Financial advisor acquisitions are multiplying. Their pace is likely to accelerate as graying advisors retire. This prompted us to commission research on what separates the most successful acquisitions from the rest.

Advisors who seek and implement acquisitions without understanding the challenges may rush into too-expensive deals that fail to retain clients or boost the bottom line. Advisors who manage the process best achieve what we call "alpha acquisitions" that make them "very satisfied." They also have higher client retention rates. Only 25% of advisors achieve this success, according to our research.

The challenges of acquisitions are discussed in detail in “Alpha Acquisition: Maximizing the Return on Your Practice Investment,” a research paper based on a survey of 100 advisors who have made an acquisition. The research was conducted by the Aite Group, an independent research firm, and commissioned by NFP Advisor Services. The respondents included advisors of various types, including wirehouse advisors, advisors with insurance-affiliated or independent broker-dealers, and independent RIAs.

Here are a few of the takeaways we found.

1. TAKE TIME TO FIND THE RIGHT MATCH

It's not easy to find a great practice to buy -- because many advisor-owners want to keep the annuity-like flow of income from their businesses.

I've heard advisors say, "I want to die at my desk." This attitude means there's a mismatch between the large number of advisors seeking a practice to buy versus the small number of sellers. This is true even despite our earlier research showing that 40% of advisors plan to turn their practices over the successors within the next decade.

My gut tells me that the advisors who achieved the most successful acquisitions worked the hardest to find their targets. In a reflection of this, almost 30% said it was "very difficult" or "difficult" to find a suitable practice. And they found it harder than advisors who were less satisfied with the deals they wound up making.

The most popular source for non-alpha acquisitions -- those that the new owner considered unsatisfying -- was when a "former owner of acquired practice actively reached out to you." This suggests that these advisors took a passive approach to identifying acquisition targets.

Unfortunately, putting the initiative in the hands of the seller is not ideal. The best firms may not become available through this method.

Only 16% of the most successful acquisitions originated in this way, although 52% did involve "personal contact with the former owner of the acquired practice."

I’ve seen examples of deals where the buyers actively reached out to owners whom they’ve come to know personally. When you take control, you can buy the best practices, instead of the practices that just happen to be available.

This process may take time; 32% of the alpha acquisition makers looked for an acquisition target for three years or more. (This contrasts with 13% and 20% of advisors who made less satisfying and unsatisfying acquisitions, respectively.)

2. BE REALISTIC ABOUT VALUATIONS

The old saying, "You get what you pay for," seems to apply to practice acquisitions. The makers of alpha acquisitions paid higher multiples of revenues, on average, than their less satisfied peers.

Alpha acquisitions commanded an average revenue multiple of 1.55 versus 1.34 and 1.27 for near-alpha and non-alpha acquisitions respectively -- and 36% of alpha acquisitions commanded multiples of two times revenue or more.

I think that these higher-multiple transactions were more successful partly because all participants had an incentive to do the right thing. It was a win-win situation for both sides.

The buyers in more successful acquisitions may have felt confident in paying higher multiples because of their holistic approach to practice valuation. All alpha acquisitions used one or more of the following five key valuation criteria:

  • Assets under management
  • Client service model
  • Revenue mix
  • Business longevity
  • Cash flow from operations

In addition, alpha acquisitions emphasized these five criteria more than their less-successful peers.

3. MANAGE THE TRANSITION

Simply finding the right practice at the right price isn't enough. You must also manage the transition successfully. Effective people management and communications are key.

The most successful acquisitions moved the previous owner out of the practice in one year or less. This applied to 52% of alpha acquisitions.

Some continuity is important. But after that first year, adequate continuity can be provided by retaining staff members who worked under the previous owner. In fact, 57% of alpha acquisitions retained all staff members versus only 19% of non-alpha acquisitions.

If the former owner stays around longer than one year, however, it creates ambiguity about "Who's in charge?"

More active client communications also distinguished the most successful acquisitions. In announcing their acquisitions, these advisors were more likely than their less successful peers to conduct one or more meetings with the clients of the acquired practices. On the flip side, the makers of non-alpha acquisitions relied more heavily on informing clients by letter (63%) or email (13%).

These statistics reinforce how important it is for advisors to have a plan for managing the transition. It's like having a prenuptial agreement for your marriage. Things will proceed more smoothly if you negotiate prior to entering into the relationship. It's tough to negotiate once you're in the midst of the transition.

Client retention correlated highly with the new owner's satisfaction with the deal.

The makers of alpha acquisitions achieved significantly higher rates of client retention than their peers, with 68% holding on to 75% or more of the acquired practice's book of business. This compares favorably with 44% and 13% for near-alpha and non-alpha acquisitions respectively.

The most satisfied buyers also acquired practices that grew faster after the acquisition: 40% grew their client assets by 10% or more, while only 9% of near-alpha and 3% of non-alpha acquisitions achieved that.

There was a similar contrast on post-acquisition revenue growth of 10% percent of more, which was achieved by 36% of alpha acquisitions vs. only 7% of both near-alpha and non-alpha acquisitions.

A carefully planned approach yields the most successful acquisitions: The buyers make alpha acquisitions; the sellers enjoy higher multiples; and clients experience smoother transitions, as reflected in the higher retention rate of alpha acquisitions.

James Poer is president of NFP Advisor Services.

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