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    Understanding, Managing & CapitalizingOn the Psychology of Buying Or

    Selling a Wealth Manager

    May 2015

    Mark P. Hurley

    Benjamin J. Robins

    Yvonne N. Kanner

    Steven E. Cortez

    Patrick D. Myers

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    Fiduciary Network, LLCMark P. Hurley is Chairman and CEO of Fiduciary Network, LLC. Benjamin J. Robins isPartner. Steven E. Cortez is Partner, Yvonne N. Kanner is President & COO, and Patrick D.Myers is Assistant General Counsel.

    Fiduciary Network provides debt and permanent capital to wealth managers for threepurposes: (i) to fund the acquisitions of other wealth managers; (ii) to fund the repurchaseof equity from outside shareholders; and (iii) to fund internal successions. To date, FiduciaryNetwork has nanced 17 transactions involving wealth managers that have approximately

    $22B of assets under management.

    © Copyright Fiduciary Network, LLC 2015This material is for your private information, and we are not soliciting any action based upon it.Opinions expressed are our current views only, at the time of writing. The material enclosed isbased upon information that we consider reliable, but we do not represent that it is accurate orcomplete, and it should not be relied upon as such.

    Cartoons in this paper are copyrighted by The Wall Street Journal, Permission Cartoon FeaturesSyndicate

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    Table of Contents

    I. Introduction ............................................................. 1

    II. Understanding the Psychology of Sellers ................... 4

    III. Understanding the Psychology of Acquirers ............. 19

    IV. How Savvy Sellers Manage Their OwnPsychology in Transactions .................................... 28

    V. How Savvy Acquirers Manage andCapitalize on Seller Psychology .............................. 38

    VI. How Savvy Acquirers Manage TheirOwn Psychology in Transactions ............................. 46

    VII. How Savvy Sellers Manage andCapitalize on Buyer Psychology .............................. 52

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    Acknowledgments

    This report is another in a series of white papers that we have written on thewealth management industry. As was the case with the others, it is intendedas a resource for industry participants.

    However, it is different than its predecessors, which focused primarily on theeconomics of providing advice. In this study, we consider the psychologicalchallenges faced by buyers and sellers of wealth management rms.

    Our goal in writing this paper is simple: we want to help owners of wealthmanagers who are prospective buyers or sellers to have a greater chance ofsuccess in completing deals. Why? A big part of our business involves providingthe funding for M&A transactions.

    Another way to think about what we have tried to provide in this report is toconsider two popular books – What to Expect When You Are Expecting andMen Are From Mars, Women Are From Venus – that looked at issues not at allrelated to any kinds of mergers and acquisitions transactions. The former is aguide for soon-to-be parents about all of the surprising aspects of a pregnancyand the latter tries to help the different sexes to better understand howmembers of the other sex think.

    Similar to What to Expect , we want to help owners of wealth managers whohave little M&A experience to better understand the many (often unexpected)psychological issues that they will likely have to address should they either selltheir rms or attempt to buy someone else’s. Similar to Men Are From Mars ,because we have found that buyers and sellers often think about transactionsvery differently, we have tried to give both buyers and sellers an idea of whatthe other side might be thinking and thus, how they might behave.

    To date, we have made 17 investments in wealth management rms thatcombined manage approximately $22B of client assets. However, we haveseen numerous transactions fail that could have (and probably should have)been completed. Unfortunately, in these transactions, a combination of thebuyers’ and sellers’ inexperience and each side’s inability to understand theother’s perspective became insurmountable obstacles to completing a deal.

    It is important to note, however, that we do not consider ourselves to bepsychologists and do not pretend that this report is any sort of scienti c study.Rather, it is based on a collection of observations of hundreds of buyers andsellers gathered from potential transactions over the last eight years.

    We also do not pretend to be mind-readers. The psychology we describe has

    been distilled from those observations, our post-closing discussions withnumerous buyers and sellers and feedback and insights from consultants andinvestment bankers.

    Of course, every individual who works at either a buyer or seller is unique. Thus,the patterns of behavior we describe are only common patterns of behaviorand are not shared by every participant in a transaction.

    Similar to all of our other white papers, many of this study’s best ideas weregiven to us by several of the industry’s thought leaders. David Canter has built

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    Fidelity’s Practice and Management Consulting into an incredibly valuableresource for wealth managers. We have enjoyed our many vigorous debateswith him. David Selig, CEO and Founder of Advice Dynamics Partners, was kindenough to share several insights from his experience in advising numerouswealth managers throughout the United States. Dave DeVoe, Founder & CEOof DeVoe & Company, spent many years at Schwab advising the owners of

    wealth managers on strategy and valuation prior to launching his own nancialservices consulting business. He has shared his thoughts with us in manydifferent discussions over time.

    Over the last several years we have also been fortunate to nd ourselves onnumerous occasions across the table from very capable investment bankersrepresenting prospective sellers. They included Steve Levitt and Jaime Carvalloof Park Sutton; Liz Nesvold, Erika Cramer, Ed Higham and Jeff Brand atSilverlane; Jon Stern, Scott Ketner and Caleb Burchenal of Berkshire Capital;and John Temple of Cambridge International. Each has had the dif cultchallenge of guiding (often very emotional) sellers through lengthy transactionprocesses. In every deal they helped us to better understand the perspectiveof their clients and many of the insights included in this report are based onwhat they have shared with us. We also have little doubt that many of theanecdotes about bizarre seller and buyer behavior included herein will makethem smile (or perhaps, grimace).

    Finally, the authors would like to thank June Slowik for reviewing and editingthe nal copy and for her many thoughtful comments.

    All of the aforementioned individuals contributed greatly to this report. Any ofits de ciencies, however, are solely our own responsibility.

    Mark P. Hurley 972.982.8705Benjamin J. Robins 972.982.8704

    Yvonne N. Kanner 972.982.8702Steven E. Cortez 972.982.8703Patrick D. Myers 972.982.8712

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    I. Introduction

    Over the last few years there has been a surge in the number of wealthmanagers brought to market. In fact, there have been a greater number ofmaterial-sized rms put up for sale in the last 24 months than there were inthe previous four years.

    There is an obvious explanation as to why this is happening: the founders ofmany rms are getting old. Many of these founders launched their businessesin the early 1990s when they were in their late thirties or early forties. Twentyor so years later, the average age of a founder is now 62. Soon, most ofthese individuals will need to conduct their own personal nancial planning.Completing a transaction could have an immense impact on the quality of theselling owners’ retirement lifestyle.

    For example, recently, there have been sales of rms with around $5M ofannual revenue that could each potentially generate more than $30M ofconsideration for their owners. (Yes, 6x revenue). Certainly, these transactionsinvolved wealth managers with relatively attractive client bases and that weregeographically proximate to their acquirers. Additionally, a substantial portionof the potential consideration in these deals was tied to post-closing growthof the selling rm. Regardless, each of these transactions provided the sellingowners the opportunity to build substantial wealth.

    At the same time, we are beginning to see the emergence of a new generationof wealth management rm owners – younger advisors who either havestarted their own new businesses or have bought out rst generation foundersin more established businesses. Many of these rms are extremely interestedin acquiring their peers.

    These younger owners’ interest in acquisitions is in no small part due to the lawof large numbers. More speci cally, these businesses now are substantiallylarger than they were only a decade ago. Their costs are typically rising atabout 5% to 7% per year and as the average age of their client bases hasincreased over time, so too has their rate of capital consumption.

    Thus, these owners face a dif cult challenge. Unless they nd a way to addincreasingly larger volumes of new clients each year, their earnings will grow (atbest) very slowly. However, many of these owners are ambitious and view theidea of achieving economics that are somewhat analogous to owning equityin a utility (i.e., 2% to 3% earnings growth while paying an annual dividend) asunacceptable.

    Unfortunately for them, sustaining high rates of client growth is by no means

    an easy feat. The industry has become much more competitive for new clients.Additionally, there is a chronic shortage of quali ed and experienced successorprofessionals to service them. 1

    Acquisitions offer these owners a potential opportunity to address bothproblems simultaneously. They enable an acquirer to add large volumes ofnew clients at once while at the same time add several additional experiencedsuccessor professionals.

