Questions You Should Ask When You Are Thinking About Buying Another Advisor's Practice

Hi, I'm Ken Heyman. As managing director of the Advisor Institute at Alliance Bernstein, I meet with financial advisors every day. One thing I hear expressed over and over is their frustration with how much they are juggling. The advisors I talk to are constantly trying to balance competing priorities from managing client relationships to prospecting for new business and of course the tasks of leading their team. This problem of juggling is why we created the Alliance Bernstein Digital Coach. This is a proprietary tool that draws on the wisdom of behavioral economics and unique perspectives from the advisor institutes practice management experts. In less than 10 minutes with the digital coach, you will be able to identify and prioritize the top needs of your practice and armed with those insights. You will be well on your way to tackling the challenge of limited resources while positioning your business to seize opportunities for growth. Let the digital coach guide your journey to success. Visit abfunz.com/go/digitalcoach. That's abfunz.com/go/digitalcoach. Welcome back to Secrets of Successful Advisors with Ken Haman. I'm Ken Haman and today we're going to take a deep dive into how to prepare to interview an individual who is trying to sell their practice maybe to exit into retirement and get the most out of that conversation as it gets started. So thanks for joining me today. We're going to take a deep dive into the questions you should be asking when you approach a colleague who's interested in selling their business. This has become increasingly an important more and more popular way for advisors to grow their business. We are seeing an enormous number of advisors who have built substantial practices now aging into that place where they are ready to think about retiring. There was a huge growth spurred of new practices established back in the 80s and 90s and in early 2000s and a lot of these advisors are now ready to monetize a lifetimes work and there are a lot of younger advisors who are interested in taking advantage of this demographic opportunity and you should. It's a great way to grow your business. Unfortunately, if you look at cross sectionally at the industry, there's a lot more regretted acquisition than there are success stories about acquisition and there's a variety of reasons for this. But the most important reason is that buyers tend to oversimplify the consideration of a practice. They succumb to narrow framing and they allow their cognitive resources to become diminished in the presence of this idea that oh, I could acquire a hundred million dollars worth of new assets and based on a fairly lean understanding or perhaps very little understanding at all of the advisor's practice that they're considering. They enter into a engagement and engagement with the selling advisor that ends up costing them a lot more and providing them a lot less and in many cases actually can turn into a very negative experience. And so what we're going to talk about today is how you can navigate the early steps of the relationship with a prospective seller to optimize your experience of the transaction unfolding in such a way that it's a real benefit to your business from start to finish. Now there's a lot of stages that go into this and I'm not going to cover all of them. We're really just going to focus on the early stages of the conversation. And the reason for that is I've talked with a lot of advisors who find themselves getting into these protracted conversations with individuals who aren't yet clear that they want to sell are kind of testing the waters and are kind of in and out a little ambivalent here. You know, today I want to sell tomorrow. I'm not sure I want to sell. And then enter into the conversations and are very challenging to work with because they're not operating on a terribly rational basis. It's safe to say that about half of the advisors you may interview who are interested in selling their business are highly rational, very solid business people interested in optimizing a transaction driven by two desires. One desire is to ensure appropriate business continuity for their clients and secondly to monetize a lifetimes work. I would suggest to you as a buying advisor that if the advisor you're approaching has reversed those two principles, just to say they're more interested in monetizing then ensuring business continuity. That should be a warning sign about how well this person can partner with you over an extended period of time to successfully transition to business. And that would be my first big insight that I want you to grapple with which is if the person you're buying a business from can't partner with you can't delay gratification can't understand that their business may not be worth the maximum that's calculable about the assets under management. If they're not making a rational decision then it's going to be very difficult for you to work through to a positive outcome for both of you. You will be paying more and for a longer period of time than the practice is probably worth and you will be dealing with a partner who isn't partnering with you is more on their own journey. And this is the most common complaint I hear from advisors is they enter into a transaction in good faith and then discover later that their partner is much more inclined to be self-indulgent than they are to be disciplined about the process. So let's create a little bit of a framework here to think about approaching possible partners. The first thing we need to think about is the fact that the buying advisor always benefits from defining and constraining the freedom of choice of the selling advisor. The buying advisor is taking a risk. They're acquiring a practice that is a perishable commodity. The clients don't have to stay and in fact depending on the age of the clients if those clients die in the period of time in which you're managing the payout to the other advisor it's very likely over 80% likely that the assets will leave when the second of the couple passes away. So we have to be thoughtful about the actual value of the business as a dynamic value rather than as a static value. It's a more complicated conversation than a lot of people want it to be and if your inclination is to hurry things up and to simplify them and then not dig into the qualities of the business then you are succumbing to that behavioral finance vulnerability called narrow framing. You're oversimplifying the problem at hand. So every advisor who's seeking to buy a practice should be seeking to have an extensive conversation and should bring appropriate skepticism to that conversation about what the actual value of the business is. The assumption should always be that the selling advisor will always slightly overvalue the business and the buying advisor will always slightly undervalue the business and if you can start the conversation with that assumption and say look we we need to find the appropriate valuation for the business that you're actually running and that should be the task at hand early on. One of the benefits of doing that if you're the buying advisor is that the individual who's ambivalent about selling will have a hard time digging into that conversation with you that if they're not resolved about its time to exit then they will