-consuming part. The team assembled by the acquirer to cover this are tasked with leaving no stone unturned and providing a warts and all report on the suitability of the acquisition and the risks posed.
The DD process could take upwards of three-to-six months and the business will continue to change over this period so there will be monthly reporting to also provide, and lots of repetition. We have a regulatory due diligence questionnaire on our website, which is a great resource for those thinking about their exit.
Although, all acquirers will approach DD in their own way, based on their own perception of risk and reward, this tool allows owners to understand better what will be required of them, and make improvements in advance.
How much planning do firms need to do when eyeing an acquisition spree?
Firms should plan extensively, not just to ensure the acquisition is a success for clients, staff and their reputation, but also to compete in this competitive space.
Coming to market with a strategy and a clear understanding of this, having the right people in the right places and being totally transparent about what will change and when is what sellers want to see when making this crucial decision. In our experience, sellers are more comfortable where firms know their proposition and have invested in the foundations before coming to market.
There are horror stories about those who have amassed businesses and now have to integrate these, and sellers typically don’t feel comforted by the line ‘sell to us, nothing will change’.
This doesn’t reflect well on the acquiring businesses who should have a strategy, should have the foundations set, and should encourage the right change to improve outcomes for staff and clients.
Ensuring you have not just the capital to acquirer, but the resource, structure and capabilities is just as important.
What does the ‘right fit’ mean for buyers?
Culture before cash. We use this phrase with buyers and sellers because the cultural fit is the most important aspect in a successful acquisition.
An acquirer is buying good-will, and the expectation that the loyal client relationships will remain. But no one owns a client, and they can vote with their feet.
So, it is important to understand why the clients have remained loyal to the seller. What do they experience that they value, and how does your offering harmonise with this? An acquisition has to be integrated to make it a success.
There is a compliance requirement to ensure a consistency of output for clients, and to protect the business.
This isn’t to say that integration needs to happen on day one but over time there will be an alignment, so to prevent client and staff attrition you need an openness about what will change for both. Is this going to work? Be honest about this and don’t chase funds under management but seek the right opportunities in the right way.
What is the best way to fund acquisitions if firms are not backed by PE or large consolidator?
Cash on the balance sheet would be the first option, to better utilise current resource and invest this into growing the business. Clearly many acquirers will be restricted by this route.
With ambitions to grow very quickly, you could seek your own PE / VC investor, which will involve a comprehensive business plan and an awareness that this type of investor is not in it to make a 10% return per annum. They are looking for significant growth over typically a five-year period so your ambitions and theirs have to match. Via this route you are typically giving up equity and obtaining a lending facility with a rate attached. Or you can look at debt to fund acquisitions and retain full ownership.
Advice firms don’t typically have assets on the balance sheet, with the value mainly being good-will. This in itself reduces the number of lenders in this space, although it is possible.
Security for the lender is usually a debenture and possibly personal guarantees. Acquirers could be looking at rates of 8-10% above the base rate, and so consideration of rising interest rates and stress testing against future expected interest rate are key in ensuring this is the right route for growth.
How can firms differentiate themselves aside from price?
It is my opinion the gulf in price between those offered by local peers or debt funded acquirers, compared to those offered by PE/VC backed firms could increase due to the restrictions on borrowing and the fear of future interest rate rises.
Smaller firms also don’t have the arbitrage potential the larger businesses do, and the ability to benefit from an uplift in value on the acquired business purely due to their own size and scale.
For this reason, buyers have to compete in other areas and sellers have to be willing to accept the offset in price for the benefit of other factors.
In the last three years I have not worked with one seller whose primary objective has been to maximise value, but the deal must feel fair and equitable. Firstly, justify your bid! Explain how you have reached the valuation, so a seller understands and appreciates your rationale and the basis of the deal.
Then, its back to culture, appreciation and respect. The lion’s share of sellers we talk to are friends with their clients, they want to pass the Tesco test, they want to demonstrate to their clients they are more important than a price tag, and they want the last piece of advice they offer their clients; to engage with their new advisers, to be as good as the advice they have always been provided.
Understand your proposition, don’t try to make an acquisition fit through mistruths or omissions, and explain how this will be a good news story for staff and clients that allows a seller exit with confidence whilst upholding their legacy.
This article was written for International Adviser by Victoria Hicks, managing director of M&A brokers The Exit Partnership.
