How to avoid issues with client novation

This is the view of Matthew Meadows, corporate finance partner with Kingston Smith, who says this is an exceptionally important element of the buying and selling process, but one which is exceptionally difficult to achieve.

He says: "It will depend on the nature of the relationship with the clients and volume of contacts involved. 

"Typically, communication should only happen when a deal is nearing its final stages and completion is virtually certain to avoid embarrassing and potentially damaging retractions."

Mr Meadows adds: "All communication should be carefully planned and jointly agreed by both sides and would ideally include input from experienced PR professionals."

For Lawrence Cook, director of marketing and business development at Thesis Asset Management, continuity is the core element involved when it comes to novating clients.

Issues around who we are, who holds their money, data security and our right to have access to their data are all common concerns. James Dingwall

He says: “Clients will be concerned about continuity. Any corporate change can impact client confidence so early communication about service and availability is important."

This is why during the novation process, many sellers will remain with the purchasing firm for a couple of years, or at least be employed in a part-time consultancy role to ensure a smooth handover of clients.

Mr Cook adds: "Many successful purchases involve the outgoing advisers doing a client handover for a couple of years. After all, a buyer of an IFA isn’t buying fixed assets, they are buying goodwill and ensuring that doesn’t go out the door is critical.”

John Joe McGinley, founder of Glassagh Consulting, agrees. "Most advisers build their businesses organically, one prospective client at a time, through networking and establishing personal relationships that lead to referrals.

"The clever buyer will retain the seller for a set period to handle the changeover. This ensures trust is built between clients and the new owners."

Change of control clause

One of the ways to ensure proper continuity for the client is to have in place a change of control clause within the agreement.

Linda Whittle, senior associate for law firm Fladgate, says taking over the contracts of a target business is in principle automatic where a company’s shares (as opposed to its business) are acquired.

However, many commercial contracts contain “change of control” clauses, which mean the counterparty or client is required to agree to continue the business arrangement when the company is under new ownership.

She comments: “In some cases the full novation of the contract with the client will be required so a new agreement is made between the trading entity and the client.

“In acquisitions of assets and businesses, each contract will need to be specifically assigned across to the buyer or new trading entity and this also may require permission to be effective.”

Although a buyer can be comforted knowing that liabilities are not automatically assumed on an assets and business sale, they may find difficulty gaining traction with any clients or contractors to whom sums are owed, even if not legally responsible for those per se.

Quality and volume

For James Dingwall, the "quality and volume" of the client data is a big issue when it comes to novation. He explains: "Our due diligence process requests a list of all active clients, active being a client whom the selling firm has recently or is currently providing a service to.

"We can then differentiate who we need to contact to arrange new terms and ongoing fees. The problem with bulk novation of clients is that they all move across, which means buyers have to carry out a large segmentation process to determine what service we can provide."

Financial crime and data security

One of the main considerations when novating clients is whether the firm has the right to process the client's data.

It is also crucial to ensure your staff have a good reason to buy into the integration process. Mark Stokes

According to Mr Dingwall, the buying firm must be certain the client has given consent to the previous adviser and therefore the firm must establish the status of all clients which have been novated across, quickly segment them and obtain an agreement and consent.

He adds: "We need to be sure the client bank does not pose a money laundering or politically excluded persons threat, and therefore we always verify the client using e-verification before we do any new business with them.

"Issues around who we are, who holds their money, data security and our right to have access to their data are all common concerns that should be addressed in the letter informing the client about the acquisition."

Talking to the clients

Keeping the client at the heart of the process is vital, and this involves good communication from both the seller and the buyer.

In fact, there’s a regulatory obligation on making sure the client has a proper agreement put in place to provide ongoing services.

Henry Blunt, managing director of Retiring IFA, outlines the rules: “If a firm carries on designated investment business the firm must enter into a written basic agreement, with the client, setting out the essential rights and obligations of the firm and the client.