    1 By one estimate only 22% of the professionals in the industry are under the age of 40.

    Slow growingwealth managershave similareconomics to autility

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    For example, if a wealth manager with annual revenues of $6M and a netpro tability of $1.5M acquired another rm with $5M of annual revenue thatwas geographically proximate, it could potentially generate as much as $3Mto $3.5 of accretion (i.e., increased marginal pro tability). 2 This would bethe equivalent to front-loading seven to eight years of organic growth (whilesimultaneously expanding operating margins). With such potential economics,

    it is easy to see why so many wealth managers have ambitions of becomingacquirers.

    Far fewer deals have happened than might have been expected

    Given all of this potential interest from both buyers and sellers, one mightexpect that large numbers of transactions would be announced every month.Acquisitive wealth managers should be snapping up other rms as sellingowners monetized the value that they have built over many years in theirenterprises. However, to date, this has not yet happened.

    Certainly M&A activity has picked up over the last couple of years and,according to Schwab, in 2014 there were 47 transactions involving rms with acombined $47.4B of assets under management. Unfortunately, as impressiveas these numbers may sound, they are misleading for a couple of reasons.

    First, because there are so many wealth managers, the number of dealsrelative to the size of the industry is tiny. The 47 transactions announcedlast year constituted less than one quarter of one percent of the industry’sparticipants.

    Additionally, in most years there has been a “barbell” nature to the deals thathave been announced (i.e., there are typically a very small number of dealsinvolving large rms and, most of the remaining transactions involve relativelytiny rms). 3

    So why are we not seeing more completed deals?

    Many failed because what were for sale were not really businesses but rather“books of business”—in other words, their owners had nothing to sell. Otherswere rife with internal problems due to a dysfunctional relationship betweenthe rm’s owners and its successors. Their mutual animosity made theirbusinesses unattractive to prospective acquirers.

    However, the most frequently overlooked hurdle to completing transactionshas been “psychology” – more speci cally, a failure of both buyers and sellersto understand their counterpart’s (as well as their own) emotions, frame ofmind and behavioral tendencies during a transaction. In many cases, there

    were willing sellers and interested buyers at the table. But, when each side wasincapable of understanding the other’s perspective, negotiations deterioratedquickly. Participants on both sides either concluded that a transaction wouldnot be a good t or that their counterparty was simply nuts.

    2 In our experience, acquirers that buy geographically proximate rms can often strip a great deal of redundantcosts and generate contribution margins of 60% to 70%.3 This trend has continued in early 2015. For example, there has been more than a little media excitementthat in the rst quarter of this year there were 14 deals totaling $29B of AUM or more than half of the totalAUM involved in those deals completed in 2014. However, nearly 80% of the AUM was captured in just threetransactions.

    In 2014, less than0.25% of industryparticipantscompletedtransactions

    Psychology: Thehidden obstacle totransactions

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    It is hard to overstate the importance of psychology in wealth managementM&A transactions. In our experience, it is a far greater determinant of successthan economics. In fact, we have found over the last eight years that themarket for wealth managers is priced relatively ef ciently and the amountdifferent buyers are willing to pay for any particular rm does not vary widely. 4

    Rather, most transaction participants who were successful recognized thattheir counterpart’s motivation for and approach to a transaction was likelygoing to be very different than their own. They also accepted that theircounterparty’s behavior at times might seem a bit odd given the inherentlyemotional nature of buying or selling a business.

    Further, successful buyers and sellers had suf cient self-awareness torecognize that they, too, faced a set of psychological challenges. They werecareful to ensure that their own decision-making and behavior was not undulyin uenced.

    The purpose of this study is to provide buyers and sellers with insight intoboth their counterpart’s as well as their own psychology during a transaction.We also have provided a road map designed to (1) help buyers and sellers tobetter manage their own challenges in a transaction and (2) provide ideas onhow buyers and sellers may capitalize on the mindset of their counterpart.

    This report is based on what we have observed of both buyers and sellers inthe numerous transactions with which we have been involved over the lasteight years (including many that were never consummated). Again, every buyerand seller is unique and these are simply examples of the common buyer andseller psychology and behavior that we have encountered. Not every issue orbehavior described in this report is shared by every buyer or seller.

    That much said, we have found only a small number of prospective buyersand sellers have even considered the importance of understanding theircounterpart’s and their own psychology prior to becoming involved in atransaction. Those who understand the psychology of the transaction clearlyhave had a competitive advantage. We hope that readers are able to use thisstudy as a tool to likewise improve their likelihood of success.

    4 When we describe the market for wealth managers as being ef ciently priced we are referring only to thosebuyers who pay for their acquisitions with cash as opposed to stock of indeterminate value and liquidity.

    Buyers generallypay thesame, makingpsychology moreimportant thaneconomics

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    II. Understanding the Psychology of Sellers

    There are six key aspects to typical seller psychology:

    1. Sellers are not monoliths.

    Wealth managers are little more than agreements by their employees to worktogether. They have no meaningful tangible assets. Consequently, the potentialenterprise value of an advisory business is based solely on the goodwill that itsemployees have accumulated with clients over many years.

    Additionally, all rms have some sort of internal “deal” – parts of whichmay be contractual and parts of which may only be implied – as to the

    rm’s governance, the roles of each person and the allocation of the rm’seconomics. The sale of a rm is effectively a re-cutting of this agreement.

    However, wealth managers are not monoliths. Each contains variousconstituencies, including owners who want to sell, potentially some ownerswho do not and successor professionals. Each individual has his or her ownunique set of goals, perspectives and biases.

    2. Arriving at the decision to sell is difcult for many owners.

    To date, one factor has dominated the reasons why wealth managers werebrought to market: their owners’ age. Certainly, sellers often like to pointto other, loftier reasons (e.g., increased scale, broader product offering,“strategic” reasons, etc.) for selling — but those factors have rarely played ameaningful role in transactions that have been actually been completed.

    Why? Because wealth managers have remarkably loyal client relationshipsthat throw off immense amounts of predictable cash ow. They also offer – tobe completely candid – a quite attractive “work-life balance.” In an industry inwhich owners can take six to twelve weeks of vacation per year and still takehome more than a quarter of a million dollars per year, it is dif cult to imaginewhy any rational owner would ever want to leave his position Consequently, theusual, non-demographic factors that drive owners in other industries to sellhave been (at least to date) largely non-existent amongst wealth management

    rms. 5

    Additionally, while founders of wealth management rms certainly are“entrepreneurial,” they should not be confused with “serial entrepreneurs”in other industries. The latter aim to build multiple companies – potentiallyacross multiple industries – over the course of their careers. For these types,the sale of any individual company is simply a demarcation point for starting

    their next enterprise.

    In contrast, the only business that most owners of wealth managers will everstart is their rms. In fact, many were motivated less by a desire to makemoney than to be able to provide nancial advice in a manner designed to bestprotect their clients’ interests. And once they have sold their companies, it isunclear as to what these owners will do and whether anything else will providethem with the same sense of purpose.

    5 We have found that divorce is typically the only other reason owners of wealth managers may suddenly needliquidity for their ownership.

    All rms havesome sort ofinternal “deal”

    It is difcult toimagine why anyrational ownerwould want to sell

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    Consequently, wealth management rms are of ten brought to market only whenowners reach an age at which they recognize that not selling would be personallyeconomically irrational (if not suicidal). Critically, because age is the driver, atransaction is much more than just an economic event. Rather, it represents alife passage – the end of a major phase of the selling owners’ lives.

    Bored Intellectual Nomads

    Over the last eight years we have encountered several owners in theirforties who explored the idea of selling their businesses. 6 None has everconsummated a transaction.

    A consistent trait amongst these “youthful” owners was that they couldnot articulate why they felt compelled to sell. While many talked aboutsome sort of theoretical “opportunity” that a potential transaction mightoffer, it quickly became apparent that they really did not have a goodreason for selling. Rather, it seemed to us that they were looking forsomething else (something “interesting”) to do other than adding thenext client.

    These putative sellers are prone to falling in love with every new idea ortransaction structure to which they are introduced. They also convince

    prospective buyers that they are unbelievably excited about doing adeal.

    Alas, what is driving these sellers’ interest is a combination of boredomand a sort of intellectual nomadism and not a desire to do a transaction.At some point they suddenly realize that selling their rm doesn’t makesense. And in the middle of the transaction process they typically beginto slow walk the deal, refusing to return the buyer’s calls with the hope

    6 It is important to emphasize that what we are describing here are owners who wanted to do an outright saleof their rms as opposed to create a mechanism for gradually transitioning its ownership internally.

