Are you an attractive acquisition target?

By Paul Barrett, CEO AZ Next Generation Advisory

Since launching AZ Next Generation Advisory earlier in the year, I have received a lot of questions about what our ideal target firm looks like. I reckon I get asked this question on a daily basis. My off-the-cuff answer usually included words like profitable, growing, quality, client segmentation, corporatisation and the like.

If I’m brutally honest gut feel has played a large role as well. Knowing the people in charge helps too, as does understanding their financials in detail. In any case I have been able to compare and contrast a lot of firms recently as well as over my career. I’d like to present here the things that I believe make a firm ‘attractive’.

Firstly I’d like to state the obvious. Not all firms are equal! If you were to build an “attractiveness index” and rank all firms based on their key drivers of “attractiveness” you’d probably end up with a normal distribution, or bell curve. What is it about the firms at the right edge of the bell curve that makes them so successful?

If you consult any of the number of ‘best practice’ manuals or consulting firms they will tell you that these firms are organised, efficient, corporatised, have eliminated key person risk, and have built a sustainable going concern. These concepts all work in theory of course. They are well thought out conventions gracing conference agendas and PD days all over the industry, probably all over the world.

As compelling as these conventions are, they are somewhat idealistic. One session with a consultant talking about this stuff would leave most mere mortal business owners feeling very inadequate indeed. I’ve spent over 20 years working in very large, well-resourced institutions (some very successful ones) and they would find it difficult to measure up to these supposed best practice ideals.

Some of the best practice ideals could potentially destroy value. For example, I always hear the theory that says you must eliminate key person risk. It sounds good in theory, and there is some real benefit in ensuring no individual has all the power, however it’s a notion that is fanciful. When I think about successful sports teams, rock bands, and corporations, there is normally some spectacular individual talent involved. Would the Rolling Stones be the Rolling Stones without Mick or Keef? Or would they being playing the suburban pub scene like my band!?

So in the spirit of keeping it real, the first thing I look for is the involvement of a visionary leader, someone who has driven the business through tough times, who is able to unite those around them. This person shouldn’t have all the client and supplier relationships (which is what I think the consultants are on about), but they will provide the critical ingredient of CLEAR LEADERSHIP.

The clear leadership will be accompanied by VISION & A LONG TERM PLAN. The best definition of vision I have come across is “being able to see around corners”. The leader or leadership group of the most successful practices takes a long term view and tries to anticipate different future scenarios. For instance, those businesses that switched to fee-for-service ten years before FOFA had vision. They saw an inevitable shift in the landscape and adjusted early.

The best practice manuals all talk about having an organised approach to Human Resources. Job descriptions, career paths, remuneration models, succession– does this stuff ring a bell? These items are all very important and good firms have them, however great firms have something more important than HR tools. They understand the role of HUMAN CAPITAL. Successful business owners understand that the most difficult thing to create, and replicate is Human Capital. Anyone can copy a system, a service offering, or a product. It is almost impossible to replicate the chemistry, the culture, and the intent of a successful team. When we talk to firms we take a very close look at the staff and their relationships with each other. The ‘best practice’ manual will tell you to look at tenure, experience and qualifications. These things are merely tickets to the game. A far more telling factor are the inter-relationships between office administration staff, para-planners, CSOs, planners and management. How shareholders interact, a lack of ‘groupthink’. The cumulative behaviours of all of the players create culture. We need as many observations of this as we can during the courting phase.

I was recently asked to pitch the AZNGA offering to a large firm that had been around for a while, but a firm I did not personally know. When I looked at the financials I had every reason to get excited. They were a large firm, reasonable growth, good profitability etc.

It took me about 25 minutes in their boardroom to establish that this firm’s best years were behind it based purely on my observations of their “Human Capital”. I watched the senior principle try and grandstand by puffing out his chest and showing me and everyone else who was boss. I saw the younger planners attempt to mimic this behaviour, and most critically I saw a complete lack of alignment of interest between the shareholders. Here is a firm with strong financials based on past performance clearly headed for the left edge of the bell curve!

The next key element we look for is another cultural element. The most successful people in life are always open to learning from others, are open minded and listen. These people, in business, typically create what I call a culture of CONTINUOUS IMPROVEMENT. The best place to look at to understand what I mean here is modern professional sporting teams. Here is an environment where players are monitored electronically – how many meters, tackles, calories, speed, endurance – it’s all monitored, fed back in real time to players, benchmarked, and improved upon.

