Transaction Advisory, Investment Management

February 29, 2016

Success and Succession Offers Targeted and Often Unexpected Insights on Internal Ownership Transition at RIAs

As the Baby Boomer generation continues to age toward retirement, many “founder-centric” asset management firms face the prospect of internal succession. The recent book “Success and Succession,” by David W. Bianchi, Eric Hehman, Jay Hummel, and Tim Kochis, is written from the perspective of three individuals who have experienced successful ownership transitions. The book provides some interesting insights into the logistical, financial, and emotional process that internal succession entails through colorful accounts of past triumphs and train wrecks.

Some of the authors’ perspectives and insights are what one might expect. Operational realities cause many asset management firms to revolve around a key man, who may not prioritize a strategic succession or may lack a viable successor. He or she may have flawed beliefs that could doom the transition process, including the insistence that the firm remain the same following succession or the assumption of an unreasonably high valuation of the firm. While ownership transition should celebrate the achievements of the founder, it must also recognize the need for change in order to continue to serve the clients. Clearly, client communication during the transition is crucial, especially for a founder-centric firm in which the majority of client meetings and responsibilities have fallen on the exiting owner.

Much of the above, while important, has been said by many others in many forums. The strength of “Success and Succession” is in more than a handful of unique insights into RIA ownership transition which get little if any attention from other industry commentators.

  • Both the founder and the successor need to be aware that firm-wide growth often declines in the first year following the change in management, as the founder-centric firm shifts its brand image and the successor takes on responsibility for creating new business. If a successor is unaware of this trend, he or she could feel additional stress regarding the financial burden he undertook when buying out the former owner. The founder could feel the need to resume fulltime involvement in operations, fearing for his ongoing financial benefits from the firm. The authors advise both founders and successors to take a long term view and not focus on this short term pullback.
  • Regardless of the firm’s performance in the first few years following succession, both the founder and the successor need to set definite (as in finite) expectations regarding the founder’s continued involvement or lack thereof. The founder should remain accessible, as his or her guidance is crucial when the successor faces major issues early on. But it should also be clear to everyone that the successor is now the one charged with minding the store.
  • Though some things do need to change following a succession of management, the successor should avoid creating new positions to retain people who no longer fit into the firm’s long term goals. One benefit of succession is that the new manager may have a fresh perspective on areas of the firm in which cost cutting measures or other efficiencies are possible. Although it may be difficult to assess which employees should remain after the transition, allowing those who are poor fits to remain with the firm does significant damage to the firm’s culture and does not set the proper tone for post-transition success.
  • It is crucial to separate compensation for labor from profit share rewards as the exiting owner becomes less involved in day to day management of the firm. This issue can be resolved through the establishment of a strict reinvestment versus distribution policy going forward. The authors even suggest that the founder employ an independent financial advisor in order to objectively estimate a fair amount of compensation following the sale.
  • Though it is clear that the founder took on a significant amount of financial risk in the creation of the firm, it must be noted that the successor is also taking on risk in the amount of debt he or she must incur to buy out the owner. Both parties have a lot to gain and a lot to lose in the process of succession, and both bear a significant emotional burden. The founder may perceive the transition as a loss of a personal identity that is tied to the firm, and the successor must now bear the responsibility of the ongoing success of the firm.
  • Controversy over what is fair or what is “enough” in terms of a sale price can be resolved through a third party valuation. While it might seem easier to rely on valuation metrics or attractive examples, these tactics are purely short term solutions and can result in overly optimistic estimates. The financial terms of the valuation are already emotionally charged. A third party valuation can provide a much needed “reality dose.”
All in all, the book is a practice-management must read for RIA owners contemplating succession – whether they are on the buy side or the sell side. Our experience advising clients on internal succession, in particular, is that successful transition requires a certain level of patience and humility on the part of both founder and successor, but above all long term commitment to a process rather than an expectation of a near term result. The book plugs the necessity of a third party valuation – and we would certainly second that – but we would add that a third party advisor with experience can often provide much needed perspective to keep a succession process realistic and give it the maximum opportunity to work for everyone.

