Sellers of financial planning practices increasingly want to retain a piece of the action to capitalize on the growth potential of their old businesses.
Sellers of financial planning practices increasingly want to retain a piece of the action to capitalize on the growth potential of their old businesses.
That's a key finding of a new study by Financial Planning Transitions Inc., a Portland, Ore., broker of planning practices.
Buyers still can get the seller to finance as much as 80% or 90% of the deal. But now sellers want to keep a stake in the business by tying the sales price to future volume, according to David P. Grau, a principal of FPtransitions, a major player in the practice sales field for financial planners.
Buyers also are happy with an "earn-out" arrangement because it lessens their risk in case clients move their accounts as a result of the sale.
"Sellers drive that [arrangement] because they want to participate," he says. "They believe that things are going to go up. Earlier on, people wanted to go the promissory-note route." The advantage of a promissory note is that the sellers can be certain precisely how much money they will receive over the years.
More than 85% of sales involve so-called earn-outs today, compared with closer to 60% just two years ago, Mr. Grau adds.
"It's known as the `schmuck clause' because people don't want to feel they left money on the table," says Robert Powell, managing director of Acadient Inc., a financial services consultancy in Boston.
The events of Sept. 11 put a slight damper on sales of planning practices in the fourth quarter, according to the FPtransitions study. But sales came roaring back in this year's first quarter, so they are now as strong as ever, according to Mr. Grau.
The study also found that the average financial planning practice sold for almost the same price-revenues ratio as it did a year earlier.
Fee-only practices sold for 2.02 times annual gross revenues, down slightly from 2.1 times in 2000. Commission-based practices slipped in value to 1.07 times revenues in 2001, compared to 1.1 times in 2000. So-called fee-based practices, with a mixture of both revenue sources, held virtually steady.
Still, selling prices were down all over the United States, according to the survey, except in the West. For instance, the average selling price in the Northeast was $654,200 in 2001, down from $673,500 in 2000. In the Southeast, the average dropped to $617,000, from $642,400. In the West, the average price rose to $633,000, from $590,000.
Mr. Grau warns that those statistics derive from the sales of only 104 practices sold through FPtransitions during the study period.
Optimism aside, the other big reason why business sales are percolating in such steady fashion is that the motivations of buyers and sellers are fairly disconnected from the economy. In down markets, the flow of sellers remains consistent because the primary motivation is occupational burnout.
And in down markets, buyers may be particularly motivated to acquire other practices because it is harder to gather assets by traditional means under those conditions.
Unlike on Wall Street, sales aren't reliant on capital markets, because in most cases the seller provides the financing.
But Mr. Grau says the economy had one clear impact on practice sales. In 2000, 54% of the business could be considered commission derived. That proportion increased to 59% in 2001. At the same time, registered adviser management fees declined to 15%, from 19%.
The reason for that is the increased reliance on commission business during rocky times, he says, particularly for sellers trying to keep revenues from sinking before a listing.
Still, Mr. Grau says, there is a growing disconnect in the practice-sales market between buyers and sellers.
There is awesome demand for practices with less than $25 million in assets, he says, as well as a decreasing inventory.
Buyers like to buy those smaller practices because they can get them for extremely good prices and terms. They don't have to pay much for goodwill, because the firms lack much expertise or organization. Instead, they just buy the client list and add the rest of the value by absorbing the clients into their own established business.
avid youngsters
But he adds that some of the most tenacious practice buyers are owners of practices that have been around for less than five years.
"Buyers in year one to five can't play in the market of paying $200,000 down on $1 million, but 10K down on 100K is OK," he says.
Many of the under-$25-million practices sprouted in the late 1990s, then faded and were sold in the past couple of years, he adds. This year, statistics show that a greater proportion of the practices sold are larger, more substantial ones.
For instance, in 2000, 25% of the businesses sold by FPtransitions had 50 clients or fewer, but in 2001 that amount dropped to 7%.
