Steve McQueen in hot pursuit of some baddies in Bullitt, with the help of a 1968 Ford Mustang GT Fastback. (photo source: Chicagocarclub.com)
In this continuing series on RIA partners responding to unsolicited offers, we thought it would be worthwhile to spotlight the number one killer of worthwhile transactions: deal fatigue.
Transaction negotiations frequently take longer than anyone expects and often start and stop multiple times. The process has a tendency to terminate negotiations on bad transactions, but it also takes down many that should happen.
Watching deal-making reminds me of car chase scenes in movies: unnecessarily long, fast-paced, often suspenseful, and with the potential for multiple fatalities – or at least bruised egos.
The car chase scene that set the standard for the past fifty years was Bullitt, in which Steve McQueen, playing the role of Frank Bullitt, drove a 1968 Ford Mustang GT Fastback equipped with a 390 cubic inch V-8 and a four-speed manual transmission through the streets of San Francisco in pursuit of some hitmen in a Dodge Charger. Fiction being what it is, Bullitt catches the bad guys in his Mustang, even though in reality the Charger was faster. The car scene took three weeks to film, destroyed two Dodge Chargers and one Mustang, and ultimately resulted in a chase sequence lasting almost ten minutes that won the film’s editor, Frank Keller, an Oscar.
Three weeks of filming for a ten-minute scene is about the ratio of time it takes to negotiate and finalize an RIA transaction relative to how long people think it ought to take. Many sellers believe that once a term sheet is agreed to or an LOI is signed, the rest is just papering the deal. Not so. Transaction negotiations, even drafting the purchase agreement, take months and sometimes years – but never merely weeks. I’ll spare you dozens of war stories, but I do have a few things to keep in mind if you find yourself going through the process.
Have a Real Reason to Sell Your RIA
Strategy is often discussed as something belonging exclusively to buyers in a transaction. Not true.
Sellers need a strategy as well: what’s in it for you? When deals involving asset management firms fall through, I often hear things like “they just wanted to use our money to buy our firm from us.” Translation: the seller gives up shareholder returns (distributions and maybe bonus compensation) and agrees to work through a transition period (often three to five years) while the buyer capitalizes those same returns and uses them to finance or at least justify the purchase price.
Sellers often feel like all they are getting is an accelerated payout of what they would have earned anyway while giving up their ownership. In many cases, that’s exactly right! On top of that, most investment management firm transactions have substantial earn-out payments included as part of the deal, such that the sellers may go from being masters of their own universe to singing for their supper.
RIAs are professional service firms and the cash flow that creates value transfers from seller to buyer when the ink dries on the purchase agreement. Sellers give up something equally valuable in exchange for purchase consideration – that’s how it works.
As a consequence, sellers need a real reason – a non-financial strategic reason – to sell. Maybe they are selling because they want or need to retire. Maybe they are selling because they want to consolidate with a larger organization, or need to bring in a financial partner to diversify their own net worth and provide ownership transition to the next generation. Whatever the case, you need a real reason to sell other than trading future compensation for a check. The financial trade won’t be enough to sustain you through the twists and turns of a transaction.
Be Aware of Your Own Psychology
One reason why we enjoy working with investment managers is that they are the kind of client who is wired like we are: analysts who think they can reduce most everything in life to an excel spreadsheet. Finance and much of economic theory are grounded in a neoclassical approach that can be expressed in logarithmic equations in which decisions are based on some logical assessment of marginal benefits. The reality of evolutionary neurobiology and the recent development of behavioral economics suggests that real life is much messier than that. People reason out dilemmas to the best of their ability, and then make a decision largely based on emotion.
Even earning your CFA charter doesn’t enable you to escape your own humanity. People don’t refer to their firms as their “baby” for no reason – you will be emotional while you contemplate things like handing your relationships with clients and colleagues to a stranger for adoption, so be ready for it. It’s a normal feeling, and if you have the right acquirer, it will subside to relief that someone can carry on these relationships on your behalf, and is willing to pay you for the right to do so.
A good analyst can justify his emotional impulse using financial analysis; a great analyst can prove it.
One way to manage this through the deal process is to have an impartial counselor be a sounding board while you’re negotiating. This might be a friend or business colleague, but keep in mind you’re going to need a lot of counseling. Ideally, this is the same person who is representing you in the sale, and thus who knows you and the setting for the transaction. Getting this from your advisor requires a financial arrangement in which you can feel comfortable that he or she is representing you and not the transaction.
Remember That Money Is Fungible and Value Is Relative
Give up on the notion of absolutes in transaction valuations or deal terms. The eleventh commandment is not 10 times EBITDA nor 3% of AUM, and neither one is engraved on any stone tablets in human history.
Everyone wants to sell at the top of the market, but the top of the market for RIAs is usually the top of the market for other assets as well, so if you sell at the top you’ll pay more taxes and your after-tax proceeds will be reinvested in a fully priced market. It’s highly unlikely that your investment management firm will fetch top dollar in a bear market; so in many regards, the purchase price you exact in transaction negotiations only has merit relative to your reinvestment opportunities.
This, again, is an argument for looking at the sale of your RIA through a strategic lens rather than a financial lens. Maybe you can do better than the market in selling your firm, but if you’ve been in the business long enough to have built a successful advisory business, you know how difficult it is to beat the market.
Conclusion: Keep Your Eyes on the Prize
So, if you’re entering into negotiations to sell your RIA, buckle up, stay composed, and be mindful of your goals. Steve McQueen was notoriously focused on managing his own career, which enabled him to drive even faster cars in real life, like his Ferrari 250 GT Lusso, shown below.
Steve McQueen’s car in real life, a Ferrari 250GT Lusso (gentlemensjournal.com)
As always, if you’d like to continue the conversation before our next post, give us a call.