You have a lot of options to sell all or part of your business. External financing is likely to play a key role in your buyer’s ability to finance the acquisition of your practice. Financing options for acquisition loans has rapidly evolved over the last 10 years and even more so over the last few years.

Fortunately sellers have a lot of free resources and support available beyond what is provided in this portal. If you would rather just talk to a human that can guide you through all the financing aspects of selling your business in the most optimal way for you, then call us today.

What's my timeline?
If you’re looking to sell in a few months or a few years will dictate how much time you have to get yourself and your business ready to sell. The typical acquisition loan takes about 6 weeks to close from the time a term sheet is executed by the borrower.
How do I want to get paid?
Do you want most all of the purchase price paid as the down payment? Will you receive income for the transition period or beyond through a consulting agreement? Do you want to spread out payments over multiple years for tax purposes?
There is flexibility in how you receive the purchase price payment. Think through how you want to get paid and just as importantly when you want to get paid.
What are the different ways to sell?
Let us count the ways…
- Sell everything and retire.
- Sell everything but continue to stick around for a few more years.
- Sell most of your clients/assets and slow down. Hold onto your favorite clients and closest relationships until you are ready to retire and then sell.
- Sell through partial client/asset tranches over time.
- Sell through partial equity tranches over time.
- Sell and merge. For example sell 50% of your equity or clients/assets, merge with the buyer’s business, continue working, sell the rest when you’re ready to retire.
While there are numerous ways to structure and a lot of flexibility, the most common asset purchase structure we see generally looks like:
100% of purchase price is borrowed from the buyer through an SBA or conventional bank loan.
50% to 75% (depending on attrition or client concentration concerns) is paid to the seller at closing (wired to the seller from the bank). The balance goes into an escrow account with a clawback based on an attrition formula or schedule after 12 months.
Either all or part of the escrow funds is wired to the seller based upon the clawback provision and any balance goes back to the buyer.
If you want to be paid out over additional calendar years for tax purposes the escrow agreement can account for this as well.
Know Seller numbers checklist
The sale of any business comes down to the buyer’s expectation of a return on their investment, so understand your financials and start preparing materials for due diligence.
- Registered Reps: Put GDC on your P&L along with line items for recurring and non-recurring revenue sources and make BD costs line items as COGs.
- Review your profit and loss statement, eliminate non-essential or personal expenses.
- Separate owner’s compensation (owner’s salary, insurance, payroll taxes, retirement plan contributions, etc.)
- Review debts of the business and long-term obligations a buyer would need to assume, including things like your lease.
- Verify total assets under management, including a breakdown f where assets are held and what types of products those assets are in.
- Prepare a pro forma P&L for any potential purchaser showing what expenses would look like going forward.
- Review historical revenue growth rates (explain anomalies).
- Review revenue sources for the last twelve months and determine if revenue is transferrable.
- If you sell alternatives that will take years for a liquidity event or have annuities with long surrender charges, be ready to provide data and explain.
- Be able to explain any uniqueness in your business

Common Ways Advisors Sell & Exit

RIP: Retire in Place

The Retire-In-Place strategy, widely abbreviated as RIP, leverages the concept of Revenue-In-Place. Advisors choosing this path often do so beyond the ideal retirement age, opting to remain actively involved in their practice to continue earning recurring revenue. This decision is motivated by the advantage of sustained income despite the potential detriment to client portfolio growth due to attrition. Such a strategy allows advisors to maintain a level of professional engagement and income without committing to selling or transferring their practice immediately.

Revenue Sharing

An advisor may enter into a revenue-sharing agreement with another practitioner, receiving a portion of the earnings generated from managing specific clients or assets over an agreed period. This approach is typically employed for managing high-risk clients or in scenarios where constructing a detailed buy-sell agreement is deemed unnecessary. Despite its utility, revenue sharing is often considered the least desirable method of exiting a practice since it does not involve an upfront cash transaction. Ongoing payments received under this model are subject to regular income taxation, rather than potentially more favorable long-term capital gains tax rates.

