Thirteen years ago, David Urovsky, now president of Rockville, Md.-based Wealth Advisors Group, owned one financial planning practice. He liked his work, with a few exceptions. "I did not enjoy the marketing and sales side of the business, but I thought I was very good at the service, relationship and investment parts," he says. "The sales and marketing part always ended up at the bottom of my to-do list, and I realized that my business wouldn't survive like that."

So Urovsky found another way to get new clients. He bought another Maryland-based planning practice, then another and another. Now he owns five practices, and his appetite for new clients is largely sated. "I feel I have reached my capacity to properly serve all of these clients," he says.

As with Urovsky, many financial planners consider buying another practice as a way of expanding their client bases, adding services that complement those of an existing practice or graduating from employee to owner. If buying another firm is part of your business plan, Urovsky's experience can help you ask the questions and check the records that can shed light on whether a potential purchase will likely turn out to be an asset or a liability.

Avoiding Liability

Like many industries, financial planning is laced with festering liabilities that can blindside a buyer long after a sale closes. Financial services firms and their professional staff must register with the SEC and/or FINRA, both of which monitor companies and individuals to assure that their practices are in keeping with industry rules. Both organizations post disciplinary records online (www.adviserinfo.sec.gov; www.finra.org), so prudent buyers should examine these records before proceeding.

Prospective buyers should also talk with the seller about a firm's regulatory history. When regulators find a problem, they typically send deficiency letters, asking a company to address an issue. Ask sellers for copies of any deficiency letters and the firm's responses to them. It's normal for a firm to have a few such letters, but make sure that they've completely addressed any problems and taken measures to ensure they don't recur. A good firm has compliance procedures, as well as an executive in charge of preventing violations and responding appropriately to any that crop up.

Though a few deficiency letters are normal, even one enforcement action is cause for serious concern. "That's bad," says Matt Thompson, partner and head of the investment management practice at Minneapolis-based law firm Faegre & Benson. "Usually regulators won't bring an enforcement action unless they really need to." An enforcement action suggests that a firm has been cavalier about fixing problems, and should prompt you to dig deeper and more skeptically into all of its records.

Being Watched?

Also, buyers should take note of how frequently the target firm hears from regulators. Regulators examine most firms every three to five years. "A problem firm might be examined more frequently, which could be a sign that they're being watched or are considered high risk," says Alan Thometz, director of transaction advisory services for chicago-based accounting firm Grant Thornton.

Disciplinary trouble might prompt you to walk away from a deal. "There was an instance in which we were representing a large insurance company in connection with the possible acquisition of a large investment advisory firm, and they backed away over some concerns about unresolved regulatory history," Thompson says.

In other cases, disciplinary items might be few and minor enough to merely warrant extra caution. "I don't think that one specific case is necessarily a fatal flaw, but if you see a pattern of similar complaints over a career, that certainly is a concern," Thometz says. "And you want to know even about just one, so you can build in monitoring or compliance around that risk—or use it as a negotiating issue." You might pay less for a company in which key employees have had disciplinary issues, for example, and you would certainly want a plan for making sure those issues don't recur under your ownership.

Ask to talk with the potential firm's lawyers about past, pending or threatened litigation. They should report the existence of such actions and give you a professional opinion on any current or pending legal action's chance of success and the potential penalty to the firm.

On the client side, it's essential for buyers to read client files, making sure the firm has recommended investments that are appropriate to clients' circumstances and risk tolerance. "That can be a time bomb—all you need is a turn of the market, and you're buying a bunch of disgruntled clients. Even though the damage didn't really occur on his or her watch, the buyer's reputation can be damaged," Thompson says.