Selling your business: valuation and deal preparation

Building on a previous Review article about selling all or part of your business, we look at valuation, pre-transaction steps, relationship with potential buyers, and the transaction process 
by Paul Bryant

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In a previous article for The Review about selling financial adviser businesses, we explore what business owners need to know before making a deal, outlining three starting points for those thinking about taking the leap.

The first is to know yourself and your staff in terms of what your goals and objectives are. Second is to know your client, ensuring you put their interests first and that the sale of the business does not impact negatively on them. Third is to know your buyer to ensure that your clients will receive the same high level of service.

With those three starting points covered, it is also vital that you establish the value of the business you're selling, who you want to sell it to, the payment terms, pre-transaction preparation steps, and what to expect from the transaction process. Here we build on the previous article to discuss these points.
Valuation ≠ offer"One must always remember that the purpose of valuation is to establish a fair value between the parties and should arrive at a value which the buyer is willing to pay, and the seller is willing to receive," says Matthew Marais CFP®, founder of Vertus Capital, which loans money to independent financial planners to help them acquire other firms.

The most common valuation method is to apply a multiple to the recurring revenue of the business, according to Rob Stevenson, founder of Kingmakers, which specialises in advising financial advisers and planners on exiting their business. This is especially applicable to deals that are 'retirement sales' – where the client base is migrated to the acquirer and the management team of the selling business, and its cost base (premises, systems etc), will no longer be part of the company in two to three years. As a rough rule of thumb, says Rob, multiples are usually between three and four times annual recurring revenue.
If the company is being bought 'lock, stock and barrel' then a multiple of normalised profit is more common Another common method is to define value as a multiple of profit, as well as revenue, says Matthew. "In many instances, both methods are used in arriving at a value. Valuation calculations can be based on historic or future performance. A valuation based on historic performance assesses the past year's performance, adjusts for exceptional costs and the owner's compensation, and then applies a multiple based on market experience," he explains. Except for smaller acquisitions where the clients will be absorbed fully into the cost base of the acquirer, the main driver of value is cashflow generated once all the direct costs have been paid, Matthew says. "I believe that it is important to focus on profit multiples as a driver of value when buying a business, not merely revenue. We see businesses with the same revenue that generate very different returns."

If, however, the company is being bought 'lock, stock and barrel' – keeping the staff and most of the cost base – then a multiple of normalised profit is more common. Earnings before interest, tax, depreciation and amortisation (EBITDA) is the profit metric usually used in this calculation. Because owners of smaller firms often pay themselves a small salary and draw most of their pay as dividends (usually for tax planning purposes), accounting profit can distort the true financial position. Acquirers will therefore look at an adjusted income statement that has the owner being paid a market-related salary as if they were an employee – the situation that would exist post-transaction.

Roderic Rennison CFP™ Chartered MCSI, director of Rennison Consulting, works with financial planning business owners to help them either secure succession or to sell their businesses. He says EBITDA gives "would-be acquirers a good picture of how the company is doing financially and can also be used to analyse and compare profitability among its peers as it eliminates the effects of accounting and financial decisions".

Profit multiples vary a lot and depend on the specific circumstances of a business, especially its size. For a smaller business, up to around £1m turnover, multiples are typically between two and four times EBITDA, rising to around six for turnover in the £1.5m to £2m range, and as high as eight to ten for larger businesses that can also demonstrate uniquely attractive characteristics, such as scalability – where profits are growing disproportionately compared with revenue.

Do's and don'ts
Some do's and don'ts when considering valuations in a deal, by Matthew Marais CFP®, founder of Vertus Capital.

Take a proactive interest in how the valuation is being constructed.

Strive for a valuation process that is fair for buyer and seller by reducing complexity and uncertainty.

Consider value in the context of the valuation and terms (uncertainty of future performance, handover responsibilities, exit timelines).

Take great care over the accuracy of data.

