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Due Diligence When Buying A Book of Business

5 KEY AREAS TO FOCUS ON

 

 

Here are 5 key business areas that every advisor must review as part of their acquisition due diligence process. 

 

It is not an overstatement to say that due diligence, or the lack thereof, can ultimately define the success or failure of any business acquisition. Simply stated, due diligence is the process of investigating certain key aspects of a target firm’s business, including its finances, client base, operations, regulatory risk profile, technology and culture. Its primary purpose is to help the acquiring advisor answer 3 fundamental questions:


1. Should I buy?
2. If so, how much should I pay?
3. How should I structure the payment price?


One of the most frequently asked questions we hear from advisors is, “What areas of a target firm should I review and what questions should I ask?” Since most advisors are looking to acquire firms that are well managed, compliant and positioned for growth, here are 5 key business areas that every advisor must review as part of their acquisition due diligence process.

 

1. Strategic (or Cultural) Fit with Seller


One of the most overlooked aspects of any acquisition is the degree to which the acquiring advisor aligns with the seller’s values, business and investment philosophy, and commitment to client service. Generally speaking, the closer the fit, the greater the likelihood of a seamless transition of the business. Imagine the likelihood of success where two advisors have diametrically opposite views on issues such as the value of financial planning, investment philosophy, fee transparency, client service standards, etc. How easy do you think it will be for the buyer to retain clients used to and comfortable dealing with an advisor who has fundamentally different way of looking at these issues? We typically recommend to clients who are buyers that they first satisfy themselves as to the strategic fit and “chemistry” with the seller prior to moving forward in the transaction process.

 

2. The Target Firm’s Client Base


Buyers should then undertake a detailed review of the target firm’s client base to ensure alignment with their own “ideal client profile,” to understand potential growth opportunities, and to identify potential underlying risks to the business. Specific areas of inquiry should include:

  • The number of clients that have assets greater than $500K, between $250K and $500K, between $100 and $250K and less than $100K
  • The average asset value per client
  • Demographic split by age and gender
  • The percentage of assets in registered vs. non-registered accounts
  • Whether there are any product gaps that present growth opportunities
  • The number of clients that have a financial plan
  • The number of high-risk clients as well as high-risk product offerings

The target firm’s client base is the lifeblood of its business. Take the time to deeply understand its composition and the quality of the relationships with the seller.

 

3. The Target Firm’s Regulatory Risk Profile


Buyers should take a hard look at the target firm’s regulatory risk profile by asking, “Does the firm’s workflows, processes and procedures align with regulatory rules and expectations?” We recommend to clients that they select a random sample of the seller’s files and assess the following as part of their regulatory review:

  • The suitability of each client’s investment holdings
  • Any improper use of embedded commissions (i.e. instances of churning or use of DSC with elderly clients)
  • Instances of KYC uniformity across accounts
  • Sufficiency of notes in the file and instances of signed blank or altered forms
  • Any client complaints or regulatory sanctions
  • Whether the advisor has dealt appropriately with elderly clients
  • Instances of high-risk product offerings

Clearly, the greater the regulatory risk, the less valuable the target firm will be to a buyer. Reviewing the seller’s files from this perspective also gives the buyer a good sense of the seller’s approach and commitment to client care and service.

 

4. Operational Effectiveness


Buyers should examine the target firm’s operational effectiveness and efficiencies with respect to processing trades, client service, financial management and human resources. Consider the following:

  • Does the firm rely on one or more key individuals to get things done or is there a set of systems and clearly defined processes and procedures in place that are effective, reliable and scalable?
  • Has the firm invested in technology such as a CRM system that will make it easier for the buyer to seamlessly connect with and service clients?
  • Do team members have clearly defined roles, responsibilities and competitive compensation structure in place and a desire to continue to work with the buyer?

Firms that operate based on a system of best practices and procedures are much more valuable than those that do not.

 

5. Financial Health of the Firm


Buyers need to determine that a target firm is financially well managed and able to deliver stable, predictable cash flow. The higher the percentage of revenue that will continue after a deal closes, the better. Key areas to review include:

  • Revenue analysis over preceding 3 year period
  • Expense ratios including expenditures on team members, benefits, technology, rent, etc.
  • Annual budgets and monthly P&L statements
  • Whether there are any outstanding debts, taxes or other obligations owed by the seller’s corporation

How a firm manages its finances and profit margins will directly affect its perceived value to a buyer.

 

Our advice to clients is simply this: do not underestimate the value of due diligence. Most advisors fail to pay enough attention to this part of the acquisition process, which is unfortunate because it is only through rigorous due diligence that an advisor can truly understand the practice they are about to acquire and its true value. If you would like to speak to a coach about business acquisition, please connect at confidence@thepersonalcoach.ca.

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