How to do due diligence when buying an advisory firm

Often, they will get experts in to check that any extensions have been done to standard, and check with the local council to see if the appropriate permissions were obtained.

After all, nobody wants to buy something that will collapse around them at some point in the future.

The same is true when buying an advisory firm. While there may be many reasons why a buyer wants a particular firm - maybe it's the right location, maybe they have expertise in a certain area or maybe they have a lucrative client book - the potential buyer must do proper due diligence. 

"Due diligence is part of any business purchase and you have to be ready for a sale, as much as willing to buy," says John Joe McGinley, founder of Glassagh Consulting. 

"While relationships are the basis of building a business, data is the way to make money out of it," he adds.

The data room should be updated as appropriate during the transaction for any changes or responses to additional queries. Linda Whittle

So part of completing a due diligence process means having an "effective client data base in place", Mr McGinley says, which will involve the buyer being able to explore the so-called 'data room'. 

Pre-digital age, this was literally a room or a corner of an office with files stuffed full of important information, such as client data, leasehold arrangements, bank statements, profit and loss statements and copies of filings to Companies House.

Nowadays, this should all be available digitally and in an organised, structured format to make it easier for both the seller and the buyer to put their fingers on the appropriate information without having to spend ages looking for it.

As James Dingwall, chief executive of Thistle Initiatives, says: "The buyer will want to ensure a specific list of requirements is sent to the seller, and the seller ensures all data is added. 

"One of the most important points for the buyer is to get the due diligence request right at the outset, so there is no ambiguity on what is needed."

What should be in the data room?

Linda Whittle, senior associate at City law firm Fladgate, comments: “A data room containing information on the target should be established near the outset of a transaction in response to a detailed set of scoped questions on the company and its business.”

For the buyer, Ms Whittle says this means ensuring the questions posed are specific and tailored to the particular business (for example, including addressing regulatory requirements, licensing approvals and other matters of compliance) and the buyer’s own priorities.

For the seller, it will be important, as far as possible, to ensure the buyer agrees they have knowledge of what the data room contains, so as to limit the extent of any claims under the warranties in the sale agreement by reference to such knowledge.

It is good practice to have all data accessible and searchable. This can be incredibly valuable when brokering a sale. Aileen Lynch

Moreover it might be worth putting terms and conditions on the use and dissemination of the data to avoid any potential leaks.

She adds: “Those setting up the data room should ensure they do not assume liability for its contents or for its upkeep except to the extent they receive information to be uploaded to it.

“Those clicking through to access the data room should take care to ensure they heed any terms and conditions of use to which they are deemed to agree. 

“The data room should be updated as appropriate during the transaction for any changes or responses to additional queries and a full record of its contents should be saved at the end of the deal, in order to be clear what was contained in it, should later disputes arise about disclosures.”

Keeping it up to date is essential, says Matthew Meadows, corporate finance partner with Kingston Smith. "A well-laid-out data room, prepared in advance of a transaction, helps ensure due diligence runs smoothly, and there is an easy link to disclosures and warranties.

"As the transaction progresses, it is important that it is kept up to date so finalisation does not yield any surprises."

What should buyers look for? 

The below checklist, from Retiring IFA, gives an indication of the sort of information a seller should be willing to show a prospective buyer so the acquiring firm can make a qualified judgement.

Henry Blunt, managing director of Retiring IFA, believes it is “very important to give the perception of a well-oiled practice". 

“As the FCA has brought about changes, such as no more block novation of clients, it is increasingly important to make sure that the information is in place to do a client by client transfer and it is well organised.”

He adds that the sheer volume of defined benefit (DB) transfer advice might also become a problem in the future - he calls it a "ticking time bomb" for practices carrying out a number of these.

Lawrence Cook, director of marketing and business development at Thesis Asset Management, says the importance of making sure all the proper due diligence and investigation is done cannot be overstated.