Fixate on getting the best headline price for the firm. The deal terms matter too!

Be distracted by a high valuation multiple before contingency, as this may be significantly reduced in the future.

Feel bound by the first outputs of a valuation exercise.

Neglect your businesses during the deal process.

Using multiples of assets under management (AUM) as a valuation method is quite rare, according to Rob, and generally only relevant if the business being acquired has discretionary permissions. Even rarer in this sector is using a discounted cashflow (DCF) valuation. Roderic explains that this valuation method is, in his experience, used by a few acquirers of independent financial advisers and financial planning firms, but is more commonly used in connection with the acquisition of asset management firms. "In addition, some acquirers, while preferring one particular method of valuation, will 'triangulate' between the three methods to test the consistency of their valuation and investigate any anomalies," says Roderic.

But, Rob says, a valuation is not the same as an offer: "Valuations are a technical exercise and only give a theoretical answer, which at best is a guideline. What is more important to the seller is the offer, which will set out how much is to be paid when the deal is done, and how subsequent payment tranches are structured. It is common for buyers to insist on the owner sticking around for a few years." These payments are usually linked to performance metrics such as client retention rates.
Prepare early"Most sellers don't start preparing early enough," says Rob. "It takes time to prepare for a transaction, easily 12 months or so to do it properly, and even longer if sellers want to make those changes that could significantly increase the value of their business, such as working on succession."

If you want to exit, you need to form a clear succession plan to get to your end goal, Matthew says. "But first, ask yourself a series of more thoughtful and personal questions:
  • What is the ideal outcome for me and my clients?
  • When am I looking to exit? Form a timeline.
  • Who would I want to sell to? For example, a local adviser firm or a large national
  • What do I want my ongoing involvement to look like?
  • Do I need the help of an intermediary?"
Once you have the answer to these questions, you will be better equipped to build a succession plan. This will likely include an action plan that directs your business towards the exit you have outlined, he explains.

Roderic says another crucial first step a business owner should take is ensuring that the business can demonstrate that it is "well run". By this, he means "up-to-date accounts, regulatory returns, and having a complete board and committee minutes, and an up-to-date centralised investment or retirement proposition".
"Ask yourself: What is the ideal outcome for me and my clients? When am I looking to exit?" Building on the 'know your' themes, Rob says a useful starting exercise is to create a brutally honest profile of your business and its clients. The business owner should look to answer questions such as:
  • What type of clients do I have (for example, age profile, wealth profile, most important needs)?
  • What services do I deliver to them (for example, the most basic of financial advice, full-blown cash flow modelling, discretionary fund management services)?
  • In which areas are my services strong and in which areas are they weak?
  • Who do my clients have their primary relationship with and how would they react to this changing?
Then a business owner can create a profile of the ideal buyer. Would it be best to sell to a firm that delivers the same services, or can add new services? Perhaps there are areas where your services are expensive (such as investment management) so a larger firm with more buying power may benefit clients. But are there firms that can do that without sacrificing service levels?

Don't forget your management team as a potential ideal buyer. Management buyouts (MBOs) are becoming a more common exit route, mostly because access to finance for the managers is becoming easier to obtain, such as from challenger banks, boutique finance houses, and even some of the isector 'platforms', such as Transact users via Vertus Capital. Rob says this last source of funds is especially attractive because individuals usually don't have to put their house up as collateral – because the lending decision is improved with the help of additional, first-hand data about the business's transactions on the platform.

Sometimes, says Rob, MBOs can be a less financially attractive option compared with selling to a third party. Managers have usually contributed in some way to creating value in the business and it might be reasonable to apply a discount to the sale price. Also, the payment terms for an MBO tend to be longer than for a third-party sale (three to five years as opposed to two to three years). However, an MBO will usually provide additional clarity on how clients will be treated and perhaps give selling owners more flexibility with respect to their involvement in the business post-transaction.