have a hard time doing all the diligence with you that they need to do providing you the analytics that you need to assess the business. If they're prepared to sell and they've been thoughtful about selling then that will go very smoothly and they will participate with you and understand the fact that these steps are necessary for you to be willing to take the risk. Another piece of guidance I would give you is to not allow yourself to become anxious that this person may sell their business to somebody else. If you've established your practice as the buying advisor as an institution that's in a position to absorb another advisor's practice and to do so with confidence that not only will the clients be well served but it's likely that the business will grow during the transition process as your team engages the clients and finds held away assets and other opportunities. You will establish yourself as an attractive destination for the advisor who's seeking to sell and therefore you should have confidence that by establishing a more orderly and disciplined thoughtful approach to the first stages of conversations with the selling advisor and revealing and demonstrating to them how you've organized your practice to be able to absorb and process the assets that are coming in and to grow that book of business. The advisor who's thoughtful and who has, in fact, prepared their business for sale in important ways will be attracted to your model because it resonates with their own rational process. And so what I'm really trying to do here is invite you to establish the high ground of rational inquiry through a series of questions that you ask that reveals whether or not this other person is as thoughtful as you and can create a peer partnership with you. Now, why is that so important? Because the fundamental issue that you're managing when you're acquiring a practice is the transition of trust from one advisor to a new provider so that individuals selling their practice is releasing the relationships to a new provider. And that would be your practice. If that's the case, that process of transitioning trust takes time and requires activity. Trust is built, as we've discussed on many other podcasts, between the advisor and the client through experiences the client has with you over time. The more experiences, the more trust, the more the experiences resonate with what the client needs to see in terms of goodwill and professional competency, the more trust. So the whole process of transitioning a business is transitioning trust from one advisor to the other. Now, that requires the acquiring advisor to take a lot of actions during that transitional period. And it requires the retiring advisor to release the clients from his or her care so that the new advisor can provide the experience that are needed to establish trust with the client. And so there has to be a peer partnership cooperation, a clear process of how we're going to hand these clients off and the compliance with that process by the selling advisor. The only personality structure that can participate in a peer partnership is one that's based on a rational decision to sell the business and a rational discipline about participating in the transitioning of trust process. So you're looking for not just a business that has a high level of assets, but you're looking for a partner you can work with. And this means in the earliest stages of the conversation with them, starting to discern how rational are they. So let's take a look at how you do that instead of just philosophizing here. Let's turn this into some practical guidance. When you sit down with an individual who's thinking about selling their business, and there's a lot of ways this is happening now. I know there's some organizations that are setting up kind of speed dating experiences where a bunch of buying advisors and a bunch of selling advisors come together and interact in a setting and have a chance to talk with each other for 10 or 15 minutes. It can also happen, but because you hear somebody's looking or you've done some research and you find your way to having a lunch meeting with them as an early exploration. What I'm suggesting to you is you see these early explorations as a way of saving you time, effort, and energy by determining as quickly as possible. Is this person able to have a peer partnership and are they able to enter into this conversation in the next meeting to do a real deep dive analytic study of how we are going to value this practice? Right now, what I see is a lot of advice we're saying, oh, you've got $100 million. It's therefore worth X, Y, and Z. And let's hurry up and get this valuation done so we can buy this practice and move forward. And what we're seeing increasingly is regretted acquisitions and noncompliance by partners who are not participating in the exiting process. And this is a remedy that we want to try to move forward on so that acquiring advisors are much more judicious and thoughtful and take ownership of determining whether or not this is a good transaction for them to enter into. Instead of getting excited about it, it's appropriate to become cautious that your excitement could blind you to issues that really will interrupt a successful outcome. So you're sitting down with somebody at a speed dating meeting or you're sitting down for a lunch with somebody. What are the kind of questions you should be asking? First question you should ask is, do you have an exit date in mind? The individual who's ambivalent, who's just in the early stages of exploring, may not have any kind of clarity about it. That's a signal that you should be concerned about because what we find is advisors spending months or years in conversations with ambivalent folks that don't go anywhere. And you would never sit down with somebody who's not interested in selling their business and waste your time on that. So you need to find out as quickly as possible do they have an exit plan in place. The other question you can ask them is, if you do have an exit plan in place, what's next in your life? Because the advisor who does not have a clear next stage plan for themselves is going to find it very difficult to exit the business and will be very distressed during that transition of trust process as they're letting go of the business that is to find their life for the last several decades. You want an individual who's looking forward to the next stage of life, not someone who is neglected to plan for it. And by the way, that's another indication that this person isn't approaching this transaction from a rational discipline process. If they're aware that they're trying to exit and they have no plan for what happens after they exit, this is a person who's weak in the area of discipline planning. So another question you want to explore with them after you determine what's your timeline is, what actions have you taken to prepare your business for sale? Now, this is a question with two layers. One layer is, tell me what you've done to prepare your business for sale. That's a really helpful thing to be able to talk about. But more importantly, the way they answer the question will reveal a little bit about their partnership ability. If they're thinking about selling their business, but they've not done anything to make the business portable, which is a pretty obvious thing you need to be able to do