Today Succession Planning

Buying a Financial Practice

The due diligence process

by Tiffany Markarian

Ms. Markarian is the managing director of Advantus Marketing and adjunct director of consulting for Weylman Consulting Group. She can be reached at 617-312-0591 or

With the advent of financial advisors considering retirement, coupled with the rising trend of advisors valuing their practices, the decision to buy a financial practice can be a means of growth and expansion. The purchase of a financial practice can replace years of prospecting and client acquisition efforts by an advisor in a relatively short period of time. It can also be the catalyst for an advisor to take on a partner or junior associate early, thus locking in the succession strategy for both parties.

With many broker/dealers establishing models to finance the purchase of a financial practice, the concept can be enticing for advisors seeking to capture assets, new recurring revenue and client relationships. The challenge that cannot be overlooked; however, is the need for due diligence. The idea of buying a financial practice can be quite glamorous; yet, an advisor most not overlook the many factors and risks that need to be considered to make this investment profitable over the long-term.

A buyer could have everything in place for a purchase, such as the appropriate legal agreements, capital funding, and a product and service platform that supports what the seller had been offering to clients. However, one of the greatest risks in purchasing a financial practice is that the clients are under no obligation to move or stay with the buyer. This is commonly referred to as transition risk. Transition risk is what is ultimately measured during the practice valuation process and should be conducted by a qualified party who understands the sophisticated dynamics of the marketplace.

The ultimate goal of buying and selling a practice is not only to transfer the fees, assets and accounts, but to assess the buyer’s ability to build rapport with the clients and retain and grow the portfolio and relationships. This process should be front and center from the onset of discussion through the communication and service procedures that are followed pre-, during and post-sale.

Capital Funding

Buying a financial practice can be risky when going at it alone, as you may be using your own personal assets to help finance part, or most, of the transaction. Buyers can try to secure financing through traditional bank channels, and although not impossible, this may be difficult. Banks will require a sophisticated valuation from a qualified professional; and, they need to be able to gauge the likelihood of cash flow – backed by collateral. In the case of a financial services practice, there is really no tangible collateral to secure the note for the bank, as the assets are tied to whether or not a client keeps their relationship with the practice.

Many broker/dealers have established parameters and programs to help facilitate the buying and selling of practices, but they generally have to occur with both parties being affiliated with the broker/dealer. At the same time, broker/dealers may be able to provide resources for valuation along with financing for a portion of the negotiated sale price. Broker/dealers will have their own requirements and stipulations for financing to occur, including caps on what they will help finance, and the types of practices they will affiliate with, so you need to fully understand the requirements.

The benefit of this route is that the buyer may not have to solely use their own personal assets to finance the transaction. In the case of collateral, the assets of the practice being purchased come onto the broker/dealer’s platform. Therefore, if the buyer defaults, the assets can theoretically stay with the broker/dealer. Again, the clients are under no obligation to stay with the buyer or broker/dealer, so the negotiation and valuation of the practice is crucial.

Factors that Affect Transition Risk

Product Platform

A buyer must carefully assess the underlying book of business they wish to purchase for many different factors. For instance, if the seller’s wealth management services have historically been mutual funds and annuities, and your practice is fee-only or comprehensive managed portfolios and alternative investments; that may be too drastic a change for some of the clients and could increase transition risk. By the same token, if the buyer or planned successor is introduced to the seller’s practice early as part of a gradual succession plan, this can provide the buyer time to build relationships and introduce new services and philosophies to the clientele.

The clients, hopefully, will find significant value in expanding their investment strategies with the new buyer. Alternatively, you also need to consider if the seller’s practice encompassed products and services that are different, or not available, on your platform – specifically if the seller was using proprietary products that are difficult to transfer or there are no selling agreements in place within your platform. If the clients have to re-paper their entire portfolio just to do business with an unknown successor that could create transition and retention risk. In this case, the buyer may decide to affiliate with the seller’s company or platform, which can cause disruption and transition risk to their own primary clientele.

These are options a buyer needs to carefully consider prior to committing to purchase another’s practice. The buyer may feel they can offer a value promise that would be equally or more beneficial to the clients, but you need to assess the time it will take, and factor in a percentage of clients that may be lost in the process, particularly the loss of any “A” clients. You need to determine exactly how many of the clients are truly producing the bulk of the practice revenues. If only 15 of the clients are producing 75% of the revenue, the risk of losing even one of those clients could be detrimental to your efforts.

Staff and Operations

In today’s marketplace, it is not surprising that most of the buyers who purchase practices are generally larger entities than the seller. The buyer generally has more staff in place, along with technologies and marketing/communication procedures that allow them to quickly mobilize a strategy to communicate the value of their practice, conserve the relationships and process the transfer paperwork. This systematic focus on communication, mobilization and marketing efforts are critical to helping reduce transition risk. You need to determine if the seller has all of their clients and accounts on a CRM database, or worst case scenario, are all housed in paper files. As a buyer, if you do not currently have enough staffing in place to support your existing operation, then purchasing an additional practice may not be a worthwhile investment right now, given the time and effort it takes to develop and conserve the relationships.