If you want to live at the right edge of the bell curve you need to be obsessed with measuring things, analysing the results, and making incremental improvements every single day. In early discussions with a firm we have now acquired we were talking about implementation of model portfolios. The key principal said ” y’know it takes me 13 minutes per client to implement a manager change in our models. We have over 500 clients – that takes my team a month to execute”. I was immediately impressed – yes there is a business problem to be solved – but here is a business leader who understood the problem because he was obsessed about measuring things and understanding the consequences. Do you reckon that adviser understands his business, and understands what good looks like and how to get there? you bet!

A culture of continuous improvement is normally accompanied by inclusiveness because you need to involve everybody to understand where the incremental innovation is going to come from. It’s a real lead indicator for us. A great principle that I learnt earlier in my career is that large one-off innovations are rare. The best way to innovate is by making incremental improvements every day. In a number of roles I have had in my career I have implemented a “one Improvement per team per week” initiative resulting in hundreds of small innovations over a year. The result of each team implementing one simple cost-effective improvement every week is….well transformational!

Now let’s focus on financials. It’s pretty obvious that successful firms have P&Ls that reflect good revenue growth, disciplined cost management, a focus on building ongoing revenue, and scale benefits. These things are all givens. To be honest there are two other financial statements that hold the real gold nuggets or in some cases poison chalices! They are the CASH FLOW statement and BALANCE SHEET! Cashflow is the lifeblood of small business. Fast growing businesses typically find it more difficult to get the cashflow right. They have a unique challenge of investing ahead of realisation of profit which creates a cash drag. We are currently assessing a firm who have ticked every box on our checklist, and in many ways are our ideal firm. We have put that deal on hold for a few months and set the firm a challenge of building up a certain cash reserve. This will tell us unequivocally whether or not they can manage cashflow.

However it’s often the balance sheet where the magic lies. The balance sheet tells you about how a business has been managed over time. It also tells you about structure. One of the critical mistakes small businesses make when they set themselves up is that they are more focussed on tax optimisation than building long term value. It’s all good and well to have partnerships of trusts, unit trusts, discretionary trusts, partnerships, and inter-company loans whilst you are operating year to year. However these types of structures can be very unattractive to buyers, increase legal and accounting costs, and often prevent a deal getting done. There are exceptions of course, however A SIMPLE STRUCTURE IS BEAUTIFUL!

Now let’s turn our attention to clients and client bases.

In my experience the most successful firms have a clear view on who their ideal client is and are well geared up to service that client and equally prepared to refer clients who do not fit the model to others. It is vital that the FEE STRUCTURE KEEPS UP WITH THE TIMES, is reviewed regularly and implemented across the entire client base.

We also like to understand a firms approach to “legacy clients”. There are a number of strategies that can be employed to deal with clients that no longer fit the ideal client model that the firm now operates. At AZNGA we are fans of communicating the contemporary approach, along with the appropriate service offer and pricing and asking clients to sign up to this, be engaged in the planning process or seek alternatives.

On the compliance side of things we look at all of the usual things however there are two vitally important considerations.

Firstly we have a good look at CLIENT COMPLAINTS. In my experience client complaints are a valuable lead indicator to future problems. I remember a situation where a complaints department had received around 7 very similar complaints regarding one adviser over about 6 months. The complaints department viewed them all as one-off. By standing back examining complaints over a long period and consider them as one you can very quickly identify more sinister or systemic issues.

The second vitally important consideration is how a firm approaches investing. ADVISERS ARE FIDUCIARIES and should be obsessed about where their clients’ monies are invested, however they should not pretend to be fund managers. We look for evidence of good governance, investment committees, implementation of well researched models. We avoid firms that take tactical asset allocation decisions or behave like stock pickers.

So in a nutshell the things that make a financial planning firm attractive to us are:

  1. Clear Leadership Structure
  2. Clear Long Term Vision
  3. Genuine commitment to staff
  4. Culture of Continuous Improvement
  5. Year on Year profit growth
  6. Profit Margins of 35%
  7. Simple Structure
  8. Low level of client complaints
  9. Fiduciary mindset to investing with efficient implementation

To find out more contact Paul Barrett at paul.barrett@aznga.com