Advice firms looking to secure bank loans to prop up their acquisition strategies can “try to run too fast”, according to one lender.
OakNorth is currently growing its IFA loan book, having recently signed a £5.3mn deal with AFM Wealth to help it fund its acquisition plans.
Over the past two years, the likes of Cullen Wealth have also borrowed from the bank.
As more advice firm founders reach retirement, there is a big opportunity to buy up books of business.
But OakNorth’s director of debt finance, Stewart Haworth, told FTAdviser the most common reason why the bank would not lend to an advice firm was if its M&A strategy was too ambitious.
“It’s where they are acquisitive, but they're probably running faster than what we would like them to run at. There is genuine appetite to lend to this group, but probably at a slower pace than what they've requested,” Haworth explained.
“It will be seen as to whether that is an opportunity that comes back to us in due course, or if another lender goes with the plan they’ve got and lends against that plan.”
Often, IFA acquisitions involve a 50 per cent deferred payment. This means the buyer expects to pay out the other half of the deal cost through future cash flows, only paying half of the deal upfront.
From a risk perspective, the bank has to measure how much it will lend against how much needs to be paid out of cash flows of the business.
“That’s why speed is important,” said Haworth. “If you try to run too fast, that’s how you end up with liabilities.”
This is why OakNorth tends to focus on operational efficiency - such as the ratio of advisers to clients, and the income these portfolios generate - as well as cash flow performance in different cycles.
The bank will also keep an eye on more obvious risks, such as evidence of defined benefit transfer advice - pension activity at the heart of some of the industry’s biggest scandals - and instances where a firm might be charging double fees for no apparent reason.
Equity uplift will beat cost of finance
With the cost of finance rising as interest rates climb, some are projecting a slowdown in M&A activity. Haworth echoed this sentiment, though he said the equity uplift in IFA deals will more than compensate for the cost of finance facing borrowers.
“We’ll see firms getting more selective. What we call ‘flight to quality’. We’ll see firms chasing better assets,” he explained.
This then leads to more competitive, higher valued deals with companies willing to pay more than a book of assets initial worth, according to Haworth.
“In terms of a corporate buying a small entity with, say, £50mn of assets under management - a typical market is paying between three and three and half times recurring income. That’s being paid 50 per cent day one, 25 per cent end year one, and 25 per cent end of year two, with deferred payments subject to clawback,” said Haworth.