    “Someday, I’ll be back and all of this will still be mine”

    Age is what forcesowners to sell

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    that the transaction will just go away. It is not unlike a teenage girl whowants to break up with a boy but is incapable of telling him this to hisface.

    3. Initiating a sale process unleashes strong emotions that can make it

    very hard for many owners to do a deal.

    Few advisors nd any joy in a decision to sell their rms. The typical ownerinitiating a sale process has been a nancial advisor for decades and hasenjoyed building, running and controlling a successful and often highlypro table business. These owners also enjoy a high level of social status withintheir communities as hundreds of wealthy families look to them for solutionsto some of their most complicated personal problems and entrust them withtheir family’s long-term nancial security.

    Thus, (and as rst pointed out to us by Dr. Andres Kanner, an internationally-recognized neurologist), the decision to sell can cause selling owners to behavesimilar to individuals who have just learned that they have an incurable disease.

    It is very dif cult to overstate the anguish that patients feel when rst toldof such a diagnosis. They face a loss of control, a recognition of their ownmortality and the elimination of a sense of invincibility (which we all carry tosome degree). Understandably, these realizations trigger a grieving processwith all of the typical stages (Denial, Anger, Negotiating, etc.).

    Certainly it is important not to over-dramatize all of this, but Dr. Kannerhas argued that when owners realize that it is time to sell their businessesthey experience many of the same feelings shared by these patients. Why?Because, just as the factors that contribute to a terminal diagnosis areout of a patient’s control, the primary factor driving the decision to sell(age) is out of the control of the owner and likewise creates a sense ofpowerlessness.

    The owners also see that by selling their lives will change irrevocably and (fromtheir perspective) potentially for the worse. Once they sell their businesses, theyare no longer its focal point. The loss of owning and running any business canstrip away one’s sense of professional status and purpose – a very frighteningprospect. Moreover, a sale forces owners to focus on their own mortality.

    Finally, many owners view their businesses as an extension of themselves —similar to how they view their children. A political commentator once said thatgiving your daughter’s hand away in marriage feels a lot like turning over yourStradivarius to an orangutan. For many owners, selling their rm to any buyer

    — regardless of the purchase price – can feel quite similar.

    Emotions unleashed by the decision to sell render many owners incapable ofdoing a deal

    Understanding the emotions that are often triggered by a decision to sell isvery important because it can create a somewhat odd mental state in manyselling owners. Because they are only doing a deal because they (effectively)have to, they often appear to resent the buyers. (Yes, it is as though they areangry at the very people who are about to give them many millions of dollars.)

    Selling one’sbusiness feelslike turning your

    Stradivarius overto an orangutan

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    More problematic, many prospective sellers wind up being emotionallyincapable of doing a deal. More speci cally, there is a widely used axiomin small private company M&A that there is some sort of “mental Rubicon”that a business owner must somehow get across in order to do a deal. Andif and until the owner reaches this point, he or she will never sell regardlessof price.

    The bad news for buyers is that, in our experience, when most prospectiveselling owners come to market they are still straddling this mental Rubicon.Although they are past the initial stages of grieving, they are still not quite yetat the point that they can do a deal.

    Unable to Get Over the Mental Rubicon

    Over the last eight years we have encountered many putative sellers whobegan transaction processes but were ultimately unable to close a deal.These owners actually believed they wanted to sell and, from a personal

    nancial standpoint, doing so made sense. They had also invested a greatdeal of their time and money exploring a transaction.

    Unfortunately at some point in the process it hit them that a sale was nolonger just a theoretical concept. They also realized that soon their liveswould change a great deal and this panicked them.

    Although these potential sellers never admitted outright that they were nolonger interested in a transaction, they began to take steps that were (or, atleast appeared to be) designed to scare off an acquirer. 7 For example, in oneinstance a selling owner suddenly refused to be personally party to any ofthe transaction documents, effectively gutting all of the representations andwarranties in the transaction documents. Another decided to launch a hedgefund – yes, a wealth manager suddenly decided to convert a part of his rminto a hedge fund in the middle of negotiating a sale of the enterprise toanother wealth manager. Still another (our personal favorite) selling ownerdemanded at the eleventh hour of the negotiations that his wife be put onthe buyer’s payroll, completely changing the economics of the deal.

    Ironically, it also appeared that these prospective sellers were largelyunaware that they were sabotaging their own transactions. Their behaviormore closely resembled a re exive response than a calculated decision.

    An obvious question is why so many selling owners would do this? Althoughthere are probably many reasons, we believe that a major factor wasthat many owners were unable to get far enough through their personal

    grieving process to be emotionally capable of doing a deal. In other words,they were far closer to “denial” than they were ‘acceptance.’ 8

    7 This is not to say that buyers do not walk away from transactions from time to time. However, in ourexperience, buyers – unlike sellers – make a “walk away” decision early in a transaction process; they rarelyget cold feet right before closing.8 At the same time, we have also found that once a prospective seller has crossed the “mental Rubicon” thereis no turning back. He or she is going to do a deal almost regardless of the nal terms. It is as though they areso exhausted from the grieving process that they cannot conceive of having to go through it again.

    Most prospectivesellers are stillstraddling themental Rubiconwhen they cometo market

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    4. During the transaction process, selling owners are scared,uncomfortable and even obsessive.

    Many buyers who have participated in wealth management M&A transactionprocesses have noticed the tendency of sellers to act a little, well, odd.And emotional. And peevish. One day hot and the next day cold. Generally,

    irrational. You could excuse the buyer for having confused the seller with apubescent teenager.

    In order to understand why, let’s review the factors that often drive a seller’sthinking during a transaction:

    Sellers recognize that they do not know what they are doing when it comes to M&A

    For starters, selling owners are terri ed of doing something stupid; inparticular, they are afraid of trading their life’s work for a fraction of its fairvalue. However, with little or no prior experience in any M&A (let alone anyindustry-speci c M&A experience), they recognize that they have no ideawhat they are doing. 9

    They also recognize that they are unable to evaluate the merits of variousproposals made by prospective acquirers. For example, what is a reasonablepurchase price? What are customary payment terms and conditions? Whatare “market” legal terms? All of this makes them feel very vulnerable. Theirlack of knowledge and experience also leads many selling owners to quicklyfall in and out of love with every new idea and proposal. It is as though theyare looking for something to believe in, leading them to suspend the logic and

    judgment that they would normally use when evaluating potential investmentsfor their clients.

    Sellers are unnerved at the prospect of negotiating with their successors /minority owners

    Every wealth manager has multiple constituents and the attractiveness of theselling owner’s outcomes is directly linked to their ability to persuade theircolleagues to support a transaction. Unfortunately, those negotiations canoften be extremely dif cult.

    More than a few successors/minority owners start from the view that theyare entitled to own the business even though they lack the resources to payfor it. Their (unrealistic) perspective is that, because they have been goodemployees/junior partners for many years, the current owners are morallyobligated to effectively give them the rm. Selling the business to an outsideparty would block that dream. Add to this, some selling owners have made a

    series of unspeci ed promises to their younger professionals (i.e., they will be“taken care of”) that further enforce a sense of entitlement.

    Regardless, selling owners recognize that successors and minority owners,once they learn that the rm is for sale, will have a strong emotional reaction.Some will be frightened. Many (if not most) will have economic demands. But

    9 Even more problematic, many selling owners may have previously attended an investment banker-sponsoredM&A conference. Such events are largely marketing events for their sponsors, provide little information ofvalue and often only confuse prospective selling owners.

    Selling ownersoften behaveoddly duringtransactions

    Successorsoften believethat owners aremorally obligatedto give them therm

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    in all cases, even if a deal does not close, the rm’s internal dynamics will beirrevocably (and adversely) altered. There is simply no way to put that genieback in the bottle.

    Thus, selling owners err on the side of caution in deciding what informationthey are willing to share with their colleagues and when. And until they have

    a deal in hand – with fairly complete transaction documents ready for signing– they often are terri ed of letting their colleagues know that they are evencontemplating a sale of the rm.

    Here Comes the Prison Riot

    On several occasions we have seen an all-out insurrection whensuccessors at a rm learn that its owners are trying to sell. In manyinstances screaming matches ensued between owners and successorsand — with one particularly memorable rm — a physical altercation brokeout. It was as though there were years of pent-up anger and accumulatedscar tissue between the generations at the rm and the news of a potentialtransaction was the spark that triggered an explosion.

