Acquisitions are a great way to grow your financial advisor practice quickly. However, many financial advisors struggle to decide the best way to finance the purchase of a book of business. For a long time, advisors had limited options, but as the industry has grown and the profession has become more established, advisors now have several financing options for purchasing a book of business.
Generally, financing options for purchasing a book of business fall into three categories: self-financing, seller financing, and loans. Each option has its own advantages and disadvantages, and what is best will vary based on the situation and the advisor’s preferences. We discuss each option and the pros and cons below.
Depending on the size of the business and your personal liquidity and resources, you may be able to finance the purchase of a practice yourself. Self-financing eliminates any obligation to a third party such as a lender or investor. Thus, there is no risk of losing ownership or control over the business if a financier decides to call the loan or if you fall behind in payments. Also, by self-funding, you keep your financial liabilities low, which can positively influence cash flow and minimize liabilities during lean times.
However, most financial advisor firms sell for an average of $1 million dollars. That’s a significant amount of money to provide at once. Not many people can generate that kind of cash or are willing to liquidate assets (and impact their personal net worth) in order to facilitate purchasing a business. As the sole source of funds, you also assume all risk should the deal go bad.
Even for those who do have the liquidity to purchase the business outright, the upfront cost of buying the business can tie up much needed capital. Those funds may be better used to invest in growing the business or providing a safety net during market fluctuations.
Another option many people consider is seller financing. The terms can vary significantly, but overall there are a few common advantages and disadvantages. First of all, when it comes to advantages, if a seller is choosing to finance the deal, they know they are also earning interest or a specific premium above the actual purchase price. In some cases, they may agree then to lower the actual purchase price, or at least to a lower down payment in order to secure the deal. Additionally, financing through a seller often requires less paperwork and is a simpler process. Still, both parties should secure legal counsel to make sure they both know, understand, and agree to all terms.
Unfortunately, the reality is very few sellers are willing to serve as lender too. Often, when they have made the decision to sell it is because they want completely out of the business and are ready to move on. They are not interested in staying tied to the firm, even just as financier. If a seller is willing to lend, they rarely are willing to finance beyond 5 years and often they want interest and terms that are too high for the buyer. Under such conditions, the “loan” is quite expensive to the buyer and can significantly and negatively impact cash flow for the business.
The most common method of financing the transaction is through loans from a financial institution such as a bank or credit union. There are many reasons to go with lender financing in an acquisition. First of all, loans from banks and credit unions often come with better terms than seller or investor related financing. This includes lower down payments, lower monthly payments, and better interest rates versus other methods of financing. This allows the buyer to maintain positive cash flow and secure the business in a timely fashion.
The other advantage is that a bank or credit union is able to fund the loan at closing, which means the seller is able to collect all of their money the moment the transaction is complete, minus any attrition clause escrow funds, should that apply. For a motivated seller who is ready to retire, this is a significant perk.
Of course, any loan means that there is a long-term financial obligation. Typically, a business acquisition loan is financed over a 10-year period. This is a significant commitment and should be considered when reviewing financing options. Also, with any loan, the lender assumes a first position role as lienholder on any collateral offered to secure the loan. Sometimes the collateral is only business assets, but in some cases, borrowers offer personal assets for collateral as well. This is a risk every borrower should weigh heavily before securing a loan.
When it comes to determining what route is best for your situation, review the pros and cons for each option against your financial position and long-term goals. Determine what amount of risk you are willing to shoulder, as well as who you would rather have as lienholder if you choose to finance. Make sure you know and understand all terms and how they will impact not only the acquisition, but the cash flow of the business for the next several years. Choose the option that not only gets you the deal, but that puts you in a position for manageable growth moving forward.
Looking to buy a book of business?
If you are ready to purchase a book of business and don’t know where to start, our free guide on Acquiring a Financial Practice can help guide you through the whole process. From finding a book of business to purchase, to onboarding new clients, this 45-page guide will help you navigate the ins and outs of financial advisor acquisitions.