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Setting sale

There are many reasons why an IFA might be interested in broadening their capital base or seeking a full change of ownership. Of specific and immediate concern is CP121 and Sandler&#39s recent proposals. More broadly, issues such as the EU directive on disintermediation will affect organisations that have an insurance brokerage arm.

The decision to sell may be the most difficult emotionally but the transaction itself will be no less demanding.

Having made the decision to sell, you need to decide what organisation will provide the best strategic fit. This will be as important as the hard cash offered because this, without exception, will be dependent on the generation of future revenues and retention of existing business as much as the current balance sheet value of the business.

It is fairly clear that future business performance will be directly affected by how the new regime fits with the old.

As we have already seen, under the FSA&#39s CP121 proposals, security of supply of new business becomes an increasing concern to product providers, hence the scramble to acquire IFA businesses.

However, the acquisition of estate agency businesses in the late 80s and the subsequent disinvestment means that providers are taking a far more cautious approach, with a much more realistic view on valuations, when appro-aching the acquisition of IFA businesses.

The first step for any IFA is to establish contact with possible buyers. A number of organisations have stated they are acquisitive and these are the obvious first port of call.

Considerations for buyers and sellers

There are a number of factors for the buyer and seller to consider, including strategic fit and target selection, screening and due diligence and valuation.

Personal motivation will be very important. Legally and ethically, a provider buying of an IFA should not make any difference to the business, but some IFAs will be uncomfortable at the thought of poacher turned game keeper.

Equally, it is vital to consider whether a vendor, used to being in control of his own destiny, will be comfortable working with the input or under the direct management control of an acquiring firm.

Several recent acquisitions have prompted a flurry of unnecessary defections which could have been avoided with more careful management.

Key questions include what the future role of the principal will be. How will he or she be remunerated? What happens if he or she wants to stay longer than five years? Who will be the authority and who specifically will the person report to?

Aims of the buyer

The potential buyer of an IFA firm will be particularly interested in sustainable profit.

A bigger firm with a high level of turnover spread between several advisers is likely to be of most interest on the grounds of sustainability.

As a guide to what is an attractive acquisition, a £1m turnover and a minimum of eight advisers would be considered the minimum.

All businesses can expect to be subject to due diligence. The buyer will want to understand not only the financials, as detailed in the report and accounts but also the way the business operates.

For example, the following questions will be asked – the quality and key performance indicators of the advisers, the percentage of commission retained by the business as opposed to paid to the adviser, the cost structure of the business, its profitability (current and projected), business plans and profit forecasts, current and future operational management, customer type, value and longevity, technology used, quality of central and decentralised administration.

All these criteria and a whole host of other criteria will then be compared with your peer group and other uses for the capital.

It is prudent to address all the issues before they arise and deal with any potential queries in advance.

The key to understanding the potential value to an acquirer and seller is a thorough understanding of where and how value is created in the target business and the impact that a sale might have.

Most buyers will work on a form of discounted cashflow techniques to estimate the value of the business or its component parts.

The value of an IFA firm will always be on an individual basis. However, the most common approach is to link the value to a multiple of net profit after tax.

As a guide, a multiple of between three and eight times is often quoted. One or two buyers may consider all cash purchases but these are likely to be at a significant discount to true value.

In addition to profit realised, the value will be subject to the strength of the business model and the profitability of its infrastructure.

Most buyers will want the advisers within firms to also benefit directly from any purchase, as the true value of an IFA business rests with the advisers.

As it is commercially challenging to tie advisers to a firm after buying the firm, it is likely that in the medium term, an acquisition involving shares, an earn-out period and an element based on future profitability will be more desirable and lucrative for all involved.

If shares are being offered as part-consideration, then the performance of the buyer and the liquidity of the stock will be all-important.

Principals should expect a two-year to five-year earn-out period linked to their consideration.

This will benefit clients, staff and advisers and will help to secure the future of the business while ensuring a smooth transition.

In an ideal world, the sale of a business should lead to a host of opportunities for all parties involved in the transaction. The buyer gains extra profit and market penetration and the vendor crystallises value. But in addition, the business unit acquired should gain access to working capital and advantages of scale, such as integrated IT and marketing, branding, access to strategic management and recruitment assistance. This may be particularly important when a phased purchase consideration, linked to a business plan, is agreed, as this will help all parties achieve their objectives more quickly.

By exchanging control for capital, a business may be able to harness other opportunities which, with careful thought and planning, could yield new income streams, controlled costs and an increasing income both for the principal and his team.

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