Your IndustryAug 26 2020

How to deal with legacy issues

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IWP
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Supported by
IWP
How to deal with legacy issues

As keen as consolidators are to buy up client banks, legacy issues (like risk-laden DB transfers, upheld complaints, and messy trail agreements) still risk derailing deals.

How can advisers get their houses in order when it comes to a sale?

Proactively getting to grips with your business, and sooner rather than later, is the best strategy according to Mark Hughes, who sold his firm, Mark Hughes & Associates, to AFH in 2018.

You’ve got to start early on, to get the business shipshape Mark Hughes, formerly Mark Hughes & Associates

“Whoever you sell to is going to want to know what they are buying,” says Mr Hughes, explaining that questions about the security of the firm’s income stream, and any potential liabilities, will immediately come up.

“You’ve got to start early on and that’s what my accountant told me some time beforehand, to get my business shipshape. You have to have a clearly defined proposition, even before you think about selling your business.”

This can include segmenting clients or even just focusing on a singular proposition and fee.

Even with a clearly defined proposition in his business, Mr Hughes says this spring-cleaning took four months.

“In that four months we tidied up and confirmed what we were selling,” he explains. “I had always said I had around 2,000 clients (categorised as individuals, couples or a business). When push came to shove, what we actually sold was around 850 clients.”

Mr Hughes explains that the balance were small clients paying token trail commissions - from a protection package sold on a mortgage arranged decades ago. After a few months’ hard work, he was able to sift through the client bank and now benefits from a cleaner book.

He adds: “It’s not a bad exercise for people who aren’t even thinking about selling their business.”

A question of culture

Julie Lord sold her business, Cavendish Financial Management, to Axa-owned Thinc (which later became Bluefin) in 2007.

Ms Lord, who has since launched Magenta Financial Planning, says her acquisition went smoothly as she designed her business to be as simple as possible.

The important thing is to make sure your service level is the same across all clients Julie Lord, Magenta Financial Planning

“We didn’t have to deal with legacy issues because we had been working with one process for many years that focused on a singular client type, so everyone was dealt with in exactly the same way,” she explains.

“The important thing is to make sure your service level is the same across all clients or, if not, to ensure it is properly segmented. That way the transition is much easier.”

However well-run a business is, a mismatch between buyer and seller – in terms of ethos, values and processes – can mean legacy issues cause real problems.

Ms Lord chose her buyer as she liked the culture match with her own firm, and believed that would help safeguard client relationships after the transaction was completed: “I happen to think consolidators just buying firms for funds under management achieves nothing, because unless you’re going to look after those clients like you had before then they will all walk away.”

Alistair Creevy, who in 2018 sold his business Independent Advisers (Scotland) to Succession Wealth, also sees the value of spring-cleaning a client book to uncover potential legacy issues.

He had around 800 clients engaged with him and, fortunately, most of these were on a platform, therefore minimising legacy risk.

“A consolidator is not looking for you to sell them a business that isn’t viable,” says Mr Creevy.

“They will see through that. So they ask about PI cover and how many complaints you’ve had, and so on.

“If you’re trying to do it on the cheap and get rid of your liabilities, consolidators are not interested.”

This is the same advice provided by IWP chief operating officer Tony Spain, who says there is no point in hiding anything from due diligence.

He says: “[Problems] will inevitably come out in the due diligence, and most issues are manageable once understood properly.

“The most common one at present is historic DB transfer exposure. Depending on the number of cases that the seller has done in the past this may mean that the acquisition needs to proceed as an asset purchase, with clear communication to clients on the change, and a Principle 11 FCA notification to ensure that the regulator is aware of the plan.”

PI pains

Consolidators will always seek to indemnify themselves from potential liabilities and Giles Dunning, a partner at Stephens Scowns LLP who has worked on many advice firm transactions, says PI cover is becoming a bigger sticking point for deals.

“There’s usually quite a lot of negotiation around the seller’s liability for those issues going forward,” says Mr Dunning.

“Insurers are much less willing to give long-term runoff cover when a business ceases trading. What we have seen is insurance is getting more expensive and some insurers will not cover some areas.”

In fact, Mr Dunning says this can ultimately reduce the transaction price of a firm: “One thing that often comes up is: who is going to fund the ongoing run-off cover for the company being bought? That is quite expensive and can effectively reduce the price, it can be a transaction cost, basically.”

“Very commonly sellers will be expected to give an indemnity for past advice, so if there are any claims or losses arising they will be for the seller’s account,” adds Mr Spain. 

“Having said that, a degree of imperfection is normal; part of the value of joining a larger group is that the firm can get better support with compliance, whether that be file monitoring and terms and conditions, or broader governance.”

Jon Yarker is a freelance journalist