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Phil Young: Death of the consolidator model?

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It would appear that ‘being a consolidator’ is officially the hardest game in the world. Or financial services, at least.

The word itself – consolidator – is pretty vague. You could be forgiven for thinking, an acquisitive advisory business becomes a consolidator on the back of a bombastic press release.

Some are quietly successful, some fail spectacularly. The business models are diverse and all have bombed at some point. How would you pick a winner if you were a seller?

In simple terms, selling your business is about transferring risk. Keep that in mind and
you will keep on the right tracks. Too many models just do not transfer enough financial risk to the buyer.

This is the financial risk of delivering future profits. If a business is prepared to pay you what you reasonably believe to be the next six years’ profits for your business in one lump sum, then you would probably have a good hard think about it. What about four years, or eight years? Typical earn-out periods are over two or three years but if the valuation is good, the earn-out looks fair, and the cash is ready and waiting, you, my friend, have yourself a deal.

What’s the snag? Here’s a few things to watch out for:

  • Running out of cash. The deal might be generous, but if the consolidator runs out of cash part way through payments, you might be left high and dry. Some consolidators are financed through debt rather than their own money, and debt can be called in. If it is private equity funded and the private equity firm is gradually taking more equity, the consolidator is probably well behind plan, and giving up cheap equity for cash. Once that stops and other investors are sought, they might have written it off. Ask for details. 
  • Impossible earn outs. I have seen unachievable earn-outs agreed, because the seller hasn’t read the detail. Example: a requirement to include a notional salary for directors’ remuneration in the profit calculations, instead of taking dividends. This might seem a cute move by the consolidator, but a demotivated workforce is not really healthy for anyone.
  • Roll up deals. Never say never but as a general rule I don’t like these deals. Swap all the equity in your business for a tiny bit of equity in our business and we’ll use our scale to save you money and sell for billions. The seller gets £0 and a few shares in a business which it has no control over and is statistically more likely go bust. Some of the businesses offering these deals have been rescued from the brink several times already. Look at the full corporate history, and ask around. You have been warned.

Too many consolidators have no real cash at all, and what they do have is stripped out by the management team as salary. The sums of money mentioned in press releases are often works of fiction, paper valuations which are entirely aspirational. Some advisers haven’t had a single penny paid to them, from roll-up deals in particular, after years of waiting.

In contrast, there are plenty of advisory businesses, and some decent larger institutions who’ve done it well, with the minimum of fuss, and left everyone feeling warm and fuzzy long after the deal was done. They don’t always get the headlines. They don’t tend to need them

Phil Young is managing director at Threesixty

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Comments

There are 7 comments at the moment, we would love to hear your opinion too.

  1. As ever, Phil calls it as he sees it and frankly he’s probably right. Unfortunately our industry has more than its fair share of exaggeration – anyone that runs a practice will recognise the difficulties of acquisition and who would want to take on pretty much unlimited liabilities? The only logical approach is to find firms that have similar standards/practices and have the data to back up their claims and I’s argue that there is too much attention on the wrong numbers… firms should focus on keeping promises for agreed service standards and ensure that they are profitable. AUM/active clients/turnover all come after not before.

  2. Simon Chamberlain 10th February 2014 at 4:14 pm

    Well Phil would say that wouldn’t he after consolidating his own firm into Standard Life!

    its incredible that these people and consultancies such as ThreeSixty who are completely unregulated and certainly not independent, are allowed to go around the market place making these kind of observations unchallanged

    obviously anyone selling their lifes work to anyone should have a good long look at the backing of those models , but they should also look at the models themselves , if someone turns up on to your doorstop offering a load of money and saying at the same time that you dont have to do any hard work to prepare your business for sale and consolidation, then expect to get disappointed !

    However any serious businessman/woman knows that Private Equity houses dont invest into firms without exhaustive due diligence and in almost every case a criteria of the prospect is that they are already being profitable and cash flow positive.

    we work in a sector that is capital starved, so consolidaters are hugely important to introducing a mechanism for peoples life work to be capitalised , the only people that benefit from a totally fragmented market place are the likes of the big assurance companies who then can dictate pricing ,client ownership and fund prices , oh yes one of those companies own a 100% of Phils company what a surprise ! !! s

  3. I seem to have hit a nerve. Which point do you think is applicable to your firm, Simon?

  4. Simon Chamberlain 10th February 2014 at 6:14 pm

    No nerve Phil ! Which part of my response is incorrect

    Your not owned 100% by standard life ?

    You are not regulated ?

    Your not independent

    The industry is starved of capital ?

    People should look at models carefully

    Have I hit a nerve ?

  5. Phil’s called it right Simon.

    Why get so tetchy about an article prompting business owners to consider how someone offering to buy their business might actually deliver on their promises, and highlighting a few common flaws? Yes, the right consolidators can represent a decent alternative, but you only sell your business once (in most cases).

    As for the exhaustive due diligence of private equity investors, I can recall several examples where that hasn’t happened or the market/consolidation vehicle has shifted to such an extent that any due diligence originally undertaken has no value.

    Whilst, as Phil says, the management teams enjoy a good living the sellers are left hanging.

    Perspective Financial Group’s recent announcement that they are deferring payments to a number of firms that they have “acquired” is a current example of how some sellers have founds themselves in what must be an impossible position. Mosaic Private Equity invested £12.7 million in this Group in April 2008.

    As for threesixty’s independence, four years on from acquisition they’ve consistently demonstrated that.

  6. I think the headline might be a touch hyperbolic but certainly there is certainly room for the acquisition model in FS to be improved. As one of the key drivers to growth, acquisitions are always going to be around but the unique nature of the adviser market does make the structure of such deals different to most industries – for starters there are no tangible assets.

    I’m not sure whether I qualify as a serious businessman but I do know that the idea of PE houses only buying into profitable and cash-flow positive businesses is a naive one. PE businesses will buy into anything at the right price, with the right equity allocation and with the right underlying protections on their investment. A business with no profits and poor cash-flow can still represent an opportunity to access a market at cheaply and with significant upside available as the equity is great as the management are generally desperate.

    It would be good to understand the financials involved in the Succession transaction particularly as the last accounts show a fairly stretched balance sheet. Unfortunately it is not possible to find the profitability of the business as they are still claiming the small firms exemption for audit purposes. You can however see that the movement in shareholders funds suggests a fairly decent loss being made.

    Maybe the nerve is more of an open wound that Phil has prodded.

  7. I was wondering why you instantly assumed I was talking about your business, Simon, given your hastily written and rather tetchy looking response. You don’t seem to like answering questions about your own business. I was asked to write about consolidator models, feel free to talk the points made. I’m happy to ask more detailed questions on Succession if you like? I think that would be of interest to readers of Money Marketing.

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