Round-table succession discussion transcript

The following is an edited transcript of the round-table discussion.

Mr. Paikert: Let’s start with an overview of the succession market.

Mr. Tibergien: It’s important to distinguish between succession and sale. Succession planning really relates to the orderly transition of clients, management and ownership. The sale may be the outright transfer of ownership to an outside party. So, in that case, there may be 100 to 200 actual transactions that occur in the year. It’s not vast, but it’s notable.

In a study we did at Pershing called Real Deals, we looked at the five years that ended in 2006 when there were about 250 transactions of practices that were between $100 million to $2 billion of assets. There is an upswing in the number of [transactions], but the vast majority of transitions occurred quietly among insiders.

Mr. Behn: That $100 million mark would have missed both of the deals that I participated in. I have looked at those numbers and it appears to me that there is some discrepancy in what is actually happening and what is being marketed out there as happening. It suggests that more successions are happening internally, quietly, than dealings to outsiders.

Mr. Hayden: There are a lot of little deals that people don’t know anything about. I had a planner come to me about five years ago with about 12 clients, wondering if I would be interested in buying his clients. I paid him 25% for a few years of the revenue that came in from those clients. If the revenue increased from those existing clients, he got benefits from that. If we got referrals, he did not benefit from that. It was a sweet deal and included some very high-profile clients. That is different from the deal we just did in November. But I think a lot of that goes on.

Ms. MacPhee: I used FP Transitions [of Portland, Ore.], David Grau’s firm. There are a huge number of financial advisers out there. They know they are supposed to have a succession plan and they are a little leery about advisers in the area, paranoid of [revealing], “I’m thinking about transitioning my firm.”

Mr. Tibergien: Planners are the worst planners.

Mr. Paikert: Are there any other market trends that come to mind?

Mr. Tibergien: The biggest one is the average age of principals in advisory firms. It is going up, which portends a significant problem for the industry, because where is the next generation of advisers going to come from? People can’t make the transition into this business and there’s a big concern about what will happen with the independent practice. Some of the older advisers are claiming the younger people can’t afford to buy the practices. If the cash flow doesn’t support the purchase price, then you’re overpricing the practice.

Second, it is not uncommon to have most of one’s clients be the same age or older than the adviser themselves, so, what is actually being transferred? It could be a depleted oil well when you get to it. So what is the opportunity for generating income to the buyer in that case?

Third, we are dealing in an environment where the market is getting stoned and the income generator for many advisory practices is getting hurt. So, for those buyers who relied on a rule of thumb that may have been promulgated by FP Transitions and others, it is a very dangerous rendition because the cash flow may not support the purchase price.

LONG-TERM RELATIONSHIPS

Mr. Hayden: Establishing relationships far in advance of selling a business really creates an advantage that could be leveraged into a really good arrangement. Can you find an institution that parallels the way you think, so you’re not selling the business as a commodity, but as a service because you’re concerned about existing clients and staff, and you want all those to not only stay together and keep working, but have it grow. And I might also mention that every planner who is selling their business doesn’t necessarily look at this as an exit strategy because I don’t. For me, it was a way of getting equity out of the business.

Mr. Behn: The vast majority of planners out there fail to plan with an exit strategy in mind. They fail to look at the long-term. They figure, I will go out and get new clients and as the normal attrition in the business occurs, I will replace that.

I started my practice with nothing. At the time I was 25 years old and it was an uphill battle talking to 65-year-old people with the money. I have some sales skills that helped me. But the vast majority of planners are not rainmakers, they are not people out there generating revenue. They want to jump on the coattails of someone who has already done that. That’s a dangerous trend because, as an owner, I don’t want to transition my practice to someone who can’t fill that attrition rate. If I can’t accomplish that, we have something that’s going to diminish to nothing eventually. It’s the nature of any practice. And that’s the biggest risk to me.

I’ve held on to my practice so long that most of my clients leave. Not because they don’t want to be there, but they pass away. That’s a risk for me. I have to look at a 10-year window and ask, “What’s the likelihood I’m going to have something to sell?”

The rainmaker tendency has to be learned. And, unfortunately, in matching up a successor, you want complementary skills, not necessarily the same skills. The worst person I can hire is someone like me. If I don’t allow that person to succeed me, ultimately they go off and do their own thing. So, the tendency for owners like myself is to hire people who can do all the things better than I can do except one thing, which is the sales component of it.

I see it from the perspective of people that call and talk to us about the practice. The common theme there is, “I would really like to do what you do, except I don’t have the experience or the clients.” To me, those two things have to go along with the package or else it becomes a problem.

TRANSFORMATION

Mr. Tibergien: These examples demonstrate an interesting transformation in the profession. There is an institutional mind-set that has taken hold, which implies that the industry is transforming from a classic entrepreneurial business to more of a business business. As a result, the way in which people will look at business continuity, serving clients and creating the magnets for new clients, may be more a function of the enterprise created than the tendency of one individual.