Succession Plan Retirement

Selling equity to internal team members or new partners with the long-term goal of building business value over years and providing a strategic handover to ensure continuity and growth post-transition. The principal shareholder can exit by selling their stake either partially or in entirety to a minority partner(s) or another entity.

Sell, Linger & Leave

Under the Sell, Linger & Leave model, advisors opt for a merger-like exit, selling their practice outright while agreeing to remain affiliated as an employee for a specified duration, usually one to three years. This path allows the advisor to dictate their involvement during the transition, focusing on client relationships, staff integration, or other critical aspects of the business. Such an arrangement can be mutually beneficial for both parties, ensuring a smooth transition while maximizing the value of the practice.

Some Now, Maybe More Later

This flexible exit strategy involves the partial sale of an advisor's assets or book of business to one or multiple buyers. Such arrangements allow the selling advisor to gauge the success of the initial sale before committing to further divestitures. This phased approach can offer valuable insights and control over the exit process, ensuring that the advisor's and clients' best interests are preserved.

Sell & Leave

The outright sale of an advisor's business or client list characterizes the Sell & Leave strategy. In this scenario, the advisor actively facilitates the transition of ownership and assists in client handovers for a predetermined period, typically ranging from 6 to 12 months. This model can be executed through the sale of assets or equity, either to a single buyer or divided among several purchasers. It is a common approach for advisors looking to fully exit their practice, including those transitioning their business to internal successors or external buyers already familiar with the client base.

Acquisition Model Types Supported

Buyout

A buyout involves acquiring all assets or equity from another advisor’s book or practice, ensuring complete ownership transfer.

Partial Asset or Book

In a Partial Asset Purchase or partial book buyout the buyer acquires a segment of a book or specific assets managed by another advisor, essentially purchasing a portion of a client list. Despite its partial nature, the acquisition represents a 100% ownership of the assets purchased.

Asset Tranches

Selling/buying assets in structured or scheduled tranches. Multiple tranches to one advisor or splitting tranches to multiple advisors. Sell a few tranches in the short term and maintain favorite clients for a much longer period of time, or more commonly to sell tranche #1, and then perhaps #2, to a single advisor, and if all goes well, then combine and sell the remaining tranches in a follow up 100% acquisition of the remaining clients.

Converger Plan

A Converger Plan is an asset tranche buyout model structured as a "sell, transition, sell" strategy, involving two asset tranche sales over a two to three-year period. This framework allows both buyer and seller to define their exit in phases, with the asset percentage sold in each tranche tailored to their agreement, and the second tranche sold at its prevailing value.

Partial Equity

A Partial Equity Purchase entails buying a portion of a shareholder's equity shares. This can occur through various means such as a partner buy-in, partner buyout, structured tranches over time, and as part of a succession plan offering.

Merger Acquisitions

Those acquisitions described as mergers because of the transition experience, not a literal legal merger between the parties. It's selling the business outright while transitioning into an employee role for an agreed term—typically between one to three years, facilitating a smooth client transition and easing the seller's eventual exit. See Mergers for merger info.

The Components of an Acquisition

PRICE

Purchase Price: Anything less than valuation price is a likely non-starter and if you’re in a competitive scenario, especially in a marketplace scenario expect to be competing against premium price offers. Recurring revenue multiples typically 2.5 to 3.5x.

TERMS

Payment Terms: Varies but commonly 100% bank financing (no down payment and no seller financing) either with/without a clawback or some percentage bank financed and the balance seller financed. Bank loans are typically ten years.

CONTINGENCIES

Contingencies: Added provisions accounting for what may happen usually referring to an Attrition Offset Clawback, and negative covenants like Non-compete and Non-solicit. Non-solicit is needed for all asset acquisition types.

CONSIDERATIONS

Considerations: Situations such as death and disability scenarios, family-based purchases, internal buyouts, attrition risk, can significantly impact the attractiveness of an acquisition. These elements represent internal or external considerations that may not be reflected in the financials but can heavily influence a buyer's decision-making process.

CONSULTING

Consulting: The seller's responsibilities post-close primarily addressing the client transition period. This may be included in the purchase price or be paid a consulting fee during the consulting period. If buyer has SBA loan then only 1099 consulting agreement for 12 months.