    Common to all of these rms was a rapacious set of rst generation ownerswho for many years had kept most of the rm’s economics for themselveseven though their successors’ contributions had signi cantly increasedover time. Additionally, in order to keep the peace within their rms, theowners had explicitly promised their successors that, in exchange foraccepting below-market wages, they would be sold equity at a very lowcost and ultimately would own and control the rm.

    However, the announcement of a potential transaction quickly persuadedthe successors that they were being played for fools by the owners. And anunderstandable reaction ensued.

    Sellers are uncertain about how clients will react

    Selling owners are usually very concerned about how their clients will reactupon learning that the rm is being sold. Why? Contrary to what many ownersproclaim, deep down many are unsure of just how robust their relationshipswith clients really are.

    Moreover, many selling owners made a commitment many years ago to theirclients – often as part of their sales pitch – that they would “never” sell thebusiness to “anyone” and would remain “independent forever.” And now these

    same owners recognize that they are going to have to tell clients that they areeffectively reneging on this commitment.

    Sellers are uncomfortable with the prospect of losing control

    Most wealth managers are run as dictatorships. To be sure, more than a fewowners can be considered “enlightened despots.” However, they most certainlydo not operate their businesses as democracies but instead personally retainauthority over every major decision.

    Owners may havepromised clientsthey would “neversell”

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    Once they sell their rms, all of this will change. They no longer will be incharge. If they do not like how something is being run in the new organization,their only recourse will be to try and persuade the acquirers’ owners to dothings differently. Of course they will have a series of contractual protectionsand any (sane) acquirer will want their input. But the idea of no longer beingthe decision maker is very discom ting.

    Sellers constantly think about and cycle over issues throughout the transactionprocess

    Many selling owners have told us that throughout the process of sellingtheir companies – a process that can last as long as 15 to 18 months –they were always thinking about the deal. A sale process, if not properlycontrolled, can dominate a seller’s professional, and personal, life. Thisconstant cycling (perhaps better termed “recycling”) on transaction issuesexacts a signi cant emotional, and sometimes physical, toll. And it is abig reason why sellers’ emotions regularly swing between extremes – oneminute they want to ght over every detail and the next moment they justwant the process to be over.

    5. Transaction-induced stress often triggers very bad behavior.

    For all of the reasons described earlier, the transaction process for sellersis, in a word, stressful. The chronic, around-the-clock feelings of uncertainty,discomfort and fatigue can lead to extremely odd behavior. From the outsidelooking in, the selling owners at times can appear to be certi ably insane.

    There are a variety of behaviors common to selling owners that manifestthemselves during a transaction process including:

    Selling owners are often petty and narcissistic and focus on the “small stuff”

    Constant cyclingon issues takesan emotional andphysical toll onowners

    “Call me old-fashioned, but mymanagement style is still do whatever I say. ”

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    In transactions in which the closing consideration alone frequently runs intoeight gures, one would expect that wealth management rm owners would befocused on the big picture. Not so.

    Many needlessly overreact to immaterial deal terms, perceiving any deviationfrom their own expectations as a slight by a prospective acquirer. For example,

    we have seen selling owners ght to the death over de minimis issues likethe post-closing location of a parking space, the size of an of ce, a new titleand the level of reimbursement for quasi-business expenses involving tinyamounts of money. In one transaction, a seller directed his legal counselto include language in the nal contract providing that the buyer, who wasacquiring 100% of the seller’s business, would have no right to the seller’scoffeepot.

    Bad Selling Owner Behavior is Common During TransactionDocument Negotiations

    The worst tendencies of selling owners are of ten particularly evident whentransaction documents are being negotiated. Because many owners havenever previously seen a purchase agreement, they are often frightenedand intimidated when they receive a rst draft, which is typically in excessof 50 pages.

    Add to that, some selling owners are even so naïve as to believe that oncethey receive the upfront payment it is theirs to keep in perpetuity under allcircumstances (“indemni cation” is not part of a wealth manager’s everyday vocabulary). Few begin a transaction process with any idea that theyare obligated to make representations and warranties as to the conditionand the liabilities of their companies, which if proven to be incorrect,provide the buyer with the ability to claw-back at least part of the closingpayment.

    Consequently, selling owners often overreact to their own (often incorrect)interpretations of certain transaction terms that are absolutely marketand customary. Thus, while a prospective acquirer may have only thebest intentions and may be genuinely trying to accurately memorialize theagreed-upon business terms of the transaction, selling owners will oftenassume that the buyer is trying to trick them into an unreasonable andunfavorable agreement. 10

    Selling owners are very focused on their own outcomes but oblivious to thebuyer’s perspective

    At the same time, selling owners will often counter with document languagethat goes far beyond the previously agreed-upon business terms and which isinvariably extremely seller-favorable. Thus, while they are hyper-sensitive to anylanguage which they may interpret as not comporting with their understandingof the deal terms, they are almost oblivious as to the implications of what theyare making as a counter proposal.

    10 As anyone who has ever done a deal will a est — 10 di erent a orneys can read the same document and reach10 di erent interpreta ons of the intent of its language. It is easy to see, then, how this tendency of sellers tooverreact to incorrect interpreta ons of deal document language can be materially problema c to ge ng a dealdone.

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    Additionally, because they are so emotional and unsure of themselves, sellingowners often attempt to spell out every single issue in the agreements toa level of precision that the English language will not permit. Thus, buyerswill often nd that the process for arriving at nal written agreements canbe overwhelming and exhausting as the documents are negotiated andrenegotiated again and again over many months, resulting in staggering

    transaction legal fees for both sides.

    Equally problematic, some selling owners have a rather one-sided view of“professional courtesy” when it comes to “turning” deal documents. Whenthey receive documents from the buyers, they will often take a very long timeto review them and return comments. However, they then become upset if thebuyer does not immediately respond to their changes.

    Selling owners actively engage in counter-productive behavior

    Selling owners can be shockingly oblivious to the consequences of theirown behavior during the transaction process. They often are so focused onthemselves that they have no idea how their own emotion-driven behavior canraise red ags with a buyer. For example:

    • As noted earlier, the aggregate purchase price in all wealthmanagement acquisitions will be structured to include a closingpayment and a series of one or more post-closing paymentstied to the retention and/or addition of client relationships.

    In spite of this, we have witnessed sellers declare that, with respectto the purchase price, they really only care about the closing paymentand are indifferent to whether they get any of the potential post-closing payments. These prospective sellers are effectively signalingthat they are very pessimistic about the buyer retaining acquiredclients, much less adding any new ones.

    • Even more bizarrely, other selling owners have demanded that, asa condition to doing a deal, they be allowed to create completelynew business lines post-closing that are separate and distinct fromwealth management (e.g., in-house alternative investment products,money management for other advisors, etc.). Moreover, they expectrevenues from these ancillary businesses to be included in anypost-closing purchase price calculations – as though all revenuesare created equal (they are not, in case you were wondering).

    These owners are effectively signaling that they have little con dencein their core business and that their only hope of capturing a full

    price is by starting new ones in its place.

    One can imagine how such self-sabotaging behavior is likely to be received bypotential acquirers. Many quickly start to wonder whether the selling ownersare nuts.

    To be sure, few owners are actually bearish about their own businesses or haveany bona de concerns about what a buyer might discover during diligence.However, stress often leads to odd, self-destructive behavior in human beingsand selling one’s business can and does create a great deal of stress. Anda great deal of bizarre selling owner behavior is much more a re ection of

    Sellers areoften oblivious

    to their ownself-destructivebehaviors

    Documentsare typicallynegotiated andrenegotiatedover and overagain, resulting instaggering legalfees

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    their attempts to cope with this stress rather than what they (once they havecalmed down) believe is rational.

    What Are You Smoking?

    Many of the more surprising selling owner behaviors we have seen intransactions were tied to a combination of an unrealistic assessmentof the quality of their own rms with a miscalculation of the prospectivebuyers’ interest in acquiring them. Understandably (and as noted earlier),many owners view their rms as an extension of themselves, almost likea member of their families. Their business is a culmination of their life’swork and represents thousands of hours of effort.