Ms. MacPhee: Many advisers are now considering outsourcing. I’m running across a good number of people who are the entrepreneur solely. They don’t want to sign up for managing employees, so they are looking at outsourcing and the ability to make the same revenue and not have all the headaches.

Mr. Tibergien: A question I have is: How is fiduciary responsibility fulfilled when advisers don’t ensure the continuity of their practice? Not only is mortality inevitable, but when people get to a certain age they lose their energy to serve the clients well. A number of solo practitioners tend to become more passive in their relationships with clients. It becomes an asset allocation strategy and, perhaps, nothing more significant than that. So, what are the obligations of advisers to ensure that the client is served well in the event something should happen to that practitioner?

Mr. Hayden: When I was briefing the board of the bank, one of the board members asked me about my role going forward. My answer was to make sure that I was not needed at some point in the future. Which meant I had to create some standardization, some transfer of ability that wasn’t there before because as an entrepreneur, you tend not to treat it as a business.

So, one of the steps I took was to find a person who had just come from the corporate world who had planned on becoming a financial planner who was a real solid businessman. I brought him in on salary and he started to turn it more into a business while I did my thing, like television and writing articles. Together, with our third person, we are documenting some things to make them transferable.

Mr. Paikert: It seems that financial advice is one place where being older is probably better.

Mr. Behn: I certainly contended with that early on in my career. It got to the point where that was a softball. Think it through. You want someone who is a generation younger than you, so you have continuity for the most important part of your life, which is the transition from working for your capital to your capital working for you.

Mr. Paikert: Does it make sense to bring in someone who is 50, for 10 or 15 years, and then sell it again to someone who is 50?

Ms. MacPhee: I think of a humorous anecdote. A female planner in New Jersey looked young and I asked, “Are you having difficulty with the retirees?” And she said, “When they ask me how long I have been doing this, I look at my watch.” I think that’s very funny but that’s not good for client comfort. In general, I agree on conveying the confidence.

THE ISSUE OF TRUST

Mr. Tibergien: When I had my stint with an advisory firm, my boss said, “There are two things you need: gray hair and hemorrhoids. The gray hair is to look mature and the hemorrhoids are to look concerned.”

But the appearance of maturity is really just an access question. In the end, the idea is how you demonstrate competence because clients pick advisers based on trust. One opportunity is to take a team approach where you have the mature adviser and the youthful technician who together can create something of substance for the client.

But what happens in many practices is difficulty with the idea of investing the younger person with trust. The practitioner may say, “You can deal with this person, but if you ever have any problems, give me a call and I will still be involved.” So, they won’t pull the rug out from them. So, the older adviser needs to ensure that trust is conveyed to the clients being transferred; otherwise it is going to be a bad deal.

Mr. Paikert: Any other succession trends?

Mr. Tibergien: Yes, the centers of influence. What is the growth engine of these practices going forward? In many cases, you have advisers who are selling aging books of business. So the buyer is acquiring something that is based not so much on aggressive selling as on referrals and building centers of influence. The centers of influence may be clients or other professionals in the community. The reality is that, as we get older, our centers of influence tend to be those growing up with us, not younger than us. So, ensuring continuity of the practice involves paying attention to all those centers of influence and the capacity to serve their children if we can. Those are big issues going forward.

Mr. Hayden: What you’re really doing is developing a center of influence that could lead you to a really compatible arrangement to sell the business and continue to build. Endowing the other people in the firm to continue to grow absent the older person is really crucial.

Mr. Paikert: How did you deal with your clients when you sold your business?

EMOTIONAL ISSUES

Ms. MacPhee: I actually told the clients before the deal closed because I felt that was more ethical. And I took a chance because if the deal had blown up, I would have to go back.

It was difficult. It was emotionally draining because I had every single appointment in person. They were worried. They said, “Will we ever see you?”

Also, my clients were older than me. I’m selling a practice with clients that are 55 years old and up. When you have consumption verses accumulation, you have a practice that could be declining revenue. Interestingly enough, my practice was 50% retainer and 50% assets under management. There were so many considerations. I can tell you any practitioner selling their practice really needs to ramp up emotional reserves.

Mr. Tibergien: Did any of your clients not feel they were compatible with the advisers that you sold the business to?

Ms. MacPhee: Five of 60. The compatibility factor was by far the biggest reason for me to sell the practice to that firm.

Mr. Paikert: How did you deal with your clients?

Mr. Hayden: First I had a quadruple bypass. If you survive that, then the clients are scared about what is going to happen. So, they were very open to this arrangement. I assured them I wasn’t leaving. But by the same token, the emphasis was so much on me as a significant problem that I immediately talked about the team concept. I said, “Look, some day I’m going to die, I’m going to be out of here and I don’t want any of you to leave, you’re going to be in great hands. I want to tell you why and who they are.”