TAX ALLOCATION

Tax Allocation: For asset purchases typically 96% is allocated towards the client list which is considered good will and taxed as capital gains to the seller. Thee other 4% is split typically between covenants (like the non-compete/non solicit) and for the consulting/transition period. The buyer writes off good will and covenants on a 15 year amortization and consulting payments is a same year deduction.

Typical Acquisition
Attrition Rates

Attrition rates depend on a host of factors of which seller cooperation, participation and time investment are paramount. Our rule of thumb for attrition expectations for bank financed acquisitions when the seller fulfills their transition role is about:

0% to 3%

Internal Successor

Generational and partnership acquisition: 0% to 3% client attrition.

0% to 5%

Internal Platform

Advisor not in the same firm but same platform acquisition: 0% to 5%.

0% to 10%

External Platform

Advisor outside of platform where clients are repapered: 0% to 10%.

Generational attrition: Don’t forget to focus on spouse and multi-generational retention strategy with older clients. About 3/4 of widows leave the spouse’s advisor after the spouse dies. About 2/3 of adult children leave their parent’s advisor after receiving their inheritance.

Typical Advisor Acquisition Tax Allocations

Upon the completion of an M&A transaction, both buyer and seller are required to file IRS Form 8594 with the Internal Revenue Service (IRS). This form reports the allocation of assets and is essential for determining the tax treatment of the transaction. Both parties must agree on the tax allocation before filing.

Filing Requirements:

Both buyer and seller are required to file IRS Form 8594 with the Internal Revenue Service (IRS). This form reports the allocation of assets and is essential for determining the tax treatment of the transaction.

Primary Acquisition Payment Structure Types

Bank financing will significantly impact which payment structures are available and added guardrails to structuring backend payments.

100% BANK FINANCED

100% Bank Financing: Allows the buyer to fund the acquisition without the need for a down payment or seller note. In these cases, the bank assumes all the immediate financial risk, and typical structures comprise 50% to 80% of the purchase price paid to the seller at closing, with the remaining 20% to 50% being placed into escrow, subject to offset/clawback provisions.

100% AT CLOSING

100% Down Payment: The 100% down payment model is less common, typically seen in partner buyouts or internal succession scenarios within the same broker-dealer. Here, sellers receive the entire purchase price at the time of closing, no seller financing or attrition offsets.

DOWN PAYMENT + EARN-OUT

Down Payment + Earn-out: The down payment + earn-out approach involves a front-loaded payment of 25% to 75% of the purchase price, with the balance settled through an earn-out promissory note. Earn-outs can be legally complex and involve tax implications. It's crucial to verify broker-dealer policies, particularly if the seller is retiring during the earn-out period, and to note that earn-out down payments are generally not eligible for SBA loans.

100% SELLER NOTE + FUTURE REFI

100% usually fixed seller note with the expectation the buyer will refinance the seller note into a future bank note (usually two years) as soon as the note allows and escalates in increments (usually in two years periods) for the buyer to try again if unable to procure financing during the first period. The SBA has a two year standby period for refinancing seller promissory notes.

DOWN PAYMENT + SELLER NOTE

Down Payment + Fixed Seller Note: In the down payment + seller note structure, the seller note can be either fixed or adjustable. For a fixed note, the seller receives a set period of fixed payments without any offset/clawback. An adjustable note operates similarly, with the added element of an attrition-based clawback at a predetermined point or in an earn-out note (see earn-outs)

100% SELLER NOTE

100% either fixed or adjustable seller note. For a fixed note, the seller receives a set period of fixed payments without any offset/clawback. An adjustable note operates similarly, with the added element of an attrition-based clawback at a predetermined point or in an earn-out note (see earn-outs)

DOWN PAYMENT + ESCROW

Down Payment + Escrow: In scenarios where an escrow agreement is utilized, a portion of the purchase price is held in escrow, and after a predetermined period (usually one year), the seller receives all or part of these escrowed funds, depending on the attrition of the client base. The balance, often linked to an attrition offset formula agreed upon by both parties, can be "clawed back" by the buyer and is typically applied to reduce the buyer's loan balance.

