3 Key Considerations When Buying a Book of Business


3 Key Considerations When Buying a Book of Business

Nobody likes to get burned by a decision.

But if you’re reading this, you want to grow your business. As we transition to a new generation of financial planners, one increasingly popular way to find growth is through mergers and acquisitions.

Buying a book of business is certainly an option when you are looking to grow exponentially. But just as it’s important to select the right clients to work with, you need to select the right business to purchase.

When looking to acquire another business, there are three main points to consider.

 

  1. Don’t Overlook Past Market Valuations

Recently, I was reviewing some financial planning firms that were sale and some valuations were extremely high.

If you’re the seller, you want your business valuation to be as high as possible. But as the buyer, you are looking for a valuation that reflects not just current conditions, but what to realistically expect in the future. Although it sounds counter-productive, a good way to do that is to look at past valuations.

Start by asking yourself what the current valuation is based on. Is it strictly market performance, an effective money manager, or outstanding customer service? And then compare that valuation to one from the past. The year 2010, for example. 

Following the financial crisis, we have seen a sustained bull market like none other in recent memory. If the valuation is based on is market performance, the value of the practice is questionable, as anyone could grow the business in the backdrop of the bull market post-financial crisis. What did the valuation look like in 2010, before the sustained bull market?

In some cases, the money manager might have outpaced the market and is driving the valuation. In this scenario, you need to determine the longevity of that manager. How much it will take to keep that person incentivized in the future, especially if that person is in the office?

Finally, you want to understand the service models and if they are aligned with your current thinking.

Growing the business organically, without respect to market performance, is an ideal situation.

 

  1. Understand the Metrics and the Opportunity

It’s important to look beyond surface metrics when considering buying a business. That is, don’t base your decision on the obvious factors:

  • Revenue
  • Gross product
  • Net profit
  • EBITDA

 

Although those factors need to be considered, it’s important to look past them. Many times, the increase in value to the purchasing firm is to trim costs through economies of scale which typically leads to loss of jobs and morale issues.

Instead, you should be looking at the metrics of the client base and the opportunities that might exist.

In a recent advertisement for several financial firms being sold, the average age was 59. That block of business might complement your existing business, but it might also create new opportunities for guaranteed income, estate planning, beneficiary reviews and next-generation planning. Are you willing to expand your practice to include services those clients will need in the near future? If yes, great. If not, you will be doing your clients a disservice and potentially hurting your existing reputation. Think about the changes you need to implement to grow the business exponentially.

 

  1. Review the Income Strategy

Many financial planners are looking at succession planning for their clients. Those clients are in their mid to late 50s. Our research has shown time and again that traditional systematic withdrawal provides a level of risk in income planning. A less risky option is the Income Alpha strategy. It allows clients to set aside a certain amount of assets for pure growth which will enhance the assets under management growth in the long term. Without similar income strategies, the assets in the book of business are likely to deteriorate over the next several years.

The income strategy should be considered in the purchase price. With current valuations nearing three times the gross revenue, the wrong income strategy is a recipe for disaster for the purchaser. Having a strong income strategy for older clients makes sense for the clients and the value of the business. With the appropriate strategy in place, there should be a multiplier effect on the value of a business as assets grow. Additionally, passing those additional assets to the next generation will help grow and retain the beneficiaries’ assets in the future.

 

Educate Yourself Before You Buy

We all want to grow our business exponentially. Buying and merging with businesses is sometimes viewed as the easiest way to do it. And, with the current age of many planners, there will be ample opportunity to buy books of business. But, just like any other big business decision, acquiring a business requires you to do your homework.

Make sure you understand the direction of the firm when considering a book of business with clients nearing retirement age. The negative flow of assets may represent a unique look at the value of the seller’s book of business.

 

Transformational Tactic: Don’t get burned by high valuations. Think before you buy. Seek to understand what is behind the numbers. Don’t buy a business that doesn’t fit your goals for growth.