“If a buyer can’t clearly see what he/she is buying then that is very likely to put a stop to proceedings,” he says, adding: “This means sellers must have data that is transparent.”

Ms Lynch also advises buyers to check the FCA's latest Gabriel submissions, to see if the firm always met its regulatory capital adequacy requirements, and whether there were any issues with its returns.

She also advises buyers to go to Companies House if they are buying a limited company. "Have a look at the accounts submission history. This will give a good picture of the financial stability of the firm.

"If it's a sole trader, do not be afraid to ask to see their bank accounts, as well as their profit and loss accounts, and balance sheets," she adds.

Being able to showcase detailed information makes a potential seller "stand out from their peers", according to Mark Stokes, proposition and marketing director for Succession.

He explains: "Every consolidator will ask for some core business information, such as your last three years' accounts, a client profile, assets under management, complaint history and the like.

"Maintaining first-rate business data on clients, assets and charges, so you can demonstrate you have longstanding clients, enjoy good referrals and deliver decent organic growth year on year, will distinguish you from the majority of your peers."

What sellers should consider

It is important not to rush the due diligence process, regardless of whether you are a seller putting your data together, or a buyer looking to pick up a bargain.

Keith Richards, chief executive of the Personal Finance Society, says: "Planning an exit strategy is a lengthy process and could begin at least two years before discussions with prospective buyers begin.

"Make sure you can articulate your client proposition and your business, and always consider whether you would buy it, and why. 

"You should be able to give a short, sharp explanation of your journey to date, your firm's unique selling points (USPs) and your preferred outcome."

He advocates, for those looking to sell, certain steps that can be put in place during those two years to groom the business for a sale.

For sellers, Mr Richards outlines: "Improve efficiency, cut out unnecessary costs and improve turnover. An efficiently-run business with strong turnover will be far more attractive than a business that wastes money."

He also advocates: 

• Clean your client data and get rid of paper records.
• Segment your client base.
• Prepare a seller's pack.
• Consider the implications of the data protection act. Use a non-disclosure agreement to ensure obligations are met under the DPA and protect you against data misuse.
• Know what statutory notice periods you need to give to your network/FCA/PI insurers.
• Be aware of potential for personal losses should clients leave.
• Prepare your own due diligence checklist on prospective purchasers.

Mr Stokes says a seller should also ensure there is a good cultural fit, which means "a deep appreciation of your own real reason for sale, and make your personal ambitions clear."

Moreover, he believes sellers should check the acquirer is "good for the money, and if part of the deal is equity, make sure they are realistic about the share valuation".

Since January 2014, Succession has bought 40 firms from its affiliated membership. Sanjay Shah, managing director of Succession Advisory Services, says the business has identified "six proven strategies to become sale ready". These are outlined below. 

Technology matters

Moreover, the better the admin systems and the more transparent the data available, the better the firm may appear to a prospective buyer.

This is the view of Aileen Lynch, head of technical at Compliance First, a trading style of SimplyBiz Services.

She says: "Now that technology is an instrumental part of the way in which advisory firms operate, there is no excuse for an adviser to have client information in a paper-based format, stored in filing cabinets.

"It is good practice to have all data accessible and searchable. This can be incredibly valuable when brokering a sale.

"The ability for advisers to know, rather than estimate, the age groups into which their clients fall, and the average funds under management, and so on, will help them achieve transparency with the acquiring firm and possibly secure a better deal."

According to Barry Neilson, business development director for Nucleus: “The increasing influence of platforms and the greater sophistication of back office systems over the last 10 years has assisted advisory businesses in improving their understanding of their key business metrics and the characteristics of their client banks. 

“Easy access to accurate and transparent data can help to demonstrate that their financial planning process is scalable, avoids unnecessary complexity and is supported by processes that are clearly followed in the firm.”

Mr Stokes warns: "I'm afraid those firms with no back-office technology, without a defined client review process and with no investment proposition need to consider what they actually have available for sale."

simoney.kyriakou@ft.com