Thursday, 28 June 2012

You need to know if you're going to buy to grow..

 by Tony Vidler.

A common topic of discussion these days is whether an adviser should buy another practice - or more commonly, whether they should just buy a book of business from another practice.

The typical reasons suggested for wanting to grow through acquisition are:

1.  Get new clients
2.  Increase business turnover
3.  Increased cost efficiency
4.  Diversify business lines
5.  Enhance market position

All of these are good reasons to consider purchasing another business, and we'll consider them in depth in a separate article.  Generally it seems that the majority of transactions in financial services are still done on some form of multiple of sustainable earnings.  This is most often a "rule of thumb" type approach, where a multiple is applied to the passive income stream that the target business promises.

The main problem with rule of thumb valuations (such as just paying 3 x renewal income for example) is that they do not recognize the ease of integration, and this a critical factor in determining the success of the acquisition for the new owners.

How well matched are the two businesses?  How easy are they to bring together, and how well do they complement each other?  

There are any number of areas to consider, and you might begin by considering:

  • Is it just an asset purchase, or are you looking to buy an entire business (warts and all)?  If so, what contingent and latent liabilities are lurking about?
  • Similarity of client profiles between the businesses
  • Geographical spread of business
  • Demographics & statistics - average ages, portfolio size, product penetration or fee agreements
  • Advice philosophy & values - how do product & process & philosophy work in each business
  • Business relationships - suppliers, research, IT, transferable centers of influence or marketing arrangements
  • Data management and CRM systems
  • Workflow and advice processes - are they similar, or is substantial change required somewhere?
  • Staffing - duplication of roles & responsibilities; individual skill sets; desired skill sets?
  • Are there any "turnkey" or proprietary solutions that you are purchasing from the target business which would or could enhance your own existing business?

The better they are matched, and the easier & better the integration, then higher the potential value should be.

This type of analysis is in reality just a starting point however in understanding how the two businesses may mesh.  Having done that one can reasonably being to assess the cost and the benefits of integrating the businesses.  Be aware that the majority of purchasers do seem to optimistically over-estimate the "synergies", or benefits from the acquisition - and often seriously underestimate (or do not understand) the actual costs in terms of lost productivity impact and additional marketing requirements for a prolonged period.

The single most important thing to my mind though is that relatively few prospective purchasers seem to have formed a clear view or understanding of what stage the target business is at in ITS business lifecycle.

There is nothing at all wrong with purchasing a business that is perhaps heading into decline - provided you understand that decline is the inevitable path unless you have a good strategy for how to re-invigorate it.  Even if the target business looks to have moved into some self-sustaining cash-cow mode and has little organic growth within it, there may still be solid rationale to pay a premium price for it.  If the business can seamlessly be added to your own business, with highly complementary systems and data management, and opens up the opportunity for your (superior?) advice proposition to unlock latent value....then it may well be worth it.

However, simply valuing a book of clients or an advisory business on an "accepted" industry multiple, without any understanding of how or where superior value from the purchase can be derived makes little sense.

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