“Where a business is acquired by way of an asset purchase, the rights and obligations (client agreement) stay with the selling company.

“The acquiring firm must be able to show that there is an agreement in place between it and its client to provide those ongoing services.”

Ms Whittle adds: “To ‘sell’ such changes to clients, many buyers choose to emphasise a blend of continuity from the existing target business that they now seek to run.

“They will also sell this together with the possibility for an improved customer experience with any new investment they may bring, the key strengths and areas for improvement they have identified in deciding to buy, and the positive impact of synergies between the two businesses.”

Moreover, as Tom Hegarty, managing director of the New Model Business Academy, points out: "Choosing whether to stay with an adviser who takes over the business is entirely the choice of the client, and it is important to remember they are not simply 'sold' like any other asset of the firm."

This involves constant communication - and not just to clients. Mark Stokes, proposition and marketing director for Succession, comments: "It is also crucial to ensure your staff have a good reason to buy into the integration process. 

"That means letting them know what the change means for them as soon as you possibly can. Secure the goodwill of staff by ensuring they are being rewarded for their part in the process and can see a clear career development path ahead of them.

"This is made easier if the acquiring firm has a share scheme and/or bonus scheme available to all staff."

How will the clients pay?

According to Mr Cook, ongoing remuneration also needs careful handling when novating clients.

He adds: “One should remember that clients authorise adviser charging, unlike commission which was in the gift of the provider.

“This means that a provider currently facilitating adviser charging cannot pay ongoing adviser fees to a new entity unless they receive client instructions.

“Having a clear process to capture client instructions is therefore a high priority.”

Mr Dingwall comments: "Under bulk novation rules we can retain any commussion agreed before 31 December 2012. 

"Where adviser fees are payable we need to ensure there is an agreement between our firm and the client in order that we can continue to receive the adviser charge. 

"This can prove difficult if the previous adviser has not made clear which of his clients pay an adviser charge and we begin to receive these fees without the agreement in place."

Moreover, it is worth the seller confirming the clients will not be forced to use more expensive propositions under the purchasing firm's processes. 

This is a key point for Keith Richards, chief executive of the Personal Finance Society, who says: "They could end up paying significantly more for the management of their money.

"Many will trust you without challenge and assume you have acted in their best interest, as well as their own.

"Successful smaller practices are often built primarily on long-standing personal relationships between adviser and client. Once that respected point of contact leaves or retires, clients may then have no qualms about taking their business elsewhere."

Keeping the regulator informed

Mr Hegarty points out the regulatory responsibility an acquiring owner has when taking over a firm. He says: "The FCA's supervision review report in February this year talked about acquiring clients from other firms.

"This review focused on communications to clients, the integration of clients into a new service proposition and the suitability of any replacement business.

Choosing whether to stay with an adviser who takes over the business is entirely the choice of the client.Tom Hegarty

"Remember a client is not looking for the same due diligence considerations as a business would: they are more likely to want to know about the people with whom they will be dealing, and the ways in which the level of service they receive will be protected."

At all times, the Financial Conduct Authority (FCA) needs to be aware of any changes.

When buying or selling a firm, business owners should fill in the FCA’s change of control forms to notify the regulator of any changes.

Note the regulator states it requires prior notice of any acquisition, not a post-purchase notification.

Its website states: “Individuals or companies that wish to acquire or increase control in a firm that we regulate must seek our prior approval.”

The notifications for changes in control are known as Section 178 notices, and the FCA says it can take 60 working days for it to assess a change of control case – so acquisitions cannot be rushed.

A spokesman for the regulator says: “It is also worth bearing in mind if the two firms are merging instead of remaining as two separate entities, then they will need to consider things such as what happens to the customers, how they are informed of the change – and what impact it has on them – whether our financial services register needs to be updated.

“One of the firms will also need to complete our cancellation form.” This can be found on the FCA's website.

simoney.kyriakou@ft.com