Plus, the law firm required a certain amount of disclosure on a number of key issues. So, the president of the bank and I and my team got together and created a communication that met all those. I did it in two installments. The first letter was to cushion the blow a little bit and to prepare clients that we were doing this and the second contained more of the hard-nosed legal stuff that might put them off a bit. Then we immediately followed up with appointments with any clients that might have had a problem with it.

Mr. Paikert: How much time did that consume?

Mr. Hayden: We spent at least a year going through all this, talking with clients and preparing them, answering questions, taking the president of the bank to some lunches and one-on-ones with some of our higher-net-worth clients. They are glad to know I will be there for a while. I have a three-year contractual commitment. But, I don’t lean on that very much. I’m telling most of my clients that they will be meeting more with Dick [Drew, director of financial planning] and Gerard [Gruber, certified financial planner] and that I will be out doing more interviews and continuing to be a rainmaker.

Mr. Behn: I often say I’m not in the investment management business but, rather, that I’m in the perception management business. You could have a catastrophic result if you don’t manage it well. Speaking from the buyer’s perspective, when I acquired the two practices that I did, we were very careful about orchestrating the communication to every client. We almost customized the approach, and that took a lot longer because we were cautious and there were issues in terms of compatibility.

Mr. Paikert: What were some key aspects of that communication process?

Mr. Behn: The big issue was making sure the clients understood there wasn’t a significant change under way. The other thing is to make sure is that no one pulls the rug out from under you. It has to be known from the very beginning, based upon the significant investment I’m making as a buyer, that I’m going to control that communication. I’m going to live by it or die by it.

The second transition got out of my control a little bit because the owner of this firm had a lot of personal relationships with these clients. They were friends. I learned very quickly that he had his own story he was telling to clients, which was different from the corporate story. It didn’t allow me to manage the perception well. I had to say, “You can’t do this, this is the way it’s going to work.” Basically, we brought those people back in and he apologized for being out of line.

In that transition, I looked at it from a business perspective and identified the clients I wanted to keep. I started from the top and worked my way down. That clashes with the human relationship component, but it’s a business. The critical component is to look at this as a business, as opposed to from a financial planning perspective. For the most part, people in this industry can’t address that concern and it’s a problem.

We also have to look at the broader scope of who is buying financial advice because the vast majority of people out there don’t seek [registered investment advisers] for advice. They are talking to “Chuck,” or whomever. That is where we have the greatest struggle in terms of marketing. You’re up against people who are in marketing every single day. Through an episode of “Lost,” you’ve got 14 commercial breaks and seven of those are financial planning or investment advisory commercials. [The Charles] Schwab [Corp. of San Francisco] buys those spots because they can afford to. We are up against it.

Ms. MacPhee: I used that as an advantage in the transition of the practice. I said, “It took a lot of time for me to carefully pick who I wanted to be your next adviser. I’m not going to turn my practice over to someone I don’t feel very good about and I’m not in any rush. I don’t want to see it go to a brokerage firm where you can have one adviser and two years later, it could be someone else.

I’m trying to get a firm where there is a relationship similar to the one we have.” That’s how the sole practitioner has to compete against the larger companies, because there are a lot of people who want a personal relationship.

Mr. Hayden: The psychological aspect was really important because of the close relationships over the years. For instance, the bank’s attorneys wanted all of the clients to sign new contracts and I said, no way. It continued to stay in my name and that gives us time to let something evolve in a more natural way so that clients won’t be as disturbed. So far it’s been working really well. They hate to change addresses, phone numbers and certainly contracts.

Ms. MacPhee: The last thing you want is to have any light shed on change. You try to keep it very even, stressing the facts.

Mr. Paikert: Let’s talk about the pros and cons of internal succession versus going to an external buyer.

Mr. Tibergien: With an internal succession, there is a greater chance of preserving the culture. Processing documents tends to be seamless, so it is fairly orderly. Internal buyers do not pay as high a premium as the strategic or financial buyer, but virtually every transaction has an earn-out component to it. So, if you have an understanding of the book of business, you’re not going to be getting the premium anyhow.

The issue for the adviser is that it would also require the principal of the firm to invest in the development of people, and you know that most advisers who are solo practitioners really have an aversion to the idea of working with other people. That may change with the next generation. But it’s a lot of work to invest and develop people. It takes away from serving clients and I perfectly understand why people don’t want to do that.

Mr. Hayden: I didn’t see it as a possibility in my situation where two key people would buy the practice and I would get any money out of it before I died, so we decided not to go that route. But once you sell the business like I did to a bank, what is the incentive for the other key people to hang around? I introduced to the bank the concept of an incentive plan for the new people. The plan that they had in effect would not have probably kept our people around, but we were able to create a model incentive and sell it to the bank’s attorney, as well as the president of the bank. We said, “If you would really like to see that five-year plan we talked about evolve the way we have laid it out, this is about the only way we can assure you it will happen.” Also, every step of the way in negotiation, including the price, I was totally open with the rest of my team. There were no secrets. In such a small group, it doesn’t work anyway. That worked really well.

