As the succession planning transaction market continues to accelerate, independent financial advisers who are nearing retirement and seek a partial liquidity event as part of their succession plan are realizing that prevailing wealth management industry lending options may not accommodate their needs.
Take the recent example that I encountered of an independent adviser based in the Midwest who has built significant wealth over the course of his 30-plus year career, most of which was concentrated in his wealth management business. At 60, he had no interest in retiring, but he wanted to increase his liquidity and diversify his net worth, as he had advised countless of his own clients to do over the years.
When he initiated his search for financing for a partial sale to his two junior partners while maintaining a controlling interest in the practice, his plans were quickly stymied by the fact that a propensity of wealth management industry loans are funded through Small Business Administration lenders that would not accommodate this kind of transaction.
Instead, after researching the evolving lending landscape for independent financial advisers, he was eventually able to sell 48% of his practice to his partners for $3.4 million, but the transaction was funded by a conventional bank loan to his partners — not an SBA loan.
With this example in mind, advisers who are interested in pursuing a partial sale of their practice and have buyers — such as junior partners in the business — who require financing to execute the transaction need to carefully consider a number of key factors from the outset.
No Deal Not an Option
First, let's establish that not doing a deal and instead winding down one's practice through voluntary and involuntary client attrition as retirement nears isn't in the best interests of any key stakeholders.
Under this approach, nobody benefits, including the independent financial adviser, the independent broker-dealers they are affiliated with, and most importantly, the clients who have not been referred to an adviser to provide continuity of their financial plans.
When No Exit Means No Loan
Yet restrictive financing options that prevent a flexible approach to succession planning transaction structures might help explain why 98% of independent advisers never sell their practice at retirement, according to FP Transitions founder David Grau Sr.
The SBA program places specific restrictions on how buyers and sellers structure succession transactions. Specifically, the SBA 7(a) program requires that the seller departs the practice entirely within 12 months of closing.
In stark contrast, conventional bank financing allows sellers to transfer whatever percentage of their practice they desire over any time line that they set.
Top Loan Terms to Focus on
Advisers pursuing a partial liquidity event need to carefully consider how the terms of a loan to facilitate such a deal could negatively impact the new equity partner or partners, and ultimately their practice.
In particular, financial advisers need to consider three key financing factors: borrowing scale, fixed versus floating rates, and default ramifications.
It's worth emphasizing here that the SBA limits each borrower to a maximum indebtedness of $5 million total. As a result, a successful practice may be quickly capped out after two to three acquisitions or one larger transaction.
Additionally, a significant percentage of SBA loans are funded at a floating rate, which may be a cause for concern over time in an uncertain interest-rate environment. And in the worst-case default, an SBA borrower's home is not necessarily protected in bankruptcy.
Know Your Choices, and Risks
Advisers who pursue a partial liquidity event need to chart a succession strategy that mitigates the probability of any worst-case scenario involving default, in no small part because clients need an adviser who can focus on growing their wealth, not on their own financial woes incurred through borrowings that aren't the best fit for their business.
Conventional loan structures may provide reprieve to some borrowers by extending financing above SBA limits, offering fixed rates, and not requiring advisers to place a lien on their home.
While SBA lenders are a vital source of funding for specific M&A transactions, independent advisers who demand more flexibility through a partial sale succession plan may find their interests best served by a conventional bank loan, rather than SBA loans.
Scott Wetzel is founder and managing partner of Succession Lending, which focuses on independent adviser M&A transactions.