Using employee ownership trusts (EOTs – see previous Review article that covers the pros and cons of these) as an exit route is also possible but much less common for smaller firms. Rob says the valuations accepted by HMRC tend to be lower when compared with a third-party transaction, and some of the conditions required to qualify for tax advantages can make them less attractive. For example, an attraction of selling to an EOT is that the seller may be exempt from capital gains tax on the transaction – but to qualify, the EOT must acquire more than 50% of the company in that tax year.

This early process of matching your requirements, and the needs of clients, with a buyer, will narrow the field of potential target buyers and also start to define and separate your 'walk-away points' from 'nice-to-haves'.
Finding the right buyer Some legwork might be needed to find the right buyer. You may want to do this yourself –some of the larger consolidators have positioned themselves so that direct access is very easy (for example, Fairstone). Or, firms could use a specialist adviser or a business broker.

If buyers show interest, get to discussions around your walk-away points as early as possible. For example, you will almost certainly have some red lines around your involvement post-transaction, says Rob. It might be the period of time or your exact role.

One business that has been through this process is Future Asset Management LLP, a family-owned firm with the father and son team of David Wingar CFP™ Chartered MCSI and Graham Wingar CFP™ Chartered MCSI being the primary advisers and financial planners.
If buyers show interest, get to discussions around your walk-away points as early as possible The Wingars were approached by a large consolidator, and with David starting to think about retirement or semi-retirement, they decided to explore the approach in some detail. "We were impressed," says David. "Some of our key walk-away points were addressed early on. There was a strong cultural fit and I was comfortable that our clients would have been well looked after. The acquirer took the time to understand us and what we were trying to do, and was happy with our succession plan of Graham managing the business after my retirement as well as the rest of the core team remaining in place."

David also says that the financial offer was very attractive, although on the downside, payment for the business would have been spread out over four years, which for a sale to a third-party, felt protracted to him.

The offer was evaluated against an MBO, where Graham would buy David's share of the business over a period of time – probably longer than the four-year payment period offered by the external buyer. On the financial side of things, David saw both options as different paths to the same destination: "Selling to the consolidator, I would be paid the capital value of my stake faster, while in the MBO option, this would take longer but I would receive more dividends during this period."

Ultimately, the Wingars went for the MBO option. David explains: "It was a tough decision and if it was just me without other family involvement, I probably would have sold the business to the consolidator as most of my requirements were met. But keeping strategic control within the family proved the swing factor for us so we went with the MBO option. That was the best fit for everyone in our case. Obviously, another business without family involvement would look at the decision differently. These are very personal and even emotive decisions."

Rob offers some additional tips to find the right buyer: "Talk to the people who will be doing the integration and who you will be working with on a day-to-day basis. They won't be the same people as the 'deal team'. I’ve heard horror stories of sellers in their fifties looking forward to finishing their career on a high, but end up being 'performance managed' in a way that was a shock to them, such as having to report to a line manager and deal with KPIs – something which they hadn't had to do for decades."

Another tip he offers is to do character due diligence on the buyer: "Do some research into their past, don't just take buyers at face value. Talk to the owners of companies they have bought, ideally someone who has already received all of their payments, so they can speak openly."
"Talk to the people who will be doing the integration and who you will be working with on a day-to-day basis" Finding a good fit is equally applicable to buyers, so expect them to be inquisitive too. Barry Horner, CEO of Paradigm Norton Financial Planning (which has concluded seven acquisitions), says one of the most crucial things is to make sure culture and values are aligned.
He says: "This isn't a quick process. We typically spend around 12 to 18 months in a 'getting to know you' period. We will meet after work and have detailed discussions about the attitude to clients, how they are serviced, the team in the business and how careers are structured. This provides a really good sense of how well the two firms might work together." Barry continues: "Culture is a key walk-away point for us. If there isn't a cultural fit, there's no deal."