    Consequently, many owners have a dif cult time accepting that what theyown is still just a tiny business - one that no one will ever confuse withJP Morgan Chase. Nonetheless, many owners still have a dif cult timeaccepting that what they own may not be that meaningful to a buyer.Often this mentality leads them to be ridiculously overcon dent as to whatprospective acquirers are willing to do to buy their business. 11

    For example, one prospective seller demanded that the acquirer (yes, theparty about to pay her a lot of money) completely replace all of its technologywith that used by the seller. Furthermore, the selling owner expected a vetoover any future technology decisions of the combined enterprise.

    Another seller demanded the right to make acquisitions of other rmsafter it had sold its business to the buyer . In other words, although he wasselling his rm, he still wanted a blanket option to subsequently acquireother wealth managers and fold them into what used to be his rm, inturn increasing the amount of post-closing consideration that he would beentitled to from the acquirer.

    More absurd, we even have encountered potential sellers who have for yearscharged many of their personal expenses (club memberships, personaltravel masked as “attending industry conferences,” their automobile, etc.)to their companies and expect that, post-closing, the acquirer will continueto pay for them. These same selling owners do not deduct these personalcosts from the nancials that they provide to prospective buyers. In otherwords, they want the acquirer to pay a high price that assumes that it will nothave to pay these costs. But at the same time, the selling owners expect tocontinue to be reimbursed for them.

    11 The inability of many owners to be realistic about their own rms is at least partially attributable to the factthat they are far better advisors than they are businesspeople. In particular, many started their rms in theearly 90’s – at a time in which there was little or no competition, catching the leading edge of Baby Boomerssaving for retirement and at the beginning of the greatest equity bull market in national history – and theirsuccess is far more attributable to timing than any business acumen. Ironically, these same owners also arefar more rational when evaluating the quality and merits of other wealth managers. Professor Richard Thalerhas written extensively on this “mine is great” but “yours is just a tiny business” way of thinking which herefers to as the “Endowment Effect.”

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    6. Four factors drive the psychology of successors.

    Successor professionals (many of whom may be minority shareholders) are theother key constituency at every wealth manager. Understanding the psychologyof these individuals is essential because the power that any particularconstituency may have over a potential transaction can be uncorrelated to itsownership stake.

    For example, successor professionals are often more important than thefounders/selling owners to a buyer’s ability to retain clients over the long term.Thus, no rational buyer is going to acquire a rm without at least a partialbuy-in from the individuals who are not “cashing out.” And the need for thatbuy-in provides the successor professionals/minority owners with a degreeof leverage in the transaction negotiations that is out of proportion to theirownership percentage. 12

    In the most general sense, the psychology of successor professionals (uponlearning that the rm is being sold) is similar to that of children of a divorceelearning that their parent is about to get remarried: although they mayunderstand the reasons for doing so, they are frightened as to what it meansfor themselves.

    However, understanding this constituency’s psychology in a transactionrequires a deeper analysis that considers four factors:

    A. How much bargaining power will successors/minority shareholdershave over a transaction?

    Three variables determine the level of bargaining power possessed bysuccessors/minority shareholders.

    12 To be sure, the “soft” power of non-controlling owners is not without its limits. We are familiar withtransactions in which successor professionals and/or minority shareholders effectively “out-kicked their puntcoverage” – assuming (incorrectly) that they could veto any deal not to their liking, refusing to participate inthe sales process and/or trying to extort exorbitant terms from the controlling owners. Unsurprisingly, in suchcases, these individuals often wound up losing their jobs.

    Old McDonald’s farm has been sold to Agribiz International—but forthe time being, you’ll all be kept on.

    Successorsview a potential

    transactionsimilarly to thatof children ndingout that one oftheir parents isgetting remarried

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    The rst is the degree to which client relationships are institutionalized. Morespeci cally, some rms operate as silos; that is, each professional has his or herown book of clients and, more importantly, the clients view the individual andnot the rm as their advisor. Thus, should individuals leave the organization,there is a material risk that clients will follow them.

    In contrast, at rms with institutionalized relationships, clients are accustomedto working with teams of different individuals and do not view any one personas their sole advisor. Obviously, in rms with the silo structure, the successors/minority owners have much more bargaining power.

    The second factor that determines the bargaining power of successors/minority owners is whether they are bound by robust (and enforceable)restrictive covenants. Without non-compete and non-solicit agreements inplace, successor professionals and minority shareholders enjoy increasedbargaining power. Why? Because few acquirers are willing to bear the riskthat key seller personnel may leave the rm and take clients with them.Hence, it is typical that as a condition of closing they require that the sellingowners persuade these key employees to execute such agreements. 13 14

    The nal and most important factor determining the bargaining power ofsuccessor professionals is the level of willingness and ability of the sellingowners to continue to work in the business for an extended period if atransaction fails to be consummated. In other words, some potential sellersare ready, capable and willing to work for an additional decade or more if theyare unable to close a deal on terms they deem to be acceptable. Others arefar more determined to retire in the near term – ve years or fewer – or areincapable of working longer. Unsurprisingly, successor professionals have farless leverage in the former scenario than the latter.

    In our experience, successor professionals have little trouble identifying whenowners of their rms are “motivated sellers.” In such instances, we have evenencountered successors/minority shareholders who openly acknowledgetheir enhanced bargaining power and effectively tell the prospective biddersthat they are the de facto decision makers about a potential deal.

    B. What is the nature of the historical relationship between a rm’sfounders and its successor professionals?

    The second line of inquiry into the psychology of successors/minority ownersrequires a review of the nature of the historical relationship between theselling owners and the rm’s other constituencies.

    13 Some prospective sellers that lack restrictive covenants on their key employees have tried to handcuffthem by paying them signi cantly above-market wages tied to the revenue generated by their clients. Theybelieve that by doing so, the employees would likely have to take a signi cant pay cut if they depart theorganization and the preponderance of their clients do not follow them to their next organization. However,in our experience acquirers are often quite (rationally) skeptical of the effectiveness of such limited “goldenhandcuffs.”14 The most rational prospective sellers make their key personnel shareholders in the rm long before thecompany is taken to market. Doing so enhances the enforceability of the restrictive covenants binding theseindividuals, which increases the value to a prospective acquirer. Nonetheless, the importance of restrictivecovenants (or even their absence) is not absolute. Such agreements cannot force anyone to do something;rather they are simply a basis for litigation. Hence, these agreements only have value if one is willing to spendthe (often large) legal costs necessary to enforce them.

    Only ownerswho are readyand capable ofworking anotherdecade havereal bargainingpower over theirsuccessors in atransaction

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    For example, the day-to-day working environment of some rms could bedescribed as a caste system in which there are just two classes of people: thefounders and everyone else. Those in the “everyone else” category are subjectto strict compliance with all of the rm’s policies and procedures (with respectto customary business hours, vacation days, legal compliance policies, etc.).The founders, however, are above the law, accountable to no one. Moreover,

    in these organizations the owners are often self-centered, sharing little of theorganization’s economic success with anyone else.

    Other wealth managers operate as true partnerships. Everyone is held tothe same standard and the organizations largely operate by consensus. Andwhile there may disagreements between individuals, generally all of the rm’sconstituents trust the organization and their colleagues to ultimately do theright thing for both the rm’s clients and for each other. 15

    Acquirers should keep in mind that, while they bear no responsibility for, anddid not create, the problems that arise from poor historical relationships,successfully consummating a transaction may require at least partiallyaddressing some of the successor professionals’ grievances.

    Firms with Avaricious Owners Are Unlikely to Consummate a Deal

    The likelihood of a potential seller successfully getting to a closing is directlytied to whether the economics of the seller’s rm have been rationally (andequitably) divided over time between the owners and the employees. A“no” answer is a strong indicator that a transaction is unlikely to occur.

    The industry is not short on rapacious owners – individuals who havekept as much of the economics for themselves as possible while payingtheir successors only the minimum amounts necessary for retention.For example, we know of a rm with nearly $10M of revenue in whichthe owner took out $6M per year while paying key employees less than$300,000 annually. Similarly, in a $4M revenue rm, a pair of largelyabsentee owners kept nearly 75% of the rm’s aggregate pro tability.

    However, when these owners tried to sell their businesses, they quicklydiscovered that a large percentage of the transaction’s overall economicswould have to go to the successors. Why? There was a great deal ofresentment built up amongst successor professionals about how their

    rm’s economics had been concentrated in the hands of the ownersdespite their declining ongoing contributions to the rm. The successorsviewed the transaction as an opportunity to correct this past unfairtreatment.