PAYMENT + EQUITY

Some form or down payment

Aggregator/rollup

Triangle merger

TRANCHE+TRANSITION+TRANCHE

Tranche + Transition + Tranche: The succession converger or an acquisition converger whereby a partial asset acquisition is executed followed by a 2-3 year transition followed by the second tranche asset purchase.

Selling to Successor:
What to Know

Selling to an internal successor is what most advisors prefer or plan.

It might be to an existing partner, junior or associate advisor, or even a family member. In most cases an internal advisor can qualify for an acquisition loan for the full purchase price.

Can I spread out payments over multiple years without seller financing?
Yes. Part of the purchase can be placed into escrow and then disbursed over multiple years.
Can they get a loan for the down payment and then do an earn-out for the rest?
If they qualify for a conventional loan they can. Any form of an earn-out is not allowed with an SBA loan.
Can I help my successor avoid a down payment?
Other than guarantying the loan, they would need to be 1099 for one year prior to the purchase and own enough assets to value at just over 10% of the purchase price.
Can I lend successor money for a down payment?
You can’t lend it to them.
Can they use the phantom stock I gave them as a down payment?
Conventional: If the buyer is doing a conventional loan, no problem.
SBA: The equity owned needs to be reported on their last two years tax returns to qualify. If the equity is phantom stock, a verbal agreement, or equity that you gave that has no benefit unless you sell someday, then lenders typically will not view that as eligible equity ownership that could be applied as the down payment.
What's this SBA equity injection seller financing all about?
For advisors with no equity ownership, no 1099 income, and no clients owned, then a 10% down payment would be required. Of this you can choose to seller finance 5% but the note would be on a 10 year standby note.
This means that while interest can accrue the buyer would not be able to make any P&I payments on that 5% note while the SBA loan is still active. SBA acquisition loans (without property) are 10 years.
For a lot of internal successors there is a big difference in their ability for coming up with a 5% down payment vs. coming up with 10%. With a little planning you can help your internal successor in this situation either prepare for a down payment or avoid a down payment all together.
Should I ever consider guarantying the loan?
As a general rule, no. However, there are circumstances that could warrant it. If you do guaranty then you will likely only be able to protect yourself in clawing back the equity that was sold.
What does it cost to see if my successor qualifies?
Nothing, AdvisorLoans provides pre-approvals for free.

Is Seller Financing Required?

Most all acquisition deals less than $5 million can be funded without seller financing if that was the only consideration taken into account. A bank will always prefer that the seller finances a portion of the purchase, but what a bank “prefers” and will “allow” are different things.

For the vast majority of the acquisition loans we do for loans under $5 million, the seller doesn’t finance any portion of the purchase. Sellers “can” seller finance any amount of the purchase with a promissory note, but have to subordinate that note to the lender’s note.

If the buyer is getting a SBA loan, then the SBA has a 10% equity injection requirement. Most established independent advisor buyers satisfy this requirement without having to make a cash down payment but some don’t for a variety of reasons.

For the advisor buyers required to put a 10% cash down payment, the SBA allows for the seller to finance this with a standby seller note.

The primary scenarios where a bank would require a portion of the purchase to be in seller financing are:

If the buyer is getting a conventional loan then some lenders may require 10% to 25% of the purchase price to be in seller financing as a standard rule. If they do we suggest you just walk away. Most all lenders with experience in advisor lending will base it only on LTV and if the LTV qualifies. usually from 75% to 85% then the bank shouldn’t care if this partially or all comes from the value of the buyer’s business.
W2 advisors, advisors without production, and advisors whose practice has too low of a value compared to the seller practice value being acquired.
If the deal isn’t cash flowing strong enough, or the lender has other concerns about the deal, the lender may require the seller to finance a portion of the purchase. In these cases, 10%-25% seller note is the typical percentage the lender would require.
For SBA acquisition loans, if the valuation that the lender orders is lower than the agreed upon purchase price, and the buyer is still willing to pay the purchase price, the difference either needs to be paid in cash from the borrower (unlikely) or the seller can finance the difference with a seller note (typical).