Mr. Tibergien: As a practical matter, to effect an orderly transition internally, you probably need at least two internal successors for every one principal and, ideally, it will be three. That has implications for most practices, since there are costs related to it. You might bring somebody in and they could not work out and then you have to wait another five years before the next person is ready.

BUYER’S BURDEN

Second, if you’re at all successful in the practice, you have increased the value, which puts a huge burden on a young buyer to finance it. If you could spread that risk and cost among others, it would make it more digestible.

I was talking to an adviser last year who has 20 years or more in the business, built an incredible practice with $400 million in assets and maybe 150 clients, but had always worked alone except for four or five administrators on staff. Now that his children had left, his wife was encouraging him to enjoy the wealth he had created and get away from the business. He created a three-year plan to exit. He asked if he should hire somebody to transition the practice. My advice was, no, because he never did it before and the chance of success was pretty low. So, he ended up deferring that succession plan and not fulfilling his wife’s wishes. If your runway is that short, it’s going to be very difficult to get liftoff. You need to have more opportunities to create management transition, client transition and owner transition. If you don’t recognize the three elements of transition, failure is imminent.

Ms. MacPhee: There is a phenomenon of solo practitioners testing the waters. I actually had some person say, “We are in the dating stage and will meet once a month.” But you could spend a year doing that and then have all your eggs in one basket.

Mr. Behn: I love that dating analogy. I compare our succession registry to eHarmony [the online dating service]. You really are courting in a way. You’re trying to find the right person for the right job.

But getting back to the question about succession or external sale, I grappled with this because I have a decision to make: Do I stay or do I go? I have a terrific lifelong friend from kindergarten. He works for me. He is better at what I do than I am. So, it’s a wonderful opportunity for a succession. It’s a one-to-one situation, not a one-to-two or two-to-three. I echo the concerns there. Logistically, it would be so much better than one-to-one, but then it’s a problem for a practice of my size. We can’t afford that kind of talent. To do so, we would have to double the fees of clients, which I have a problem with. We are probably under-market in terms of what we charge our clients. There is a strategic advantage and it allows us to begin to grow with clients.

CAPITAL INFLUX

But when you look at sale versus succession, you have that influx of capital, which again, is a wonderful problem to have. You actually extract that value more or less up front and there is some earn-out component and it’s worked out very well for both sides. The second deal I made, we virtually doubled revenue, so the earn-out to the second owner was tremendous.

But, I’m left at the end looking at both sets of data. On the one hand, I could make the sale, extract that value and walk away. If you structure that deal properly and you have a definite earn-out period, as long as those clients work out with the adviser you picked to succeed you, it is a home run. Look at the 10 years [that I’m in this]: how much do I have in this case versus the sale? You compare and contrast the two revenues, the consulting business, all those kinds of things supplementing your income as opposed to getting that large clip of money up front.

That speaks to the problem most internal successions have: How do internal buyers get the money? As the owner, I have kept it. I haven’t shared it with my employees. Why would I, right? I was the rainmaker, I built the practice. And I have some guilt issues about that. But ultimately, you have built something, you have value, which truly you deserve to extract.

Mr. Tibergien: Can I challenge a little bit on that? The first issue is whether adding another potential principal is going to result in raising fees to existing clients. That assumes you’re not going to grow anymore. When you add capacity, you add clients. There is no question there is an oversupply of people who need your advice.

The second part of the challenge would be on the economic reward. I think that most advisers earn their value out of ordinary income every year and that whatever they sell their practice for is a bonus because there is some residual value that they are able to transfer to a buyer. But the reality is that most advisers would admit they could not have grown the practice without the people within the practice. That isn’t to suggest that the employees should be overpaid, but the opportunity to share in that growth is fair and reasonable and, to the extent that they’re driving your growth, entitles them to equity. The dilemma is the idea of relinquishing control and allowing others to be owners.

Mr. Paikert: How should potential sellers going through a succession plan to evaluate buyers?

Mr. Hayden: I could give you an example that shows how it shouldn’t work. A friend of mine had a practice out in California that they ended up selling like a commodity to somebody from Fifth Avenue who thought they could hit the buttons and it would work out. It took about eight years to bury that practice totally, starting with about $120 million under management. So, trying to sell it as a commodity to an outsider who doesn’t care or understand the business and thinks they could just remote-control it is a disastrous thing.

Mr. Tibergien: The first issue for many sellers in selling to an outside buyer is price, but it probably should be the last one. Because if you have that personal relationship with your clients, it’s almost a co-dependency; you want to make sure that they’re going to be taken care of. So, that becomes a pretty big issue.

The second is not just their financial ability to buy but their willingness to buy. It wasn’t uncommon when I was in a consulting practice to find buyers, or even sellers in some cases, wanting to unravel the deal, for a variety of reasons. It could be ethics, it could be culture, it could be default on payments, could be any number of things. So you want to be able to judge that.

