How Deals Get Done
Created: Tuesday, 21 September 2010 16:11
Written by David Grau Sr., JD
Today, advisors have measureable equity, an industry specific valuation system, and a mountain of comparable sales and transactional data to rely on. Transactions between independent investment professionals result from a wide variety of plans and circumstances, ranging from a long planned internal succession to a sudden unplanned sale due to the failing health of a principal. While every transaction is different, all transactions share certain common features and address similar issues.
The independent financial services practice model is often characterized by one key advisor who anchors the client relationships. The terms of the sale and acquisition often represent a balancing of the risks in transferring this personality- and service-based intangible asset model. Post-closing motivation of both buyer and seller is an essential part of the payment arrangements and financing options and is built into the deal structure.
There are two primary lending sources in this industry. The first, and most prevalent source, are the exiting or affected owners themselves, or, for larger firms, the business enterprise. This is often referred to as seller financing. The second lending source is a non-conventional, SBA backed bank loan, not yet a strong or reliable option for most advisors. (Broker-dealer or custodian based financing is often provided on an ad hoc basis and is usually limited to acquisition of practices outside of the lending broker-dealers’ network when it is available.)
The most common funding mechanism in financial practice transactions is to rely in whole or in part on the seller to provide the financing. Seller financing, in turn, means that practice sales and acquisitions require a high degree of cooperation and flexibility between the parties, all in all, a good thing.
Seller or company financing means that sellers look to their successors for more than just the highest purchase price or the largest down payment. In a seller financed transaction, buyers rely heavily on their own cash reserves or lines of credit for the down payment and seller financing to pay for the balance of the purchase price. In other words, it takes buyer and seller, in a cooperative effort, to make a deal financially viable. This co-dependence often results in sellers choosing very highly qualified buyers who are excellent matches in terms of practice style, business model, investment philosophy, and personality, which, in turn, usually results in very high client retention rates.
There are three common components used to pay for a privately held, independent financial services practice:
- Cash (including down payments and earnest-money deposits)
- Promissory Notes (basic notes and performance-based notes)
- Earn-Out Arrangements
Although no two deals are exactly alike, these basic components tend to be used in most transactions. Practices that sell on an internal basis, such as between partners or between employer and employee(s), are more often characterized by a small down payment and extended financing using a fixed or non-adjustable promissory note, while transactions to an outside third party are characterized by a higher down payment component, shorter terms, and possibly less allocation (if any) to an earn-out component. Examples of recent seller financed transactions illustrate this point:
Third-Party Acquisition: Purchase Price: $ 900,000
Buyer Down Payment: $ 400,000
Seller Carry (Note): $ 350,000
Seller Carry (Earn-Out): $ 350,000
Loan Term: 5 years
Employee Buy-Out: Purchase Price: $ 650,000
Buyer Down Payment: $ 50,000
Seller Carry (Note): $ 600,000
Loan Term: 10 years
Third-party acquisitions involve two separate businesses, with two separate cash flow streams, whereas an internal transition has only one cash flow stream – as a result, the payment terms tend to be much longer.
These payment methods, present in one form or another in almost every deal, are used regardless of practice size; we see them in acquisitions valued at $250,000 and at $25 million. Knowing how to finance a transaction impacts the implementation of almost every equity transfer, whether for just 5% of the business at a time or a complete sale or acquisition of 100% of the assets or stock. In other words, financing options determine how a practice owner is going to actually realize his or her value, and put it in the bank.
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