in order to sell a business is to move it from a heroic individual effort to an institutionalized process where the asset management model and the advice model that is the standard of care of the practice are able to be handed off to other providers. If the individual has made no consideration that the asset management and advice model will someday not include their expertise, in other words, they've trained their clients to be dependent on them rather than the process. It's a lot harder challenge to transition the business. And again, it reveals to you that this person isn't thinking about the business they're running, they're thinking about their own personal process and what feels best to them. So finding out what actions they've taken is a really important part of the process as well. And if they haven't taken any action, start asking the question, why not? If you're thinking about selling, why aren't you moving in the direction of institutionalizing the business? That will reveal a ton about how they think about business and may start you thinking about whether or not they can partner with you if you're running an institutionalized business that's absorbing other practices. Now, there's some other obvious questions you should be asking, such as, you know, what's the average age of your clientele? If they don't know the average age, or what's the average asset level of your clients, or how are the assets distributed in your practice? Is it a top-heavy practice with the top 10 clients accounting for 80% of the revenue? That would be a wonderful question to ask right off the top of your head. These are the kind of questions that reveal the value of the practice. If the top 10 clients account for 90% of the revenue, which by the way is not at all unusual in retail financial services, then you have a very top-heavy practice there, and you would be very concerned, how well will these people transition to my business? Now, they may transition very well if the institution that they're currently working with is portable, but if the advisor has created a high dependency on these clients, it's going to be a lot of hard work to transition them. That also would be something to look at in terms of what are the ages of those clients? There's a tremendous amount of illusion in the business today about the tenacity of assets in a practice. The idea is that in the second to die of the couple who's a client, typically results 80% of the time in the assets moving within a year of their disease. The idea is if you have a very elderly top-heavy practice where no action has been taken to secure those assets by the incumbent advisor, I would question the value of it, which isn't to say it may not be valuable, but it is to say you may want to consider a different price that you're going to pay for it over time because of the nature of the business. These are questions that the selling advisor should be able to answer pretty quickly in an early-stage conversation if they've thought about selling their business. Again, what we're looking for here is someone who's thought about selling their business and is serious about selling their business and is capable of partnering in the sale of their business. Let me give you another area to explore. It's a great question is to ask what kind of legacy intergenerational planning does the practice offer their clients? And what resources do they use to do that? The big final step in many people's journey financially when they become uniquely successful and they now have maybe one or two generations downstream from them, the big missing link in many practices, legacy planning. If they have a strong legacy planning standard of care where the clients as they move into this stage of life where they have wealth and now need to think in terms of multiple generations, if the advisor's not touching that, then again, there's a weakness in the connectivity between the clients and the practice. If they're doing a lot in that area, well, there'll be a lot of trusts and other structures in place that will preserve the connectivity of the assets as they transition to the new practice. These are the kind of questions. How many clients, what's the average size of the assets under management? What's the standard of care of advice you provide? All of this allows you to start exploring the business model, but equally importantly, 'cause eventually you will do a due diligence with this individual where you'll cut through all the analytics to determine the valuation. What you're also determining is how well they've thought about it, how thorough their consideration has been. Have they put themselves in your seat as the buyer and made it easy for you to see the value of their practice? Are they thinking in an institutional way about this? Are they thinking about a standard of care and the ability to deliver a high standard of care that increases the perceived value of the practice by the clients? When these things are in place, this becomes a highly valuable and highly manageable engagement to pursue. When these things are not in place, you may still wish to pursue the engagement, but I would strongly recommend that in the absence of this kind of thoughtfulness, in the absence of this kind of discipline approach, in the absence of this kind of institutionalization, that you significantly reduce what you're willing to pay for that business and assume that the challenges are going to be greater and so that the way you're going to pay for it will need to reflect the fact that you're working a lot harder on the early stages of the transition and through the course of the transition, then you would have otherwise had to work. This influences valuation. It is definitely going to influence your partnership and it's definitely something that you should be considering in the early stages. Now, obviously, these early stage questions reveal a whole bunch of stuff. And if your spider senses say to you, you know what, I think this is a solid business, even though there's some challenges, and by all means, do the next meeting, do that heavy duty analytic due diligence, dig in to all the dimensions of the practice, really get clear about the business. That's another opportunity for you to assess how cooperative and knowledgeable is your partner to be. And if they can enter into that and rationally engage with that and potentially metabolize the disappointment that maybe their business isn't as valuable as they would like it to be, or maybe the price can't be as supported at that high level as they thought. But again, as you see the way they cope with that, that's going to give you a lot of indications of whether or not you want to be engaged to this person over a long period of time. There's a good start for your process of diligence and consideration should start in the very first meeting. You have with that person, and obviously, we've written a lot about some of the other areas of this process and some of our writings on succession planning and growth through acquisition. So if you're interested in exploring more from the advisor institute, obviously reach out to your Alliance Bernstein Regional Manager, reach out to us and ask us for an opportunity to search our library through the digital coach. And I will look forward to chatting with you again in the near future here at Secrets of Successful Advisors. with Ken Hagen.