Many advisers, being prudent, have entered into cross-purchase agreements with another adviser, a peer, so if something happens, that peer will take over the practice. The problem is that the peer is probably already busy. That person may not be able to handle the business if they take it on.

What we found in the Real Deals study that we sponsored at Pershing was that in cases where the seller took the initiative to find a buyer, they received up to 15 legitimate inquiries. In cases where the seller reacted to overtures, they only got five inquiries. Those who take control over their destiny and say, “We are going to find a buyer who is most compatible,” are probably those who benefit the most.

Ms. MacPhee: Since I sold my practice, the landscape has changed in terms of valuation. I was a little bit shocked that there were 52 responses to the listing. For me, it was important to sell to a fee-only firm, so that narrowed the candidates down as well. Then it was a matter of very long interviews.

I did an Excel spreadsheet, a buyer’s score card. And I kept my identity anonymous as long as I could because I wanted to make sure my clients heard from me first instead of somebody else.

For me, price was not my No. 1 issue; it was more about the culture and compatibility. And then how many financial planners were in the firm, and did they have a comprehensive financial planning process? It went on and on with a number of criteria that I felt were important for my firm.

Mr. Paikert: Did the firm to which you sold match most of those things?

Ms. MacPhee: Absolutely.

Mr. Paikert: Could you tell from the beginning?

Ms. MacPhee: Yes. A lot of it is the feel when you first meet, and the tone of the office. I asked them, “How do you hold client appointments? What do you do?” I didn’t offer a lot. I asked a lot because I didn’t want to spill the beans.

Mr. Paikert: Was it someone close by physically?

Ms. MacPhee: Literally, seven to 10 minutes away. I had seen them at conferences but did not know them well.

Mr. Tibergien: Were they a lot bigger than you?

Ms. MacPhee: No. They had just purchased a firm four months before my closing date, which took them from being about two-thirds of my size to about 40% bigger than me. So my firm tripled their original size.

Mr. Behn: There is a company called Financial DNA [in Atlanta] run by Hugh Massie. It is an excellent tool for compatibility and is the basis of my thinking for this succession registry concept. What do we have that matches well before we take that next step of letting each other know who we are?

It’s a tremendous opportunity for a buyer. As you said, that buyer just bought a firm four months before you, and all of a sudden, they are triple the size following your deal. There is no way you can do that through any other marketing mechanism. That’s what brought me into the buyer market in the first place. I was struggling to meet one client at a time and do the seminars and all the things we do to spend money to get money. I invested a tremendous amount of capital in growing a business. Then I decided there’s got to be a better way. So instead of building it, I bought it, and then I bought it again and tripled my business to the point where I am today. I could sit here for the next 10 years of my life and not add another client and probably be OK. So it’s a luxurious position.

A DIFFERENT DEAL

When I look at it as a buyer from a lifestyle perspective, I think, “What am I getting myself into?” The second acquisition was anything but easy. There was a lot of work and struggle, and I didn’t want to involve myself in that. Looking back, I say, “Do I want to sell my firm to an outsider?”

There are two ways to value a firm: cash in hand and potential cash in hand. Depending who you select, you’re going to have more in one pocket than the other. If I’ve got 10 times multiple today, I would probably sell because it’s enough, but five times, maybe not. If I last another five years and then sell, then I have got much more than I would have had I sold today. You start to play with the numbers. I have done this with my accounting people, and the best I can tell is, no decision is a good decision. The wait-and-see approach pays off as long as everything else stays pretty static.

Most people aren’t even considering these decisions; they’re thinking about adding two clients, not which two clients. And that’s a more important thing. If I had one client instead of two, was it a better quality client that ultimately resulted in long-term revenue, instead of adding two because two was in my business plan? Conceptually, those are different issues that most business owners don’t even consider.

Mr. Hayden: One issue that’s not so relevant for you is age. That makes a big difference.

Mr. Behn: It’s a factor. It certainly was a compelling factor for both of the people I bought from. Age tends to be the pressure point that forces the issue to a certain degree. How many more five-year intervals do I have?

Mr. Tibergien: One issue that comes up in evaluating buyers is their motivation. It may be a strategic acquisition, a consolidation or just people buying a job. Knowing the motivation will help you structure a deal that is of mutual benefit. There may be cash-plus terms, there may be stock-plus terms, there may be all cash, which is rare and not wise. Ultimately, knowing the motivation of the buyer will help you position the business for sale. Also know what their issues are. If they’re looking at your business as a growth engine, how do you make it appealing to them?

Mr. Paikert: What are your thoughts on the roll-up phenomenon?

Mr. Tibergien: The first challenge for every seller is to think strategically about their optimal buyer. The consolidators are an option, and each of the consolidators has a different proposition. Focus Financial [Partners LLC of New York] is far different from United Capital [Financial Partners Inc. of Newport Beach, Calif.], which is far different from National Financial Partners [Corp. of New York], which is different from WealthTrust [LLC of Nashville, Tenn.]. They all have different profiles of the optimal firm, different deal structures, different objectives.

