Better M&A Liquidity Means More Buyers, and Higher Deal Multiples, for Practice Sellers

Over the past few years, independent advisors looking to buy practices have started receiving better financing options from lenders.

This has led to increased liquidity for them, and attracted more potential buyers to the market. Due to the laws of supply and demand, this influx of would-be purchasers competing for roughly the same number of sellers is leading to higher deal multiples for advisors ready to exit their businesses.

Let’s take a look at how this works from a valuation and lending perspective, and what that means for advisors pursuing M&A or succession planning deals.

Seller Notes

Prior to modern financing innovations, buyers often would rely on a seller’s note to purchase a practice, where the exiting advisor supplies a loan with a four- to five-year term and high monthly payments on a fixed rate, typically putting the buyer under financial stress during that time period.

Although common, this arrangement has always been less than ideal for either party. Sellers have tended to think, “I do all the work and take all the risk,” while buyers have tended to think, “I’m giving the exiting advisor too much influence over my business.”

Seller’s notes usually produce a relatively small down payment for the seller based on the buyer’s cash on hand. Due to the deal terms, this has resulted in eligibility falling only to those buyers whose own practices already generate significant free cash flow to meet the debt obligation. In other words, despite numerous advisors who wanted to purchase a practice, only a few actually could do so.

Bank Financing

Positive disruption in recent years has changed the game. Institutional financing from banks came first in the form of SBA loans and more recently conventional loans. Banks have long been hesitant to enter the fray of lending to the independent wealth management space, largely due to lack of familiarity with advisor business models and concerns that the average advisor’s lack of collateral would prove too risky.

The advent of Small Business Administration loans to advisors was a clear improvement over seller’s notes in that banks could serve as an objective source of financing removed from the often emotional buyer-seller dynamic. However SBA loans come with floating rates, put liens on the buyer’s personal residence and are generally arduous to conduct.

Conventional loans have fixed rates, no residential liens and can process paperwork much faster than SBAs. These are the ideal financing structures for advisors who can obtain them. On the other hand, some would-be purchasers cannot qualify for them due to the condition of their personal finances.

Deal Multiples

Fortunately, bank financing allows advisors to leverage their current books to give them a leg up during a potential purchase. The ability to receive such financing is not based solely on an advisor’s existing book, but the combination of his or her current book and the target acquisition, which together presents a much larger bargaining chip with sellers.

For example, take an advisor whose existing book has no debt against it and is valued at approximately $3 million. If the advisor seeks to purchase another book initially valued at $2 million, with the combined funding ability of both practices she could offer the seller $3 million for the targeted book of business. Combining the value of both practices at $5 million would support $3 million in financing.

Through financing and market competition, even if a seller’s practice is initially valued at $2 million, the seller could receive $3 million for their business. After all, the value of an asset is essentially what someone is willing to pay for it. Now, why would someone pay more than the initial valuation of the practice? A few reasons.

First, competitive advantage is worthwhile in any negotiation. In the Investment Advisor industry, there are approximately 50 buyers to each seller, so buyers must make their offer stand out. Second, the buyer in this scenario has the business capacity to take on all of the acquired clients without taking on an equal increase in costs. Therefore, most of the revenue generated by the acquired business would become profits.

Seller Appetite

All of this should be comforting news to not only exiting advisors ready to sell their practices, but to advisors who have wanted to exit the business for a while but doubted they could find a buyer capable of paying top dollar. Times are changing, and sellers who take the step

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