By Jim Palumbo, Principal and Chief Development Officer
This is the second of a two-part series on how to grow your practice strategically.
In my previous post, “Grow Your Practice, Build Your Business,” our focus on strategic growth centered on adding professional and paraprofessional staff and services to your practice to create additional clients and revenue sources.
For example, rather than adding administrative staff to your team, you can outsource the administrative and portfolio management, and then add professional and paraprofessional team members such as CPAs, accountants, paraplanners or advisors. These team members can attract additional clients and assets as well as create additional revenue centers within your existing practice and client base.
In this discussion, we’ll focus on strategic growth ideas that fall under the umbrella of Mergers & Acquisitions. Indeed, each advisor-to-advisor relationship is unique, so we’ll look at the variations and overlaps in different types of relationships. Particularly, in four core M&A scenarios:
1. Take on a partner (often share, unit or interest acquisition)
2. Merge Your Practice (often asset purchase by the surviving entity)
3. Acquire a practice (often asset purchase by the surviving entity)
4. Succeed to a practice (often share, unit or interest acquisition over time)
Share Sales vs. Asset Sales
Before exploring the four scenarios, we’ll address briefly the difference between asset sale and share sale. In most M&A arrangements, one entity survives and becomes the controlling entity of the combined or acquired practice. If you are the acquirer, you can purchase either the shares, units or partnership interest of the seller’s practice. Or, you can purchase the assets of the practice which are most often the contracts or investment advisory agreements between the seller and their clients (along with the goodwill embedded in those agreements).
We won’t consider the tax consequences of each type of sale here, but rather look at the most common legal perspective, which is that the acquirer almost always purchases the assets of the seller. Buyers typically don’t want to take on the liability of the seller’s entity. There are rare cases when the seller has favorable but unassignable contracts that the buyer wants to acquire, and they will execute a share purchase.
However, acquisitions and mergers are commonly asset purchases, while taking on a partner and succession arrangements often involve share purchases.
It’s important to remember that while categorizing the four M&A styles and delineating share vs asset sales, there is a fair amount of overlap. You will find that each real-life scenario is different and may possess characteristics of different categories. You can read more about share vs. asset purchases in my blog post, Nobody Wants Your RIA.
Take on a Partner
One way to gain scale is to take on a partner. You may find an advisor with whom you are compatible, share values and find efficiencies together. By bringing a partner into your firm, you may increase intellectual, administrative and advisory capacity. The partner’s client relationships and assets may help you share overhead and increase net margins. You may ultimately take on several partners. Some of the most successful advisory practices in the country are partnerships or multi-member limited liability companies.
Partnerships do not need to be equal. If you are worried about control issues, bringing in a minority partner may provide all the benefits while allowing you the majority vote on the big issues. If your business is an LLC, you will want to style it as a “manager managed” LLC rather than “member managed.”
In manager managed, the designated manager manages the company rather than a plurality of leadership equally among the members. In this case, the incoming partner or member would be a silent or minority partner with full equity and revenue rights, according to the partnership or operating agreements while ceding control to the majority partner or member.
Typically, the incoming partner will acquire shares, units or partnership interest in your entity and may sell, assign or contribute their client contracts to the surviving entity.
Merge Your Practice
Like taking on a partner, you may find a firm with whom you are compatible, share values and find efficiencies together. By merging the two firms, you may have the opportunity to increase intellectual, administrative and advisory capacity. The additional client relationships and assets may help you share overhead and increase net margins.
Acquire a Practice
I divide straight acquisitions into two types:
- Sell and Stay
- Sell and Go
Sell and Stay sellers are common in this marketplace. They’re often baby boomers who have built a practice over many years, are invested in it emotionally but recognize that they need a succession plan, an exit strategy. They’re often looking for a succeeding advisor who will treat their clients well and provide a payout scenario that will supplement their retirement income.
Some Sell and Stay sellers are simply tired of the administrative burden and want to cash out of the business but still manage some households. They are like the seller of a salon that wants to stay on and cut hair.
Sell and Go sellers are already aged out of their practice, or they’re pursuing another course in life. They desire more money up front and won’t stay past the transition period. Unlike the Sell and Stay sellers, they don’t want to continue advising clients in the practice they’ve sold.
According to Kris Kjolberg, partner at NAVCAPITAL Group, practice sales are ranging from less than 1X to 4.56X, averaging about 2.68X gross revenue. It’s important to spend time assessing your business model and overhead to determine the feasibility of an acquisition being accretive to your bottom line.
Simply put, if you can pay off the acquisition in a few years, it can generate income for decades if managed well. It can be a profitable investment with Return on Investment (ROI) much higher than other investments. Case in point, your ROI on a piece of rental real estate today may be 6 to 8 percent per year. A well-run RIA should generate three for four times that in ROI.
Succeed to a Practice
A succession is often much like the Sell and Go scenario. An aging advisor seeks a successor to their practice. Or the advisor is deceased, and the seller is a surviving spouse. The remainder of the scenario circumstances can be applied.
As mentioned in the previous article, there are two ways to grow a wealth advisory practice: organically and strategically. The former typically results in low double digits. A recent benchmarking study from Schwab cited 18 percent as the average growth rate for their most successful firms.
Bottom line, if you want to grow faster than your natural organic growth rate, you’ll want to consider a long-term strategic growth plan. One that can improve the resources you bring to your clients—and the growth rate of your practice.
(Photo: Michal Parzuchowski, Unsplash)