In the case of Mark Hurley [president and chief executive of Fiduciary Network LLC of Dallas], it is more of a passive investment. They’re not looking for liquidity; they’re looking at preferred interest in growth businesses, which is a very expensive form of financing for the younger partners and a sweetheart deal for the older partners who are considering getting out.

Focus Financial is arguably the most successful acquirer of RIAs. They are now looking at some liquidity event in the next three to five years. If it’s an [initial public offering], the seller’s going to have to have substantial market cap to get institutional coverage in the marketplace. The question is whether the business can get to a size where the market capitalization will generate a following.

WHY SHARE?

In many cases, it’s a pretty appealing option. In some cases, it’s like a buyout or sell. What I mean is that in many of the structures, the buyer is prepaying you for future earnings. For you to get the premium multiple, you’re going to have to grow at 20% to 25%. So you’re going to have to ask yourself, “If they want me to grow at that rate in order to get the premium price, why would I want to share it?” If you’re long in the tooth in your career, you’re saying, “This is an option because I have no other qualified buyers, and I can get something out of it, and I might get a pop on the IPO.” But every seller, if they’re getting stock at currency, has to realize that in most cases, they’re getting a … restriction … on the currency. So you can’t value that as the same as a dollar.

Mr. Paikert: What should someone considering selling to a bank take under consideration?

Mr. Hayden: A lot depends on their value system and how much urgency there is. I put myself in a position where I did not feel urgency to sell, because I didn’t want that kind of stress to affect the arrangement. Before I met with the president of the bank, I laid out some criteria. My first was that there be continuity with respect to clients, service and staff. In other words, everything stays in place, and we continue to function as though we are independent, but take advantage of the bank’s relationships with upscale clients. We would not open any kind of business in their lobby. We would not talk mutual funds or variable annuities, which is typical of banks. We would not use any proprietary products. That the chemistry is good and there be incentives for staff. The last was that I would not negotiate the price, which doesn’t sound very smart, but that was the half of me that really didn’t want to lose control.

Mr. Paikert: On what was the price based?

Mr. Hayden: There was a number at the time — 2.1 times gross. Then another formula, which was 1% of assets under management plus seven times net revenue, plus three times gross revenue, and you divide the result by three. Strangely enough, it comes out to be the same. Once I figured what the business was worth, I added a premium for me staying with the business because of the [public relations] capabilities and that sort of thing. That was almost one-third of the price. And there was total agreement on every point.

Mr. Paikert: That is a great segue to my next question. What is critical when valuing a practice?

Mr. Tibergien: There are a lot of myths about valuing practices. The reality is that it’s the terms that will dictate the net proceeds to the seller. If I’m a seller, I would always use the rule of thumb. If I’m a buyer, I would never use the rule of thumb. Because rule of thumb assumes a couple of things: The past will repeat itself, all practices are the same. And the rule of thumb is rational. And none of those things exist in the reality of the marketplace.

If you looked at the future earnings of a business after fair compensation and overhead expenses, and you applied 2.1 times multiple, you could buy a bond for a better rate of return. So there is absolutely no logic to paying that kind of premium for a business that had a finite life and whose client base is old. But that doesn’t mean people won’t pay it.

People say, “If the market is willing to pay for it, isn’t that the value?” I can’t argue with that. You always hope in an active market there is a greater fool — and there are quite a few of them out there. So the real issue for the buyer is whether the cash flow hurts purchase price. If the cash doesn’t flow, the deal doesn’t go. This is a not a passive investment; it’s an active investment. So you have to separate what is the reward for labor and reward for ownership, and what you pay for from the financial standpoint is a reward for ownership. In the end, it’s a financial decision.

Mr. Hayden: There is an important footnote that I should mention with respect to my deal. My team and I did a five-year business projection. It was a one-page summary, and the intermediary took it to the bank. When I first met the president of the bank, that’s the only thing he had on his desk, and he said, “Do you believe in these projections?” I said, “Yes, I didn’t do them for you; I did them for us.” And I really did. Within two months, the bank relationship brought in an additional 5%. More of that is going to occur because they’re selecting high-net-worth people through one-on-one meetings. That’s where the synergy is.

Mr. Behn: There is an economy of scale that’s achieved, and that can’t be ignored. I probably overpaid for the second practice I bought, and given all of the benefits of the first practice, I probably underpaid. But the reality is, it didn’t matter, because of the economy of scale that I achieved. My overhead went up by 2 or 3 percentage points, and the revenue went up by three times. So it’s clear there is a profit margin built in, and from that profit margin, you pay the prior owner.

You’re taking client revenue that is coming from the day-to-day operations and paying it out to someone else. But the money never leaves my pocket as the buyer. It comes in and goes out. It’s a very clean transition if you’re careful about how you run the business and there is sufficient profit on the books already to support your overhead. There is enough of a margin in this business. It’s not like a hardware business where a wing nut has a 2% return. In this business, you can build returns and profit margins that are sufficient to support that activity.

