Over the years, the question about buying a wealth management practice has been posed to me by many CPA firms. If you've got a longer time horizon, acquiring a wealth management practice could be a great idea. But the difference between finding a good acquisition versus just any acquisition can be a make-or-break decision. Here are the things to look for in your due diligence process.
Start by obtaining a copy of a recent third-party valuation of the target practice. Some may not have one, but I've discovered that when a seller is serious about selling, they typically have that valuation completed to give them an idea about the range of values. If they don't have one, see if they'll give you the time to get one done. I know that many accounting firms have some competency in business valuations, but I'd prefer to see a valuation prepared by specialists in valuing wealth management practices.
The valuation is more than just a starting point; it is typically a report that will explain the justification for the value by highlighting the strengths and weaknesses of the target practice. A smart seller would be obtaining third-party valuations annually and using the findings to shore up the firm in the areas noted as weak or needing improvement. You may ask to also see prior valuations if they are available.
Most CPA firms have helped with traditional due diligence for clients making acquisitions, so I won't bore you with that stuff. I will, however, share some unique elements of evaluating a wealth management practice beyond the basic diligence checklist.
Important asks
Ask for a client listing for the past three years, ranked by recurring revenue. What you don't want to see are a few very large relationships followed by an army of average to small clients. On the ranking, you are hoping to find that the client list is somewhat consistent from top to bottom. Draw a line somewhere near the bottom of the list and see how many smaller clients you could eliminate and not ruin the firm's profitability. You are also hoping to see longevity, and that the firm's largest clients have been on board for the entire three-year period.
The age of the clients is a big factor in arriving at a reasonable valuation. If the average age of the target's clients is 78, you may have an issue. Again, maybe not a deal killer, but an issue to evaluate nonetheless. If there is no evidence of regular communication with the next generation, the older average age is a valuation detractor. If there is clear evidence of communication with the next generation, assets owned in trust to provide for continuity of service by the advisory firm, and the next generation as existing clients — things begin to look a lot brighter.
Ask if you can get a login to their CRM system. If they don't have one or a similar system for storing notes, workpapers, documents, etc., I'd be concerned. This wouldn't be an instant deal killer, but it is a good leading indicator of the level of technology that the target has adopted.
Once in the CRM, you want to get a good feel for the frequency of communications with clients, especially "A" clients. Look at the frequency and the scope of the conversations. If you see note after note of discussing market performance, and nothing about any other financial planning matters, keep digging. If you begin to feel that the target isn't really a financial planning shop and giving light duty to the planning part of the relationship: strike one.
Of course, your firm can be the hero and shine the light on all the planning matters that haven't been serviced with the target's clients and then deliver those services. This additional service will likely create a favorable start to the new relationship, but it may consume many professional hours, taking away from the net financial results of the target in your hands. It is not likely that these clients will pay additional fees for this service. Most feel they were getting financial planning, even though a diligent planner can easily spot the gaps in their plans.
Understand the source of the clients. Were they a referral from a client, a law or accounting firm, or obtained through some sort of marketing program that the target successfully utilized? Hopefully the target documents the clients' other advisors in the CRM system. If they do, I'd try to organize the lists to see if there are any concentrations of clients being serviced by any other professional services firms. Then evaluate the firms to understand if there is a close professional relationship with the target or any of the employees of the wealth management practice.
Look at the tax returns of the clients, especially the better clients. As a tax professional, you can spot issues from reviewing a tax return that may indicate the need to upgrade the CPA relationship or to spot gaps in the financial plan. The acquisition of a wealth management practice should also provide many opportunities for the traditional side of the CPA firm.
Follow the money
The nature of the revenue is very important. Break it down by source. Does it come from assets under management fees, financial planning fees, or securities or insurance commissions? To me, the commission business isn't worth much, partially because I don't have a securities license and, more specifically, I believe that a fee-only fiduciary type of practice is more suitable for an accounting firm and consistent with the other sources of revenue for the firm. If there is some commission business, and you don't want that, the deal isn't dead yet. Many broker-dealers will buy back securities clients from advisors who no longer want to service the commission side of the business.
Also, look at the commission business to see if some of it may be well-suited to a fiduciary type of relationship, and potentially become AUM. It is common that brokers may have sold annuities in the past. Some of these annuities may be doing great for clients, but some may not. If there are no bells, whistles or useful benefits with the annuity that make it a keeper, your new client may be better served in a very low-cost annuity where you can manage the underlying subaccounts for a fee far lower than the internal expenses of the old annuity.
You want to understand how the target firm delivers their advice. You may be shocked to see that many traditional financial planning practices don't really have good systems and processes or a system for quality review. I would like to see the chain of communications with clients, especially in the early days of the planning relationship. The first months of a planning relationship frequently set the stage for client expectations for years to come.
Does your target do a canned plan, and print out inches of paper with meaningless charts, forecasts and fluff? Or do they deliver their advice in a plain-English, easy-to-understand style? Is the advice well documented or just talked about in meetings with no good record of the conversation or the alternatives that may have been evaluated before concluding with the advice rendered?
Does the target charge for planning services, or is it bundled with the AUM fees? This may be more of a personal preference thing, but it is important because the clients of the target firm are used to the way that the target is delivering the advice and getting paid for it.
My preference would be to see that the plans are billed and paid separate from AUM, at least at the start of the engagement. The reason for this is that it squarely focuses on the importance of the planning part of the relationship, which I've touted for years as the stickiest service that a planner can deliver. Lip-service planners who don't go deep in a financial planning client are one introduction away from leaving that firm if they ever get an idea that there is a far better service being offered by a competitor for a similar fee. In fact, I can tell you that 99% of our best clients come from other advisors (many from the largest firms in the country) and frequently their reason for changing is that their former advisor left a lot of issues on the table. They are either lazy, lacking the knowledge or time to offer comprehensive advice, or simply trying to maximize their profits by delivering "the least they can do" to keep a client satisfied.
Also look at review meetings after the first year. If they are basically limited to a portfolio review without ever refreshing the moving parts of the financial plan, it's time to be careful.
Last, and certainly not least, pricing. The valuations coming out today are quite high. In fact, multiples have never been higher. But don't let price alone drive your decision. The more costly practice may be a better fit because of the qualitative factors that make it a great fit. That could be from client demographics, staff retention, or some other strategic issue that improves the value and utility of the target firm in your hands.
Instead of obsessing on price, see if you can negotiate terms or third-party financing so that this acquisition can be accretive to your bottom line as soon as possible. A mature wealth management practice should deliver between 20-30% EBITDA. Today's top-tier practices are all pushing 30%. Arrange your purchase so that you can have profits in year one.
