When it’s time to move on

Suddenly everyone who is not selling is buying and understanding what is on offer is not always easy. There are really only two different types of transaction, let us call them a ‘company sale’ and a ‘business sale’. Understanding the difference (and which one you are trying to undertake) really helps everything else fall into place, so let us try and bust some myths and send you off in the right direction.

Company sale

A company sale is a transaction where the legal entity (body corporate) is acquired by the purchaser. That means all assets and liabilities are acquired and this could be a limited company or limited liability partnership. In a perfect world, every vendor would achieve this deal structure, as your post-transaction liabilities can be managed and the tax treatment frequently means a 10 per cent rate of tax on the consideration (subject to meeting all criteria for entrepreneurs’ relief). Valuations are usually based on a multiple of profitability (between six and eight has always been a good starting point), rather than an individual income stream and you should expect the due diligence process to be comprehensive. It is normal for a significant proportion of the consideration (third to a half) to be paid at completion and the balance is often supported by loan notes and/or shares of some description.

The typical cost of this deal (advisers, lawyers, accountants and so on) and the risk it represents to the purchaser (by taking on liability for all historic advice), mean it is generally only offered to businesses that can demonstrate sustained investment and a good return. It is hard to say exactly what that looks like but as an example, strong management, enduring relationships with quality clients, receiving a proposition that focuses on them and not just their money, delivered using a sound operating platform that drives productivity while getting the best out of staff and above all a pattern of consistent profitability – phew. For numbers, think £1m turnover, £200,000 profit and a value of £1.2m as the absolute minimum. These firms are often purchased by businesses in parallel sectors (investment managers, private banks and so on) or by national IFAs and/or consolidators looking for regional hubs to build on with further acquisitions.

Business sale

So, that is nice, but what about the majority of firms in the so-called cottage industry? Well, the alternative is a business sale, which really means the sale of the business as a going concern. The purchaser does not buy the legal entity; they just buy the assets they want and leave the rest (including all the liabilities) with the vendor. One caveat to that is the staff, who are protected by transfer of undertakings (protection of employment) regulations in all but a few situations. Many industry commentators (and doubtless all firms that pay the Financial Services Compensation Scheme levy if they really thought it through or planned to be around long enough to pick up the tab) object to this type of structure, as it can and does put pressure on the FSCS. That aside, it is still the most popular type of deal in our industry. In this type of transaction, the purchaser buys two assets; the tangible commission generating agencies and the intangible goodwill of the clients. Valuations are usually based on a multiple of the trail income (renewals from regular premium contracts do not often attract a multiple these days) and most people reading this article will be familiar with three times trail, half upfront and the balance over a few years (often based on a promise to pay).The amount of due diligence depends on the purchaser but it is usually pretty straightforward and undertaken in a day or two (if the purchaser is well prepared and knows what they are looking for). The legal contracts are more straightforward than those used in a company sale and the timeframe for this type of deal can realistically be three months from start to finish, versus six minimum for a company sale.

So what about all these letters you keep getting in the post offering 10 times this and 15 times that? Well, they still fall into the definition of a business sale but with a very important difference; there is no fixed consideration on offer, just a promise to pay based on what is received by the purchaser over n years. Obviously this type of deal structure places all the risk with the vendor and needs very careful consideration. It is perhaps inevitable that such structures exist, as the implications of the RDR and in particular the rules on legacy trail commission mean that IFAs need to offer a service in return for trail, but delivering said service will often result in adviser charging, bringing into sharp focus exactly what it is that one is delivering for 0.5 per cent a year. In other words, the trail income is no longer as secure as it perhaps once was and to make money post-RDR, many firms are focused on moving assets wholesale to an environment that makes it easier for them to deliver a service to clients. So you should think long and hard about the suitability of the purchaser’s client proposition for your clients, because if they are not successful with your clients, you will not get paid.

Here are a few questions you probably want to ask, before you even see the whites of their eyes:

1. Are you proposing a company or a business sale? Establishing your position with regard to liabilities will help determine how much cash you will actually get in your pocket, net of tax, the cost of professional indemnity insurance run off cover and so on.

2. Who owns the business? Look out for firms with investors who expect a high return on capital, as their motivations will be very different to a typical IFA owner/manager/adviser.

3. Can I see the business plan? Identifying a purchaser’s motivation is very important – get to the bottom of why they want to buy your business, how many others do they want and what do they plan to do with the consolidated business. Look for sensitivity analysis in the financial projections as this can help determine whether you will get your money over the long term (that is, does the business model generate sufficient profit to pay you as well as the new adviser?).

4.What is your client proposition, investment management proposition, ideal client and so on? Get a good feel for possible ‘fit’ with your clients. If it looks expensive, then your clients might think so too.

5. How many transactions have you completed versus aborted and why? A purchaser’s actual experience is important and you should not be afraid to dig for clues as to the success of their proposition. Try and get example heads of terms, sale and purchase agreement etc as early as possible and ask around.

6. What evidence have you got to suggest your business plan will be successful? This is the ultimate killer question and many businesses that look wonderful at first glance, have failed to undertake a thorough review of their own market to determine their chances of success.

Entering into negotiations with the wrong party, can be an exhausting waste of time, energy and money. Take care and do as much due diligence on the purchaser as you can. The good ones will not mind a bit.

Rob Stevenson is director of business consultants Kingmakers