In terms of the buyer’s motivation, you’re buying to build something that you’ll live off of long-term rather than waiting to build it one client at a time. I’m very much of an accelerator. I need a catalyst to bring me from where I am to where I want to be much sooner than everyone else. Lots of people can do it if they’re careful about how they do it. There are lots of horror stories.

Getting back to valuation, when you look at a multiple of gross revenue, it’s crazy because my gross revenue at two times earnings would be nowhere near that operating profit component if I multiplied it out, because my business operates so efficiently.

Mr. Paikert: What happens when you have two different ways of valuing it and neither one is necessarily right or wrong?

Ms. MacPhee: I’m definitely more on the amateur end. I read as much as I could beforehand. For me, the rule of thumb worked favorably as a seller. In that climate of late 2005, I sold at a 2.2 [times] gross revenue. My transaction was very friendly, back of the envelope. When we talked about structuring the deal, I was comfortable with one-third lump sum, one-third promissory note, one-third earnings. What I would tell a seller now, as a consultant, is that you need to anticipate how much involvement you want post-sale to protect that retention of clients. It’s now my third of three years, and I’m happy at how it worked out. One sticky issue is how to talk about this when you’re first thinking about doing it, because people are very paranoid. They don’t want to get the word out that they’re thinking of it, they don’t know what a good number is, and they don’t want to appear stupid.

Mr. Behn: It is very similar to the real estate market. If the broker is setting the multiple or setting the price on the house rather than the market determining what the value really is, you have got a problem.

When you look at a practice, there really is a very limited market for it. We have 50 inquiries on a sale because there are people like me who say, “I want an opportunity.” Whether they are qualified to take on that opportunity is a different story.

Ms. MacPhee: One of the things I would say to a potential seller is, “How do you feel describing the buyer to your clients? Do you feel good? Are you saying, ‘I feel great. You are going to be as happy with them as you were with me.’” If you can say that with full confidence, then you have a good buyer.

Mr. Paikert: How was the negotiation process?

Ms. MacPhee: Fine. I basically said, “This is not negotiable, and this is not negotiable.” I think the 52 inquiries helped.

Mr. Tibergien: I wasn’t directly involved in either one, but they both had strategic buyers who were willing to pay a premium for the synergy they could see. Both buyers received a benefit over and above the practices. But most deals are not that smooth. When you have a motivated buyer and a motivated seller, they will work toward the end. But far more deals don’t get done, and it’s rarely for financial reasons; it is usually for emotional reasons.

SUSPICIOUS PARTIES

If it’s a first-time buyer and first-time seller, there is an immediate suspicion that one is trying to pick the pocket of the other. And they’re anxious because the buyer is saying, “This is a lot of capital,” and the seller is saying, “If you don’t put the price high enough, you’re making a judgment about my worth.” So they take it very personally.

In my book [“How to Value, Buy and Sell a Financial Advisory Practice,” 2006, Moss Adams LLP], I wrote about the concept of buyers’ and sellers’ coming up with a set of assumptions that lead you to a conclusion about value. Value is not an exact science; it’s more art than fact. You have to agree on a set of assumptions, including the quality of the client base, the process that you’re going to adhere to and the probability of transferring. If you have a common set of assumptions, then the only thing left is whether you are philosophically in tune.

Ms. MacPhee: In my case, there were hardly any negotiations, because I very much liked the people who bought my firm and there was loyalty coming from me. I said, “These are my clients for 16 years. I don’t want to see this fall apart.” Everyone is going to win when you go in with that kind of energy.

Mr. Behn: Besides the motivation of the buyer, there is the motivation of the seller. Matching the two of those up is important to what you want ultimately. As a seller, whether you are selling internally or externally, the concept is the same. If you’re motivated to stay involved long-term rather than short-term, it is a home run from an evaluation standpoint. In my own personal situation, over the next 20 years, I would be much better off working in a limited capacity one or two days a week, or whatever it requires to maintain those relationships and extract continuous value.

Mr. Paikert: How much time does this process consume?

Ms. MacPhee: I had a compressed time period. It was mid-September that I listed and mid- November that I picked a buyer. That is very quick. It speaks to the demand. Almost 80% of the work week was devoted to not only screening out the buyers but also preparing client appointments. I did as many as I could within six weeks in person. There were maybe 15% done by phone. You need to have reserves emotionally. There are buyers that so badly want you to sell to them, and that’s taxing.

Mr. Hayden: Our deal could have been done in 30 days, but the attorneys got involved. That, along with coaching clients along the way, took about a year. And it was mainly because all the documents were being drawn up and my attorneys had to go through it, then I went through it, and then the banks went through it and then the attorneys for them. That kind of thing drove me nuts. But because I had help from my team in putting together certain numbers and all that, I spent probably a half a day a week for a year.

