"We all talk about increasing scale to better compete with the giants. However, most mergers are unsuccessful, and if you are not careful, you can easily make some costly mistakes."

Selling Strategically

By John Bowen

Whether you want to sell your company today or believe you never will, you should design your business for maximum value as if you were going to sell. This focus will allow you to build an extremely profitable business that will be dependent not on you, but on the systems that you have put in place.

Tread Carefully With Potential Buyers

In our competitive environment, one way to grow is to join forces with another firm through acquisition or merger. We all talk about increasing scale to better compete with the giants who are focusing on our clients. However, most mergers are unsuccessful, and if you are not careful, you can easily make some costly mistakes. I have seen several very talented financial advisors make expensive mistakes because of their inexperience in deal-making.

Most advisors have no idea what their businesses are worth. They share with everyone that their business is for sale, talking to all comers with the hope that "this is the one." They focus first on selling to key employees, then to competitors and then to key clients. Each of these markets presents inherent problems.

First, key employees can move across the street, taking your clients with them. Because they can effectively buy your business for book value, employees will be unwilling to pay much for your company. They can get started for the cost of simply replacing your tangible assets—a much lower price than you will be willing to accept for your hard work.

Competitors can also use your situation to their advantage. They can gain proprietary information, such as your client list or processes, during the due-diligence phase, before any dollars have changed hands. In addition, selling carries a negative connotation, particularly if you've been in the market for a long time. And even though you might ask potential buyers to sign a confidentiality agreement, word can still get out.

Given all this, you don't want to go to your employees or competitors. What about approaching your clients? Again, tread carefully. This approach may cause some loss of credibility, even if you can figure out a way to steer clear of the regulatory environment.

Finally, don't make the mistake of considering financial buyers who are just doing roll-ups. These buyers are looking to acquire your earnings, and it's unlikely you will get the premium price you need in order to make the sale work. Don't get caught up in the dream of going public by joining a group of advisors who have signed a letter of intent contingent upon going public. There has to be some increase in value created by bringing the group of advisors together.

What if someone approaches you out of the blue? It's hard not to be seduced into closing the first deal to come along, but it's also a common mistake to negotiate with only one buyer until the deal closes or goes away. Remember, one of the best measures of a committed buyer is one who is willing to commit to funding immediately.

Clear Your Vision

Identify strategic buyers to maximize your equity. You'll want somebody who shares your vision of what this industry will be five years down the road, and how to add value to the collective organization. Be as clear as possible about what you hope to accomplish. Put together a three to five year pro forma, recognizing that the market will change. The clearer your vision, the better your position.

Tie Up Loose Ends

1. Document your systems. Most financial advisors, when they have systems at all, tend to carry them in their heads. To the extent you have documented procedures, your business will be much more valuable. Put the backgrounds of key personnel in writing. Document your teambuilding approaches. Make sure your compensation plans are in writing and that there are no undisclosed promised compensation benefits.
2. Work on your pro forma estimates. Because many buyers will want to pay you based on you delivering your numbers, spend some quality time on your pro forma estimates. Fight the desire to overreach, because buyers will tie a portion of the purchase price to the numbers you presented.
3. Settle lawsuits in which you're the defendant. Buyers do not want to be exposed to any risk beyond the normal course of business. Contingent liabilities will substantially reduce the purchase price. Worse yet, they could kill the deal. If you're a plaintiff in any legal actions, it's less of an issue, though you must disclose this, too.
4. Make your office shine. When a buyer walks into your office, how does it feel? Is it a showplace? Think of selling a home. Just prior to sale, most people fix up their houses, making all the improvements their spouses always wanted. Why? It increases value dramatically by showing a sense of pride. You must do that to your business.

Steps to the Sale

Let's say you've done your homework, corrected any problems and been approached by a strategic buyer. These are your next the steps for a successful merger or sale.

Step One: Exploration. The first meeting should be a sharing of each other's vision to determine whether there is a basis for going forward. Do your homework before the meeting and check them out. The Internet is a great place to start. Check their press releases and, if they are a public firm, pull up their quarterly filings. Is their vision aligned with yours? If it's not, there's no basis for continuing the conversation.

Step Two: The Confidentiality Agreement. Both parties should sign a confidentiality agreement before sharing any nonpublic financial or sensitive material. Make sure the agreement works both ways. Review it with your attorney to ensure that it doesn't overstep reasonable bounds, is primarily focused on the deal itself, and doesn't impact your business operations.

Step Three: The Formal Proposal. The potential buyers should present a formal proposal of how they would purchase your business. This facilitates an open discussion about whether enough synergy exists to make the deal work for both parties.

Step Four: The Letter of Intent. This is a binding document that specifically identifies all the major terms of the definitive purchase agreement. It typically includes the purchase price, any earn-out provision, non-competition agreements, employment agreements, and so on.

Step Five: The Due Diligence Meeting. This is the opportunity to see if what was represented is true. Expect to have all your filings with regulatory agencies, financial records and procedures reviewed. You should have voluntarily disclosed every "I got you"—anything that could make your deal less desirable, such as litigation, a problem with a partner, or an administrative error. Telling the potential buyer about any problems at the beginning will give them confidence in your ability to deliver.

Step Six: Definitive Agreement. This is the process of documenting the letter of intent, and always takes longer than everyone expects because of level of detail it requires. You need to have professionals representing your side who are experienced in mergers and acquisitions, but do not give them complete authority. Stay involved and push to move the agreement along. Professionals often spend inordinate amounts of time negotiating minutiae, which will add substantial costs and delay the transaction, or possibly even kill the deal.

Finding the right strategic buyer to partner with to reach your next level of success will make tremendous sense for many financial advisors. Start the process today. Clarify your vision and get your systems in place. If you've done it right, you will be in the envious position of being able to pick your buyer. Your clients—and your net worth—will be glad you did.

Reprinted from: FINANCIAL PLANNING