    Consequently, a very emotional and dif cult negotiation betweengenerations ensued and neither was able to consummate a transaction.The selling owners – true to form – were too greedy to share a suf cientportion of the transaction’s aggregate economics to make up for howthe successor professionals had been paid over time. And the resultingstalemate precluded getting a deal done.

    15 In our experience, unfortunately such organizations are more often acquirers than sellers.

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    Few successorsare entrepreneurs

    C. What is the risk appetite and nancial condition of the successors/ minority shareholders?

    Both the risk appetite and individual nancial condition of successors/minorityowners are important in understanding their psychology.

    With respect to risk appetite, it is important to remember that most successorsare not entrepreneurs; rather they are employees. Certainly, more than a fewmay claim to be fearless, ready to walk out and start their own businessesin a moment’s notice. However, successors capable of starting their own

    rms usually have already done it! Most are accustomed to getting a regularpaycheck (and bene ts). They also are accustomed to having someone elseensure that they have the infrastructure and technology necessary to do their

    job as nancial advisors.

    Hence, it is far more likely that they elect to leave and join a competitor (andpotentially try to take some of the rm’s clients with them) rather than leaveto start their own rms. But even that is relatively unlikely for individuals whoare fairly risk averse. In particular, these professionals often have workedin the same rm for many years and are very comfortable. Although joininganother organization may on the surface sound alluring, the realization of howdifferent their lives might be elsewhere can be intimidating.

    Equally important to their decision making is each person’s individual nancialcondition. Many successors/minority owners are in their thirties or forties,have young children and have not accumulated much wealth. Thus, they oftenare very dependent upon their next paycheck, making them relatively cautiouswhen it comes to potential career moves.

    Similarly, older successors/minority shareholders often have kids in or aboutto attend college. And unless they have accumulated a material amount ofwealth, they too will think long and hard before doing something drastic.

    D. What are the unique professional aspirations and goals of eachsuccessor professional?

    That both younger and older successors/minority owners are often not very bigrisk takers and may be constrained by their personal nancial circumstancescreates an opportunity for savvy acquirers. More speci cally, structuring atransaction to include meaningful professional and economic opportunitiesfor a seller’s successor professionals can allow the buyer to quickly convertthose successors into advocates for a transaction.

    Understanding the personal goals and career aspirations of successor

    professionals is a prerequisite to designing effective inducements. These goalsand aspirations, too, vary widely by individual. Although nancial rewards areimportant, so too are responsibilities, career development opportunities andtitles.

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    A Guide to Translating What Selling Owners Are Really Saying

    When they say: They really mean:

    “Money doesn’t matter to me.” “The only thing that matters is the money.”

    “There is zero chance that any of myclients willleave.”

    “OMG, what are my clients go to do once I tell themI am selling?

    “I am unable to work on the deal for thenext two weeks because I am goingon vacation.”

    “I don’t care that the buyer’s owners havecompletely disrupted their own business andpersonal lives in order to put a deal together that

    will pay me a lot of money. I am such a narcissistthat my vacation is much more important than anyof that.”

    “In reality, I don’t need to sell mybusiness.”

    “Who am I kidding?”

    “If my company’s structure causes taxissues that is your problem.”

    “Don’t remind me (and above all, please do notpenalize me) because I set my company up as aC-Corp (and also passed up the earlier opportunityto convert into an S-Corp with no tax penalty).”

    “I don’t care what may be “market-level”terms, everything is negotiable.”

    “I want everything to be negotiable except for themoney.”

    “We are now ready to capitalize on ourlong term investments in our rm.”

    “We don’t make much money and probably won’tfor a long while.”

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    III. Understanding the Psychology of Acquirers

    Acquirers view a potential transaction, rst and foremost, as an economicevent. Unlike sellers, an M&A transaction for buyers is not some major personaldemarcation point in their lives. Rather, it is just another way to make moremoney. 16

    At the same time, however, buyers are often distracted by psychological factorsthat cause them to lose their focus on why they were interested in pursuingacquisitions in the rst place. There are six key aspects to typical acquirerpsychology: 1. Similar to sellers, acquirers are not monoliths.

    There are a relatively limited number of rms within the industry with legitimateaccess to the capital that would be necessary to fund a material acquisition.More speci cally, capital providers are very reluctant to invest large amounts ofcapital into any wealth manager that is effectively a glori ed sole proprietorshipbecause of the risks involved in being so dependent upon a single individual.Rather, only wealth managers with multiple owners and a deep bench ofsuccessor professionals are able to raise the large amounts of capital necessaryto fund material acquisitions. These kinds of organizations generally functionas partnerships and make major decisions in a consensual fashion.

    Consequently, bona de acquirers have multiple internal constituents, eachwith their own perspectives and biases. And there are often widely varyingviewpoints on the virtues of acquisitions in general, much less whether anyparticular opportunity might make sense.

    We have found that acquirers rarely have an internal consensus at thebeginning of a transaction -— some employees will be advocates for pursuinga particular acquisition while others will be far more skeptical. This (obviously)creates a complicated internal dynamic that underpins the psychology of everyacquirer.

    2. Five questions typically drive an acquirer’s decision whether to pursuea particular acquisition.

    Pursuing a potential acquisition can be emotional and potentially costly to aprospective acquirer. There are few issues that are more emotional — andabout which partners can easily disagree — than the decision as to whetherto bring in an outside investor / capital provider as a shareholder of the rm.Additionally, just preparing an initial bid for another rm involves the investmentof an immense amount of time, work and resources. That investment is not

    only extremely disruptive to the acquirer’s organization but also offers nocertainty of success.

    Consequently, most prospective acquirers are cautious when consideringpotential acquisition opportunities. Many (either formally, informally or

    16 Over the last ve years, there have been a handful of wealth managers who have made acquisitions for“strategic” reasons, largely ignoring the lack of economics from doing a deal. These transactions typically haveinvolved relatively small amounts of nancial capital and the acquirers have tried to justify consummatingthem as part of some grander vision for their rms. Given how tiny wealth managers are as businesses, ourview is that these so-called “strategic” transactions make little sense, are unlikely to occur in the future andover time will greatly hinder the success of their acquirers.

    Not everyone ata prospectiveacquirer thinksacquisitions are a

    good idea

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    intuitively) rely on a risk/reward calculus that considers the magnitude ofthe potential economic bene t of the proposed transaction, the likelihood ofcompleting a deal and the risk, cost and aggravation involved in integratingthe seller into their own business. Five questions typically drive that analysis:

    A. Is there really a deal to be done?

    For starters, acquirers have to evaluate whether the selling owners are actuallyever going to do a deal. As noted earlier, far more transactions come to marketthan those that are completed because many owners are not emotionallyready to sell. No acquirer wants to waste its time or resources. Consequently,smart buyers only proceed into an acquisition process if they believe that theselling owners will ultimately be able to pull the trigger. 17

    B. What will we make from the deal?

    Prospective acquirers must also somehow estimate their potential accretion(i.e., the resulting marginal increased pro tability) from the transaction. All ofthe economic bene t from doing a deal is tied to this number. Consequently, itdrives what an acquirer should be willing to pay for the seller.

    Unfortunately, this calculation requires that acquirers somehow accuratelyforecast the likely level of seller client attrition that they will experience afterclosing. Determining the magnitude of such client attrition can be problematicbecause buyers only rarely personally know any of the seller’s clients andthere is no fool-proof methodology for measuring the robustness of a seller’srelationship with its clients. Moreover, it is similarly very hard to know whetherthe goodwill that a seller has built up with its clients over many years canbe transferred to the buyer as part of a transaction. At the same time, aprospective acquirer must also project what seller expenses it can cut withoutdamaging the underlying business.

    Prior to conducting extensive onsite diligence, this is an exercise that is farmore art than science.

    C. Do I want the seller’s successors to become part of my organization?

    Another key variable in an acquirer’s risk/reward calculus is whether theseller’s successor professionals are the kinds of individuals it wants as long-term members of its rm. Determining this can be challenging because inmost transaction processes the rst opportunity for the acquirer to meet themis after it has prepared and made the winning bid for the seller and has largelynegotiated a purchase agreement.