Compliance Considerations of the greatest risks in purchasing a financial practice is that the clients are under no obligation to move or stay with the buyer. This is commonly referred to as transition risk

If the seller was not previously known to the buyer, it is imperative to conduct an assessment of the seller’s record – either on the FINRA CRD database or in the independent RIA space with the state. It is also encouraged to assess the seller’s credit history and personal background. You need to gauge the seller’s character to determine if there may have been unsuitable sales practices occurring with the products and services they were offering. A buyer could find themselves handling client complaints down the road that would take time from their primary focus on building the business. In this case, the buyer should determine if they need to purchase additional Errors and Omissions coverage or increase their existing coverage as part of the sale.

You also need to consider if the seller has full ownership of all of the client relationships in their book of business. The seller may have worked with other advisors in the past on joint-work cases, so you need to assess if there are other advisors involved from the seller’s world that have first rights of refusal on the relationships within the book you are purchasing.

The Legal Agreements

When buying a practice, the legal agreements are critical in protecting both parties. It is strongly encouraged to secure legal advice from not only a qualified lawyer, but an entity that is actively involved in these types of transactions. The legal agreements should not only articulate the financial and operational aspects of the sale, but they should also have clauses to protect the buyer’s ability to build relationships with the clients. For instance, once the practice is purchased and fully transitioned, will the seller cease contact with the clients? You may desire the seller to stay on for a transition period, but after that period cease contact with the clients. Are you protected if the seller decides to “check in” with the clients on their own to see how things are going and starts to question some of the services you are offering?

Negotiating the Deal

How the sale is structured can be a significant factor in the transition risk. Most sales of financial practices generally are structured using a combination of cash down payments based on a percentage of the valuation (for instance 20% or more cash down), along with notes or loans financed by the buyer with specific terms and interest rates based on a percentage of the valuation over a specific period of years. The more compensation the seller is asking for upfront creates more risk for the buyer. In some cases, the seller may be amenable to a gradual buy-out that occurs over several months to years, allowing the seller, or a key member of the seller’s staff, to be involved in face-to-face introductions and communicating the value of the new entity – thus reducing transition risk. In other cases, this luxury may not be available, particularly if the sale is occurring due to the death or catastrophic illness of the seller. In these circumstances, the transition risk is solely held by the buyer.

A short-sale can further become complicated if the seller never had a practice valuation done on their business and there is a lack of technologies in place to properly understand the make-up of the practice. This could result in a buyer underpaying for the practice, which is unfortunate for the seller, or the buyer overpaying for the practice, in which case the buyer may have difficulty realizing the value of their investment.

In instances where the seller and/or their staff are willing to stay on for a period of several months to years to help with the retention of the clients; you may decide to further negotiate performance-based compensation paid over a defined period of years that allows for the seller to earn a percentage or fixed dollar amount of the practice valuation or gross revenues. This helps the buyer realize the value of the practice by helping to decrease transition risk through the ongoing assistance of the seller. These arrangements may also benefit the seller if gross revenues exceed expectations, and the seller is being paid a percentage of the growth
Negotiation is key. As stated, purchase and sales that are structured with more upfront compensation to the seller creates more risk for the buyer. Deals that are structured where the seller stays on for a period of time can create more risk for the seller. Buyers also need to be aware that they are generally not the only offer on the table a seller is considering. A buyer needs to have the proper team around them to help with the due diligence, negotiating the purchase and sale parameters and to make their investment profitable over the long-term.

The benefit of buying and selling financial practices today is that there is an established marketplace that has been built over the last two decades that allows for transactions to be made available to interested parties. Additionally, with the advent of practice valuation services, there are sophisticated valuation strategies available that help the seller realize the value of their lifetime of hard work. This also allows the buyer to be in a better position of strength by understanding the mechanics of the practice they may be purchasing. The valuation is key, but so is projecting and assessing the likelihood that the clients will remain with the practice post-sale. A client may have been loyal to the seller for many years, but if given the opportunity, they may decide to go with someone else once they learn the advisor is leaving the business. This transition risk is what needs to be factored and considered carefully during negotiations.

At the end of the day, when properly structured, three parties win when purchasing and selling a practice. The seller can feel good and be fairly compensated for what they have built, the buyer has a means to grow and expand their practice, and the clients of the practice will have the continued support and additional services they need to expand their net worth and long-term security. ♦





The concepts and content discussed in this article are meant to be educational in nature and are not to serve as specific business, financial, tax, legal or regulatory guidance. Individuals are advised to seek the counsel of such licensed professionals. Advantus Marketing and Weylman Consulting Group are independent entities are independently responsible for their own respective lines of business and activities.