Once his business and the seller are comfortable with their strategic and cultural fit and reached a rough agreement on price and payment terms, it is a fairly quick process to put together a 'heads of terms' – a two- to three-page non-binding agreement outlining the main terms and conditions of the deal.

Matthew agrees that finding a buyer with a cultural fit is one of the key items to consider. "In my experience, the most successful deals are those with a like-minded business that will continue to service your clients to the same standard as you do, if not better. The most rewarding deals to see are those where disruption to clients has been minimal, there is no mass re-platforming, churning of assets and where clients will continue to have a trusted independent adviser to call on. Surprising to some is the fact that these deals can be completed at a comparative commercial valuation to corporate alternatives," he explains.
The transaction Preparation for the next phase of the transaction gets a lot more detailed. Due diligence will follow the signing of a heads of terms agreement, and involves the buyer taking a detailed look 'under the bonnet' to verify that what they think they are buying, is what they are actually buying. It will cover nearly all areas of the business, including:
  • commercial due diligence (for example, verifying the age profile of the client base)
  • financial due diligence (for example, verifying the actual recurring revenue or profit number)
  • compliance due diligence (for example, checking the number and nature of complaints received)
  • legal due diligence (for example, making sure all contracts are in place – such as employment and supplier contracts – and that no unusual legal risks exist, such as pending litigation). 
Rob recommends that sellers do their own 'trial due diligence' in advance: "Pick some client files out. Check that all compliance requirements are done properly. Check your human resources files to make sure they are up to date with current legislation. Go through your financials. Make sure you can explain your balance sheet properly. You'd be amazed at how many people can't."

Barry explains the process from the buyer's side: "All through the deal process and the due diligence we regularly hold senior executive meetings, with the person leading the deal keeping the others abreast of developments. We have a green, amber and red light system. If we complete a stage and all checks out, it gets a green light to move onto the next phase. Amber means we need to dig a bit deeper to clarify something before we move on, and a red light means we have found something that is probably a deal-breaker."
Deals that go wrong can negatively affect your value and negotiating position in future, for a number of reasons Once due diligence is complete, the final transaction documents, known as the 'sale and purchase agreement' will need to be agreed. According to Matthew, the total cost to the seller for all advisers can be as high as 8% of the transaction value including specialist deal and corporate finance advisers, lawyers and accountants. This typically excludes costs for intermediaries and financing.

And what if things go wrong after the deal is concluded? There is no easy answer. It may be a case of dealing with it until the earn-out period is completed and the business can be exited. Or if the situation warrants it, that is the time to get lawyers involved.

It is important to get your exit right the first time, says Rob. Deals that go wrong can negatively affect your value and negotiating position in future, for a number of reasons. "First, you will probably have focused on the deal at the expense of your business and clients for a long period of time, which will start to erode value. Second, if a deal falls through, you may well be asked to provide information to future buyers as a matter of company record. This can weaken your negotiating position. Also, you may be fatigued or disillusioned by the prospect of a sale, which will affect your ability to execute the best deal possible."

Roderic gives some final advice on the issue. "Business owners want to avoid mistakes at all costs as once a sale is completed there is no going back, and for most owners, it will be the largest financial transaction that they will undertake," he says. It is therefore important that business owners who are contemplating the sale of their business do these things. "Make sure you prepare appropriately by being clear why they want to sell, and ensure their business is in the best possible state to do so. Then you should undertake detailed 'reverse' due diligence on the preferred acquirer to ensure that they meet the owner's criteria. You could also appoint advisers who can assist in making the appropriate decisions."

Start the process early and do as much homework and preparation as you can beforehand, Rob concludes.

Seen a blog, news story or discussion online that you think might interest CISI members? Email
Published: 15 Apr 2020
  • Wealth Management
  • Training, Competence and Culture
  • Financial Planning
  • MBO
  • financial planning
  • discounted cashflow
  • DCF
  • CFP
  • AUM
  • adviser
  • acquisitions

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