    D. What will it be like working with the selling owners post-closing?

    Equally important, acquirers must also somehow predict how it will be to workpost-closing with the selling owners. These owners – people who started theirown companies and who are accustomed to being in charge – are going tobe part of the acquirer’s organization for several years. Prospective buyers(understandably) often wonder whether the selling owners – after being paidmany millions of dollars — are going to be committed to building the new

    17 Unfortunately, buyers are never certain that they are not just chasing their tails until a deal actually closes.

    Acquirers relyon an economicbenet vs. risk/cost/aggravationcalculus

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    combined enterprise or whether they are going to be corrosive, disruptiveforces within their organizations.

    E. Are we ready and willing to have an outside investor in our rm?

    Lastly, separate and distinct from all of the issues involving the seller,acquirers need to consider whether they are actually ready to have an outsideinvestor. At some level, all potential buyers recognize that any deal worth doing(i.e. any material deal) will require a lot of capital (small transactions, as wehave repeatedly pointed out, are rarely worth the headaches). But few wealthmanagers have the pro tability and retained earnings suf cient to fund anymaterial acquisition, requiring them to turn to an outside capital provider. Theidea of doing so can be very discom ting.

    More speci cally, all capital providers demand speci c contractual protections,including involvement in at least certain major organizational decisions. Theyalso receive contractually de ned rights to cash ow that often includes apreferred return.

    However, the owners of prospective acquirers have had largely unfetteredauthority in running their companies since their founding. And while they mayonly be running Lichtenstein, it is still good to be king.

    For many owners, agreeing to have even modest constraints on their authority(and/or their cash ow) is a very dif cult emotional obstacle to surmount.

    Many view the inclusion of a capital provider into even only limited aspectsof the rm’s decision making process as effectively stripping the rm of someof its virginity and virtue. Consequently, just as there is a mental Rubiconthat selling owners must get over in order to sell their rms, there is a similarone that prospective buyers must get over if they are going to get the capitalnecessary to do a deal. 18

    18 This combination of needing outside capital to fund material acquisitions along with so many ownersbeing unable to even conceive of the idea of having their authority over their rms restrained in any wayhas effectively eliminated many of the industry’s larger participants from ever successfully completing anacquisition of any size.

    Marry me, Judith ... with the understanding, of course, that pastperformance is not a guarantee of future results.

    Getting thecapital necessaryfor materialacquisitionsrequires an acquirerto cross overits own mentalRubicon of havingan outsider as apartner in the rm

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    Provided that after analyzing the previous ve questions a prospective acquirerdetermines that the potential risk/reward/aggravation tradeoff from doing adeal is net positive, it will usually prepare a formal bid. The seller must thenselect from the various proposals that it has received and attempt to negotiatea deal with the prospective buyers.

    3. Buyers begin transaction processes far from convinced that completinga deal makes sense.

    More than a few prospective sellers have confused the willingness of a buyerto prepare a bid with an indication of being prepared to do a deal. They aresadly mistaken.

    An acquirer’s decision to bid only indicates that it is willing to consider doing adeal. And we have found that, right up until the point at which they sign transactiondocuments, most prospective acquirers (similar to prospective sellers) have akind of internal emotional pendulum within them that swings back and forth.One moment they are very interested in making an acquisition. The next theyare wondering whether they were foolish to even agree to participate in thetransaction process. Consequently, buyers approach the transaction processwith a “wait-and-see” approach and deep down retain at least some level ofskepticism right up until the nish line. Their diligence process on the seller isalso often more of an exercise in trying to identify reasons to do a deal than itis an attempt to con rm a prior assumption that buying the seller would makesense.

    We also have found that prospective acquirers regularly return to the vequestions described above throughout the transaction process as they gathermore data and use it to update their risk-reward/aggravation calculus. And ifat any point they conclude that this calculus is no longer attractive, they willquickly lose interest in the deal. 19

    4. Acquirers compensate for fear by overpaying for greater certainty andunderpaying for risk. Similar to prospective sellers, most potential acquirers have little to noM&A experience. And suddenly having the opportunity to make a materialacquisition — and pay the seller many millions of dollars at closing — can be abit unnerving.

    On one hand they are afraid that they might not succeed in buying the seller.They recognize that just participating in an acquisition process alone will costthem a great deal of time and money. And having never done a deal, they lackthe ability to gure out which opportunities make sense to pursue and for how

    long.

    19 Because prospective buyers effectively are still looking for a reason to do a deal (as opposed to star tingfrom an assumption that a transaction makes sense), few things more easily kill buyers’ interests in atransaction than a lack of transparency by the seller. Why? Acquirers must predict a series of very uncer tainoutcomes – namely, whether a seller’s clients will stay post-closing, whether the forecasted accretion will beachieved, whether there are hidden risks and liabilities that they will inherit from a deal, etc. – in determiningwhether to buy and/or what to pay for another rm. They must base their predictions primarily on theinformation that they gather from the seller. And unless they feel they can have a real insight into the otherorganization, more often than not they will just walk away from the transaction.

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    On the other hand, many prospective acquirers are equally scared that theymight actually succeed in buying the seller. They have little idea of what theyshould pay and under what terms. Equally important, having never previouslyacquired and successfully integrated another wealth manager into their ownorganizations, they are unsure of whether they can actually make an acquisitionwork. And if they are attempting to make a major acquisition, the dollars and

    risk involved are most certainly going to be material and the acquirers may beeffectively “betting” their own rms on the deal.

    So stop for a minute and consider what is likely going through the minds of theowners of prospective buyers. While they are interested in making a lot moremoney through an acquisition, they recognize that they really do not knowwhat they are doing. They can see that, at a minimum, making a run at buyinganother rm — whether successful or not — is going to take a lot of their timeand cost them some money. At the same time, they aren’t certain that theselling owners will ultimately decide to sell the rm, much less that they will beable to make a winning bid. Further, in order to buy the other rm they are goingto have to take capital from an outside party and the accompanying conditionsfor doing that could materially alter how they operate their businesses. And ifthey do wind up buying the seller, there are no guarantees that the acquisitionwill be successful.

    A common byproduct of these fears is that acquirers will often overcompensatefor their lack of M&A experience by overpaying for those opportunities thatoffer the greatest level of certainty (i.e., a buyer becomes convinced that thereis an extremely high likelihood of retaining the vast preponderance of seller’sclients, the seller successors are likely to be great long time employees/partners of the acquirer and the selling owners are going to do everythingthey can to make the transaction successful over the long term, etc.) . At thesame time, however, buyers usually signi cantly underpay when the certaintyof good outcomes is far less obvious.

    In other words, there is a non-linear function in the difference in what acquirersare willing to pay for acquisitions that they think should be easy to successfullyintegrate into their own rms and those opportunities which have moreambiguous outcomes: Robust amounts for the former and, in the rare instancesthat they are even willing to bid for them, fractional amounts for the latter.

    All Hat, No Cattle

    We have encountered many owners of very large wealth managers whoclaim that acquisitions are a “core part” of their future growth strategies.However, when shown an opportunity to make a material acquisition, they

    appear to suddenly become paralyzed with indecision. They will ask foradditional information and analysis. But once receiving it, the ownerssimply go silent for weeks. They do not return phone calls or emails andeventually the opportunity passes them by. As a capital provider it oftenfeels like we are just sending something into a black hole from whichnothing will ever come back out.

    When these owners emerge from their cocoons many months later, theytypically claim that they had seriously considered the opportunity (and

    Acquirersare oftensimultaneouslyafraid not doinga deal as wellas actuallycompleting one

    There is a non-linear function inwhat buyers payfor certainty vs.risk

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    would like to be shown additional transactions in the future). Unfortunately,they tell us, this particular seller “was a not a natural t” for or had “culturaldifferences” with their organizations. So they decided to pass.

    Certainly such issues are very important to consider in any acquisition.However, it is beyond us how any acquirer with only very limited information

    could ever arrive at such a de nitive conclusion.

    We used to attribute such behavior to owner ego (i.e., “We are one of thegreatest wealth management rms in the country and thus, acquiringanother, less exceptional rm would be beneath us.”) or just a generallack of understanding of the M&A market. However, having spent a greatdeal of time with such owners we now believe that they are instead veryrisk-averse because they are surprised by their own success to date andare frightened of damaging what they have now. Additionally, they appearto have deep-seated lack of con dence in their ability to run a larger, morecomplex business as well as be able to manage the risk of transitioningand retaining the sellers’ clients.