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Eagle Ford – 2017/2018 Acquisition & Divestiture Commentary (1)
Eagle Ford – 2017/2018 Acquisition & Divestiture Commentary
Transaction activity in the Eagle Ford Shale has been fairly steady over the past 12 months, with the majority of transactions in the $100-300 million range.  The seller’s rationale has most often been about balance sheet management and re-allocation to other plays, usually the Permian Basin.  However, the Eagle Ford area has some quality economics of its own, which has been attractive to buyers.  Many argue it has the best shale production economics in the U.S. next to the Permian Basin.  These differing strategy based swaps have been at the heart of transaction flow.  This has also led to consideration that Devon may sell its Eagle Ford division in search of returns elsewhere.  The chart below, drawn from Mercer Capital’s newsletter, shows some details in regards to the transactions including some comparative valuation metrics.Magnolia – Blank Check Company forms a New South Texas ProducerThe largest transaction in the past year was the recent announcement of a special purpose acquisition entity (“SPAC”) coming to an agreement with certain Enervest controlled funds.  The result of the merger is the creation of a pure play Eagle Ford and Austin Chalk company with 360,000 net acres in South Texas.   The majority of that acreage is in what is known as the Giddings field which is an oil play in the Austin Chalk (mostly held by production).Break-evens are claimed to be in the low $30’s per barrel with one year (or less) paybacks in Karnes and Giddings field.  Magnolia1 is led by a former Occidental Petroleum executive, Steve Chazen, who has both short and long-term optimism for the opportunity.  Estimated EBITDA for 2018 is projected at $513 million including approximately $240 million of cash flow after capital expenditures.Highest and Best EconomicsDenver-based Sundance Energy Australia Ltd. struck a deal with Pioneer Natural Resource Co. to buy almost 22,000 acres and 1,800 boe/d of production in the Eagle Ford Shale, bolting on to an existing leasehold in South Texas.The pure-play Eagle Ford player agreed to pay $221.5 million for the leasehold, which runs through McMullen, Atascosa, LaSalle and Live Oak counties. The transaction would give Sundance 56,600 total acres in the play, with an inventory of 716 gross undrilled locations.Meanwhile, Pioneer was exiting to focus on the Permian Basin.  Pioneer announced in February it would put most of its resources going forward into the Permian and planned to sell nearly all “non-Permian” projects, including in the Eagle Ford, Raton Basin, and West Texas Panhandle.  The table below demonstrates why its desire to focus on the Permian was warranted.  However, one thing to note is that purchasing acreage in the Permian is much more expensive than the Eagle Ford, so drilling most likely needs to be based on existing acreage positions. Overall, the Eagle Ford’s economics are improving (Venado – a KKR backed Austin firm, made a $765 million purchase from Cabot that was based on this optimism). About 61,500 net acres of the Venado position, which is located primarily in Frio and Atascosa counties in South Texas, is operated and about 9,400 net acres are non-operated. Production from the properties during third-quarter 2017 was 15,656 barrels of oil equivalent per day. An interesting discussion on this acquisition can be found in this video: ?? Have a great week! Endnote1 In case one was wondering - Chip and Joanna Gaines are not involved.
Oil & Gas
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Bankruptcy: An Overview Part 3 (1)
Bankruptcy: An Overview Part 3
From January through May of this year, 39 E&P companies and 31 oilfield services companies had to file for bankruptcy. This post is the last in a series of three aimed at helping those companies, and any others who may face bankruptcy in the future, to understand the valuation-related aspects of Chapter 11 restructuring. In the first post we highlighted two reorganization requirements tied to valuation. First, the plan should demonstrate that the economic outcomes for the consenting stakeholders are superior under the Chapter 11 proceeding compared to a Chapter 7 proceeding. Second, upon confirmation by the bankruptcy court, the plan must not be likely to result in liquidation or further reorganization. In the second post we explored in depth the consequences of the first requirement. Here we examine the importance of the second requirement.Cash-Flow TestFor a company that has followed the steps explained in the previous post, this second requirement represents the last valuation hurdle to successfully emerging from Chapter 11 restructuring. Even if a company shows that the restructuring plan will benefit stakeholders more than liquidation will, the court will still reject the plan if it is likely to lead to liquidation or further restructuring in the foreseeable future. To satisfy the court, a cash-flow test is used to analyze whether the restructured company would generate enough cash to consistently pay its debts. This cash-flow test can be broken into three parts.The first step in conducting the cash-flow test is to identify the cash-flows that the restructured company will generate. These cash-flows are available to service all the obligations of the emerging entity. Remember the discussion in the second post—a stream of cash-flows is developed using the DCF method in order to determine the reorganization value. Thus, in practice, establishing the appropriate stream of cash-flows for the cash-flow test is often a straightforward matter of using these projected cash-flows in the new model.Once the fundamental cash-flow projections are incorporated, analysts then model the negotiated or litigated terms attributable to the creditors of the emerging entity. This involves projecting interest and principal payments to the creditors, including any amounts due to providers of short term, working capital facilities. These are the payments for each period that the cash-flow generated up to that point must be able to cover in order for the company to avoid another bankruptcy.The cash-flows of the company will not be used only to pay debts, and so the third and final step in the cash-flow test is documenting the impact of the net cash-flows on the entire balance sheet of the emerging entity. This entails modeling changes in the company’s asset base as portions of the expected cash-flows are invested in working capital and capital equipment; and modeling changes in the debt obligations of and equity interests in the company as the remaining cash-flows are disbursed to the capital providers. A reorganization plan is generally considered viable if such a detailed cash-flow model indicates solvent operations for the foreseeable future.ConclusionAlthough the Chapter 11 process can seem like no more than a burden, a rigorous assessment of cash-flows and a company’s capital structure can help the company as it tries to develop a plan for years of future success. We hope that these past three posts explaining the key valuation-related steps of a Chapter 11 restructuring help managers realize this potential.However, we also understand that executives of oil and gas companies going through a Chapter 11 restructuring process need to juggle an extraordinary set of additional responsibilities—evaluating alternate strategies, implementing new and difficult business plans, and negotiating with various stakeholders. Given executives’ multitude of other responsibilities, they often decide that it is best to seek help from outside, third party specialists. Valuation specialists can relieve some of the burden from executives by developing the valuation and financial analysis necessary to satisfy the requirements for a reorganization plan to be confirmed by a bankruptcy court. Specialists can also provide useful advice and perspective during the negotiation of the reorganization plan to help the company emerge with the best chance of success. With years of experience in both oil and gas, and in bankruptcy, at Mercer Capital, we are well positioned to help in both of these roles. For a confidential conversation about bankruptcy proceedings and how we can help, please contact a Mercer Capital professional.
Oil & Gas
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Does AI Spending Increase an RIA’s Value-or Just Reduce Its EBITDA?
Does AI Spending Increase an RIA’s Value - or Just Reduce Its EBITDA?
AI investment can create value for RIAs by improving capacity, growth, efficiency, and risk management, but the benefits must ultimately translate into stronger cash flow or reduced risk. Recurring AI costs generally remain operating expenses, making measurable adoption and returns critical to valuation.
RIA Valuation Insights Blog Investment Management
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