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Beware of the dog

The spate of mergers and acquisitions in the IFA sector has slowed in recent months. This is not surprising as there has been a general lull in completed deals and most of the big players made their strategic moves for the post-depolarisation world some time ago.

However, with depolarisation around the corner and new business models taking shape, a new wave of consolidation is likely.

With this in mind, businesses looking for a new owner can usefully spend time preparing for a sale while those looking to buy will be refining their strategy and modelling the types of IFA practice where they can add value.

Research has shown that most deals do not add value for the acquiring shareholders. However, major players in this market need turnover of at least £5m-£10m and many firms are inefficient in generating income so there is scope for benefits of scale.

But the best strategy in the world will not help if the target business is a dog. I will look at issues for due diligence, marketing the business and structuring the sale.

After verifying the accounts, most effort will go into checking the compliance environment. This is nothing new. Three years ago, Towry Law suffered dire consequences through not knowing the true extent of Advizas&#39 pension review liabilities until after the purchase.

The pension review is a thing of the past but target businesses will still need to prove this to a buyer.

The current issues are, of course, endowments and split caps, even for the best of businesses. But having complaints under control and being able to report in detail on current exposure should go a long way to reassure a buyer.

Linked to compliance is the firm&#39s professional indemnity insurance cover – or lack of it. Firms with decent PI cover will be more attractive but having the PI cover note alone is not enough.

The history of notifications and outstanding claims should also be reviewed. Any sensible seller will put extra effort (if this is possible) into this year&#39s PI renewal and ensure that they are not at risk of losing cover through nondisclosure.

It is a sign of the compliance pressures on firms that the emphasis so far has been on liabilities rather than assets.

Let us not forget that the greatest asset of a firm is its people. This mantra has, of course, tripped off the tongues of chief executives for decades but the difference now is that they mean it. Just look at the difficulty in recruiting expert advisers for organic growth.

A seller is likely to rely on a number of staff, not all of whom will have improved prospects in the merged entity, and appropriate incentive packages should be considered. The buyer will want to identify the key staff (not always an easy process) and ensure that they are happy to stay after the sale.

For both sides, ensuring that the cultures of the two businesses will fit tog-ether in the future is crucial and service contracts for staff will be important, including non-competition undertakings that are in line with the current thinking of the courts.

No due diligence process should forget the clients. The seller will have checked that terms of business are up to date and that client files will pass an audit. But more than that, how sophisticated are the systems for managing the client relationship?

For example, can the firm identify the value of the funds it is managing for its clients? The client base will need to be preserved for the future so communications with clients should not be ignored until the last moment.

After preparing for due diligence, the next challenge is deciding how to market a business for sale with matching concerns for a buyer looking for a target to acquire.

Being in a business where everyone seems to know everyone else may well mean that the likely buyer of a business is already known, whether it is a competitor, a product provider or a new entrant. Many businesses will be able to draw up a target list and hit the drinks circuit with a view to eyes meeting across a crowded room.

The alternative is to invest time and money in the services of a corporate finance adviser.

They can help prepare an information memorandum and should be able to provide research on the likely sale price. They may or may not have a better idea of who the potential buyers are but they can add value by running an auction process and encouraging buyers to put forward their best offers.

Having found the buyer or seller, the sale structure needs to be finalised. Arguably, the main question for any sale structure, and assuming the target is a limited company, is whether to buy the share capital or the assets of that company.

Caution dictates that a buyer should buy the assets only, leaving the limited company behind to deal with its historic liabilities. Assuming that the liabilities do not exceed the value of the ongoing business, the FSA will need to be kept onside by ensuring that the target limited company retains sufficient assets to pay their estimated cost (often by leaving trail commission behind).

Meanwhile, the shareholders of a limited company will usually want to sell shares. Double taxation is avoided and historic liabilities are not retained.

A buyer, being confident about the risks in the target business, may offer to buy the shares in order to facilitate the transaction or differentiate its offer from competitors.

With the structure agreed, this leaves the negotiation of the sale agreement and getting any necessary consent from the FSA.

There is little one can tell an IFA about negotiation but, for sellers in particular, do not start reading Country Life&#39s property pages until the money is in the bank.


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