Buyers and sellers: Finding the perfect match

By Alison MacAlpine | October 17, 2008 | Last updated on October 17, 2008
6 min read

(October 2008) Last month, Peter Gemmell, branch manager at Assante Wealth Management in Abbotsford, B.C., guided us through the early stages of buying a book of business for an advisor in his branch. Click here for that story.

This month, we’ll focus on how he ensured the seller’s book matched the buyer’s needs, and the negotiation process that led to an agreement that satisfied both parties to the transaction.

Through a series of face-to-face meetings, Gemmell and the buyer got a good sense of the seller’s practice. In particular, they wanted to ensure that the selling advisor took a financial planning approach with his clients. Transaction-oriented books, he says, are much harder to retain through the transition to a new advisor. He also wanted to make sure there wasn’t a large concentration of individual stocks and bonds, which tend to be traded more frequently than mutual funds, since he knew that wouldn’t be a fit with the buyer’s philosophy.

An ideal book, he says, has sales opportunities that haven’t been fully exploited — perhaps gaps in insurance or estate planning — so there’s room to grow quickly. In addition, the industry has administrative procedures that permit the conversion of mutual fund investments sold with a deferred sales charge to front-end loads at no cost to the client.

“Over time, you essentially double your income just by administratively handling things properly,” he says, pointing out that DSC trailers are generally 0.5%, compared to 1% for most mutual funds in the front-end world. “We want to find a book that has tremendous upside — that has made a good living for the person who is selling, but that is going to make an even better living for the buyer with some administrative changes and some work in terms of implementing a full financial plan.”

Throughout the courtship process, the buyer is probing to find out information about the seller. Of course, the seller is probing to make sure the buyer is a good match, too. In this case — as in most of the books Gemmell has helped the advisors in his branch purchase — the seller was preparing to retire from the business. He needed a succession plan, and one of his top priorities was to ensure the new advisor would take good care of his clients.

Gemmell worked hard to build a solid relationship before the conversation turned to the cold, hard numbers of the deal. At no point did he rush or pressure the seller. He simply kept channels of communication open so the seller would think of him first when he felt he was ready to sell his business and retire.

“It can be six months plus in the discussion phase,” Gemmell says. “I fully expect that [sellers] are being courted by other people as well, so sometimes there are gaps of months when they just don’t want to talk. When they eventually do come back, it usually means you’re on the short list and you’re really going to start talking terms.”

In this case, after about six months, it became clear both sides were ready to get serious. At that point, Gemmell and the buyer prepared a proposal and presented it to the seller.

Negotiating the price

Simplifying the negotiation process are fairly well-established industry-wide expectations about the value of a book of business: “A model got floated out there about seven or eight years ago in terms of what compensation should be paid for businesses, and it seems to have been fairly well accepted. It runs anywhere from 2.5 to 3.5 times net recurring income.”

An important factor in determining exactly where a particular book falls within that range is the likelihood of retaining clients. In this case, the seller’s book had well over 1,000 clients, which meant that the terms of the agreement had to give the buyer time to reach out to as many of them as possible.

For this reason, the parties agreed to split the purchase into two parts. The larger portion would transfer over a period of 18 months, and the rest would transfer over the following 12 months. This would make it possible for the buyer to make contact with the vast majority of his new clients within a reasonable period of time. Clearly, clients transferred and ignored for too long are far more likely to leave for another advisor.

For his part, the seller wanted a 50% downpayment on the book. But Gemmell insisted on a retention clause that required the seller to replace assets or refund the purchase price of assets that left the buyer during the first 30 months — so the remainder of the money was paid gradually over that 30-month period.

Tying the final price to retained clients eliminates a large amount of the risk the buyer assumes when purchasing a book — especially important if the buyer doesn’t know the seller extremely well. It may be less of an issue in the case of a junior advisor buying a senior advisor’s book when he or she already has relationships with many of the clients.

Since the seller was an advisor from outside Assante, Gemmell says, “The retention clause was a more important aspect to us than any of the others in this particular transaction. You have quite an exposure still that goes beyond that, but what you do know is that at the end of the retention clause period you’ve got a 30-month history with many clients and enough of a relationship to pick up the phone and talk to people.”

Formalizing the agreement

In this case, the purchase price fell in the range of 2.5 to 3.5 times recurring income. In return, the buyer doubled the size of his book, acquiring an additional $100 million in assets under administration. Next month, Gemmell will provide insight into the potential impact of a book acquisition like this one on the buyer’s bottom line.

Now it was time to draw up the paperwork and document everything from the price to the timing of payments. The seller engaged a lawyer to prepare an agreement, which formalized the purchase terms the buyer and seller had accepted, clearly defined each advisor’s role through the transition period and explained precisely what would happen in the event of a default.

Gemmell didn’t feel a lawyer was necessary on his side. “We simply reviewed the form of the agreements that were sent to us, and we asked for changes and then negotiated those changes if there was a need to do that,” he says. “Eventually, we came to an agreement that everyone could live with, and off we went.”

One of the most important terms in any deal, he says, is the one that sets a clear departure date for the seller. Otherwise, the buyer may find himself or herself in the uncomfortable position of trying to oust the seller while maintaining the good will of the seller’s clients.

“Sometimes it’s hard for sellers to let go, so it is really important to nail down dates,” Gemmell says. “You want to avoid becoming the assistant to a seller when the whole deal has been defined except the departure time. Because what happens in a situation like that, quite often, is a seller gets very comfortable — earning the same kind of money and doing a lot less work.”

Other terms can take precedence in certain deals. For example, one transaction he negotiated involved a younger seller who was moving into a different industry. In that case, the “no compete” section was critically important.

“If they don’t succeed at whatever they’re doing, they still have that relationship with those clients. No compete goes into all agreements, but that section may be enhanced with a guy who is younger and changing careers,” Gemmell emphasizes. “There’s always a question about how legally enforceable no competes are but I think a pretty strong argument could be put forward if somebody simply spun around six months later, got back into the business and took all his clients back. It’s a contract. You have recourse should somebody ignore the terms that they’ve agreed to.”

Whatever terms make it into the final agreement, it’s essential that each one be thoroughly discussed, understood, defined and documented. Memories can shift when a deal hits bumps in the road, Gemmell says. In addition, the process has the potential to be emotional since the seller is stepping away from his or her livelihood. Putting everything in black and white gives everyone more objectivity.

Questions that must be answered with particular clarity include: When will the transition process begin? What role will the seller play? What role will the buyer play? What are the terms of payment? And, perhaps most importantly: how will clients be successfully retained as they move into a new relationship with the buyer? This will be covered next month in the final installment of our three-part series.

Read part 1 of this article, How to buy a book, step by step, by clicking here.

Alison MacAlpine