    5. Acquirers are focused on long-term outcomes and successor happiness.

    Buyers have to think in much longer terms than do sellers. Selling ownersare largely fully paid out within ve to six years following the closing of atransaction. For acquirers, however, the closing is just another step in the long-term process of building their business.

    One byproduct of buyers taking a longer view is that they carefully studythe demographics of the sellers’ clients. Older client bases are problematicbecause they both generate smaller fees over time and, even worse, as clientsget older they often will require more of their advisor’s resources.

    Acquirers are also as focused on how well the combined enterprise will likelygrow over the next 10 to 15 years as they are on retaining the seller’s existingclients. Certainly, as part of any transaction acquirers expect to eliminateduplicative costs to boost their accretion. However, once they have rationalizedthe two businesses, all future additional pro t is going to come from growth.

    Thus, a less obvious but extremely important aspect of a buyer’s diligence isdetermining whether it will be able to assume the client-generating referralnetworks that a seller has built over many years and use those networks tocontinue to recruit new clients after the closing. A subset of this analysis isdetermining how dependent a seller’s growth has been on only a small numberof referral sources (a concentration of referral sources obviously increases risk).

    Acquirers also study the internal dynamics of how sellers have actually generatednew clients in the past. More speci cally, the buyers want to understand whichindividuals at the rms — be it solely the company’s selling owners or alsosome of the successor professionals who will accompany the transaction —have demonstrated an ability to recruit new clients. At the same time, acquirersview those rms in which the selling owners have historically generated all ofthe new clients as far less attractive acquisitions than those in which successorprofessionals have a demonstrated ability to help the rm grow.

    Acquirers caremuch moreabout successorhappiness thanselling owneroutcomes

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    Finally and most importantly, because acquirers are focused on long-termoutcomes, they care far more about successor happiness as part of atransaction than what the selling owners get from the deal.

    Why? Buyer risk and outcomes are very closely tied to the post-closingproductivity of the seller’s successors. These successors are critical to

    retaining and servicing the seller’s existing clients as well as adding new ones.Thus, buyers normally allocate a material portion of the aggregate economicsof the transaction to the seller’s successor professionals.

    It is easy to see, however, why striking the balance between the interests ofthe selling owners and the successors can be dif cult for any acquirer. Onthe one hand are the founders who took the risks necessary to create andbuild the company – they understandably feel that they are entitled to be fairlyremunerated (or, as a practical matter, they won’t do a deal). On the otherhand, the acquirer is paying a lot of money for the rm and needs to ensurethat it will keep the seller’s clients. And most problematic, there is a niteamount of aggregate transaction economics to divide between the two groups.

    6. Acquirer M&A team members often feel that they are caught in animpossible position.

    As noted earlier, prospective acquirers are made up of multiple constituents,many of whom have very different viewpoints on the merits of acquisitionsin general. Thus, those rms that enter into a transaction process will oftendelegate the responsibility for seller diligence and transaction documentnegotiations to a small group of individuals within their organization. Withrespect to any particular transaction, that group typically includes thoseindividuals who have been the strongest advocates for acquisitions in generalas well as for this potential transaction in particular.

    This team at the acquirer often nds itself in an almost untenable positionbecause team members must manage a complex, multi-faceted negotiation.On one side, the M&A team must negotiate with sellers who often are behavingbadly. At the same time, the M&A team must negotiate with its capitalprovider on both the terms of the capital provider’s investment as well as theprotections the capital provider will require from the seller as a condition tofunding. And because most acquirers function as partnerships that operate ina consensual fashion, the M&A team members must also somehow persuadetheir colleagues to support a transaction.

    Making this situation even more problematic for the M&A team is that, at mostrms, there is a faction that is against doing all acquisitions in general, without

    even getting into the speci c terms of any particular transaction. We have

    found that such individuals often operate in a passive-aggressive fashion –i.e., one moment they profess support for doing a deal while the next they tryto undermine the M&A team by privately criticizing one or two minor details ofthe transaction as being too generous.

    Consider the unenviable position in which the acquirer’s M&A team membersnd themselves. Their rms are considering risking many millions of dollars to

    buy the seller. They have been tasked with overseeing their rm’s due diligenceand for determining whether there are suf cient reasons to do a deal. Theyalso must conduct a grueling, drawn out negotiation of transaction documents

    Acquirer M&Ateam membersmust manage amulti-dimensionalnegotiation andare blamed if adeal does not getdone or, if a dealis completed, isunsuccessful

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    with the selling owners. And while they are doing this, they are expending largeamounts of the rm’s resources.

    However, should a deal not be consummated, they were the ones who “wastedthe rm’s time and money.” And if they do a deal and it turns out badly, theyare the ones who damaged the rm.

    Understandably, being caught in such a position can be very stressful. Italso can lead many of the acquirer’s M&A team members to at times beas emotional as their transaction counterparts. They too will often cycle —and recycle — constantly on deal issues throughout the transaction process.Their emotions will regularly swing between the extremes, one minute beingdesperate to get the deal done and the next trying to nd a way to gracefullyexit the process. And they, too, often overreact to even small amounts ofincorrect or misinterpreted information.

    Thus, precisely at the point that the selling owners are behaving irrationally,members of the acquirer’s M&A team also star t acting up. And is it any wonderwhy so few deals in this industry are ever consummated?

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    A Guide to Translating What a Buyer’s M&A Team Members Are Really Saying

    When they say: They really mean:

    “Getting the money is no problem.” “We don’t have and probably won’t be able to getthe cash to buy your rm.”

    “Your projections for future growth areinteresting.”

    “Are you out of your mind?”

    “Everyone in our rm is excited about thisopportunity.” “We are happy to look and see whether you haveanything to sell.”

    “It is a bit unusual that your attorneyis trying to renegotiate what is in theterm sheet.”

    “You had better tell your lawyer to stop being awannabe investment banker if you want to haveany chance of getting a deal done.”

    “Your successors were very candidwhen we spoke with them.” “Boy, are these guys angry at you! They somehoware under the impression that you promised to givethem the rm. You had better set them straight orwe are all wasting our time.”

    “We want to help you to get on withthe next phase of your life.”

    “Clearly, you are a raving lunatic.”

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    IV. How Savvy Sellers Manage Their OwnPsychology in Transactions

    As noted earlier, selling one’s rm can be an extremely emotional and dif cultprocess. For the selling owners, it is often much more than simply a nancialtransaction — it also serves as a demarcation point in their personal lives.

    Much will change and, for many prospective selling owners, these changesare not very attractive.

    However, for most potential selling owners, a transaction that monetizes theirequity is the most (if not the only) rational personal nancial strategy. Further,these owners also recognize that they have a personal duciary obligationto ensure that their clients are taken care of and continue to receive quality,independent nancial advice. In many instances, selling and combining their

    rms with another wealth manager is the best way of meeting this obligation.

    Given these considerations, what steps do savvy sellers take to manage thepsychological challenges that are endemic to selling a rm? The answer isfairly simple and straightforward (and, for anyone who has been in this industryfor many years, should not be surprising): Plan ahead.

    There are two aspects to such planning; one is very personal to the sellingowners while the other involves taking steps to address the psychology oftheir successors when the rm is brought to market. The former is much morechallenging than the latter.

    Preparing Yourself for a Sale

    Preparing oneself for the sale of a rm is a bit harder than it might seem at rstglance. It requires engaging in some serious self-re ection, which can be verydif cult for anybody to do (even without the prospect of selling your business).It also takes a lot of time and work.

    For many owners reaching the stage of considering a sale, running andbuilding their rms has been an all-consuming process since they startedtheir businesses. Even when they are not at their of ces or with clients, theyare still thinking about work. Additionally, helping others with nancial advicebecomes a permanent part of their DNA.

    However, after closing a transaction, their lives will suddenly have a big void.They will no longer own a wealth manager and, even worse, they will no longerbe in charge of their rm. All of this is a very frightening prospect for anyonewho has started and built a business. Unfortunately, the worst time to fullycome to grips with such a realization is in the middle of a sales process.

    Consequently (and based on our experience with several savvy selling owners),we offer the following six recommendations for preparing yourself for a sale:

    1. Do not come to market until you are emotionally ready to sell.

    In an earlier chapter we focused a great deal on how dif cult it can be for manyselling owners to get across the mental Rubicon necessary to agree to a sale.Unfortunate