As part of my role at
Focus Financial, I regularly talk to advisers who are considering selling some or all of the equity in their business. Naturally, one of the most common questions I hear is: “Is this a good deal?” Most advisers focus on the valuation alone. If you are leaving the business, this is for the most part sufficient. However, if you plan on sticking around and working with (or for) the buyer, valuation is only the starting point.
Just as any prospective buyer will need to perform due diligence on your business, you need to conduct that same due diligence on theirs. Internally at Focus, we refer to this process as “reverse” due diligence. While reverse due diligence cannot guarantee a great valuation, it can certainly help to avoid a poor cultural or business fit. The following is a short list of basic – but very important – reverse due diligence questions that every potential seller should make sure they understand.
“Show me the financials!” In the heat of the moment, this crucial yet obvious point is often overlooked. In most deals you will not receive all the consideration upfront. It's important to understand whether the buying firm will have the money to meet their obligations a few years down the road. We recommend measuring profitability by using EBITDA, which gives a clean view of enterprise cash flow. It's also important to have a good picture of the firm's financial history: if there were losses, how were those losses funded? Is there default risk? You should review at least three years of audited financial results, including a P&L and balance sheet.
Second,
“How much control will I have over my firm after the deal?” Perhaps the simplest way to get a sense of this is to ask the question a different way – “Will I be an employee?” If you can be fired, you do not own equity value in your business, rather you own shares in your employer. Additionally, the amount of control you have after the deal pertains to your firm's investment choices, as well as hiring and firing decisions. If you are an employee, your firm can limit your investment choices or provide incentives to sell a particular product. Simply because a firm isn't doing this kind of thing today does not mean you are protected from it in the future.
Third,
“What is this offer really worth?” Cash is very straightforward. A dollar is a dollar. Equity in a buyer, though, can be a bit trickier to value especially if the buyer is a private company. A few sample questions here: will you own the same share class as management and the investors? When the buyer does their next deal, will you be diluted? Will management and investors be diluted as well? What is the liquidity strategy for this equity?
Fourth,
“What is the buyer's overall strategy?” We've all seen advisers be acquired by regional banks and then struggle with the different environment they find themselves in. What is the buyer's plan? Will your team continue to operate as an independent unit, or will some aspects of your business be centralized? Will you be part of a branch? How much freedom will you have to hire employees or choose systems that work for your business? Another area to examine is the firm's relationship with vendors: does the buyer have revenue sharing deals with vendors, or make money from platform or product spreads? If so, it's important to know how much freedom you will have to choose custodians or vendors who are not participating in the scheme.
Equity is a precious thing – it is the value that you build up, client by client, over the course of a career. Realizing that value is your reward for the hard work you've put in and the long hours you have spent serving clients. By asking the right questions, you can make sure that you are getting a great deal after all.
Rich Gill is a Managing Director at Focus Financial Partners and Head of Focus Connections. He is responsible for business development and acquisition activities at Focus, with a particular concentration in counseling strong broker teams and individuals from wirehouses.