Mr. Paikert: Is there any kind of rule of thumb for this?

Mr. Tibergien: It’s not uncommon from the moment you begin the search to when you consummate the transaction for it to take up to 18 months and then another year for the transition. But I have seen it done in two or three months. When the stars are aligned, it can be done very quickly. Up until now, it’s been very much a seller’s market. The adjustments in the equity markets and elsewhere are causing some freeze-up, but it’s been a seller’s market with well-capitalized buyers and that created a great dynamic for transitions.

Mr. Paikert: Will the current equity markets and even credit markets affect buying and selling?

Mr. Tibergien: Imagine you pay 2.1 times gross for a practice generating $1 million in revenue and its current runway is $900,000. You still have to pay your overhead, pay your staff and pay yourself. How are you going to feel about that? The presumption that the past will repeat itself is something we have to think about. It will have a depressing impact on value because the growth potential and cash flow is going to be a factor.

Many advisers who are worn out, tired or bored have been holding onto their practice because it’s been growing 20% a year. I think we are going to enter into a phase where all those bored, burned-out advisers say, “Maybe this is the time to liquidate.” But the buyers are going to say, “What are you really selling me?”

When you assume practices are equal, when you apply that rule of thumb, you’re making a huge mistake because the cost of doing that can be great. That’s where there is going to be more scrutiny around the purchase price.

The final point is the terms that make a difference. When you look at the tax structure, the time value of money, the way in which it’s financed, the real question is: What do sellers walk away from? And I would be willing to bet that most who thought they sold their practices for 2.1 times probably ended up with a net of 1.5 times.

Mr. Behn: Speaking to the credit markets specifically, as a buyer, they are a very limited source of capital. You’re not going for [a Small Business Administration] loan. Very rarely is that an opportunity. You’re drawing on personal reserves and revenue from the practice to pay for it.

So in terms of the current situation, I don’t think it’s going to have a great impact. The demand is going to continue. Whether the people who make the inquiries can do it financially or not depends on their own personal situation. Do they have the capital?

Institutional players like Focus Financial and broker-dealers that are smart are going to do well because the individual practitioner is going to be able to get the capital. With home equity lines drying up, where do practitioners that are interested in getting involved get the financing to do so? That’s the thorn in the side of the succession plan. If you want to sell equity within a firm to an existing employee or outside people that are coming in to succeed you, where do they get the capital, and is it the responsibility of the owner to finance it?

Mr. Hayden: We want to acquire firms carefully on an ongoing basis. And we are very fortunate to have the ability to buy practices because the bank went public two years ago and it has cash. That’s not going to be a problem. Properly evaluating and working it out are the issues. So it’s nice not to have that as a big issue.

Ms. MacPhee: That buyer needs to be very in tune with how secure these clients are, as best as they can guess — those clients’ demographics, such as: How old are your clients? Where do they live? Who is relocating? Who is not going to have an adviser two or three years from now?

Mr. Behn: In a market like this, it is a tough time to make a transition, because everybody’s scared to begin with. It would be a difficult time to sell. If you say, “This guy’s going to take better care of you,” you run the risk of hearing, “Well, you’re not taking very good care of me anyway.”

Mr. Hayden: Two years ago, we did an adviser impact survey, and we also just repeated that. To show the results of that to the acquiring bank offered a great deal of leverage.

Mr. Tibergien: I want to make emphatically clear that the 2.1 times multiple should not be relied upon. It’s bogus, it is wrong, and it is not relevant to most practices.

The ultimate test of value is whether the business generates sufficient cash flow, and what is the reasonable rate of return to get access to that? If you’re a large, stable practice with cash that is flowing and you have an institutional approach to the business, the multiple times cash flow would be much higher than if you’re a small solo practitioner. New buyers may choose to overpay, and too bad for them. To rely on this crazy revenue multiple, from a buyer’s perspective, is not only irresponsible, it doesn’t demonstrate good judgment from a financial planning standpoint.

Mr. Behn: That speaks to being a financial planner versus a businessperson. They are two different animals completely. There are different models that work for different reasons. The bottom line is that when you put these things into a spreadsheet, you understand all the components. The advice I would give, from the buyer or seller perspective, is to really look at those terms to make sure ultimately they benefit you now and in the future. There’s got to be a balance between the two.

Mr. Paikert: Do you have any final words of advice?

Mr. Hayden: People ought to do this enough in advance so they’re not under pressure to make a deal.

Ms. MacPhee: Do you feel comfortable about the firm taking over your clients? Do you feel in your heart it was a good thing to do?

Mr. Behn: Grow your business with an exit strategy in mind. That’s a critical component that’s overlooked in this business.

Mr. Tibergien: This is a great business to be in, but if I were a broker-dealer today, I would be more concerned about the buyers than the sellers because they have to think about how they are going to replenish what they have and capitalize on the opportunities in the market.