Seller Note Subordination

The subordination of seller promissory notes to the lender is a critical requirement for most acquisition loans.

Subordination is based on The "Senior Debt" and the "Seller Note":

Senior Debt: This is the main loan provided by the bank for the acquisition. When it comes to repayment and default scenario, the Senior Debt takes precedence. It essentially holds the strongest claim on your assets if a default occurs.

Seller Note: The Seller Note is a form of debt given out by the seller to you, the buyer. Rather than making an upfront full payment for the purchase, you agree to repay the seller in installments, with interest over a predetermined period.

Seller Note Subordination

Seller Note is "subordinate" to the Senior Debt, implying:

Repayment Order: In case of financial strains, the Senior Debt has to be settled in full before any payments can be directed towards the Seller Note.

Implications of Default: In the event of a default on the Senior Debt, the bank has the right to claim your assets to recoup the outstanding loan amount. However, regular servicing of the Senior Debt leaves the Seller Note untouched.

Security Interest: The bank may use your Seller Note as extra collateral for the Senior Debt, thereby enhancing their claim on your assets in case of a default.

Rule 2040 Applies to Advisors Selling Their Practice and Giving Up Their License

When a licensed financial advisor decides to sell their practice and retire, they need to navigate the regulatory landscape to ensure they receive their fair share of the sale proceeds. FINRA Rule 2040 provides a framework that allows for such a transition, ensuring compliance with federal securities laws while facilitating ongoing compensation for retired advisors, provided certain conditions are met.

Under Rule 2040, a retiring registered representative can continue to receive commissions from accounts held for continuing customers. This is permissible provided there is a bona fide contract established while the advisor was still registered, detailing the terms of the ongoing payments. The contract must explicitly forbid the retired advisor from soliciting new business, opening new accounts, or servicing existing accounts generating the ongoing commissions. This ensures that the retired advisor's activities remain in compliance with applicable federal securities laws and FINRA rules.

For the arrangement to be valid, the advisor must cease their association with the member and leave the securities industry. Still, the contract can stipulate provisions for continuing payments even in the event of the advisor's death, directing these payments to a designated beneficiary or the advisor’s estate.

https://www.finra.org/rules-guidance/rulebooks/finra-rules/2040

Fixed & Adjustable
Promissory Notes

Fixed and Adjustable Notes

Promissory notes are commonly used in advisor acquisitions, with two primary forms: fixed and adjustable. The main difference between these two types lies in their payment structures and the degree of protection they offer to the borrower.

Fixed Promissory Notes

In fixed promissory notes, the amount owed remains unchanged throughout the payment period, regardless of any changes in client or revenue attrition. The buyer makes fixed, predictable payments to the seller, typically with interest, over a set period, regardless of the performance or financial outcomes of the acquired business. This type of note offers stability to both parties but limits the potential for adjustment if the retention underperforms.

Adjustable Promissory Notes

Adjustable promissory notes are structured to provide some level of protection to the borrower in the event of unexpected attrition in clients or revenue. In these notes, the amount owed by the buyer is subject to adjustment based on predetermined benchmarks or clawback provisions. If the retention benchmark for clients or revenue isn't met, the buyer has the option to adjust the price and "claw back" a portion of the purchase price from the seller. With Small Business Administration (SBA) loans, the adjustment amount to the seller can only be decreased and cannot be increased.

Utilizing Escrow Agreements in Acquisition Loans

Purpose of Escrow in Acquisitions

An escrow account acts as a secure holding account for a portion of the purchase price. It provides protection for both the buyer and the seller by ensuring that funds are available to fulfill specific obligations or contingencies outlined in the acquisition agreement.

Escrow agreements are typically utilized in 100% financed loans for a clawback provision. The seller will typically receive most of the purchase price at closing wired from the lender.

The portion set aside (usually from 20% to 50%) for the clawback provision, is wired into the escrow account when the loan is closed. Some lenders will handle the escrow internally and others will require the borrower to find their own escrow firm. In either case, there is an escrow agreement between the buyer and seller.

The agreement spells out when the funds will be distributed and the formula that will be used to calculate the distribution(s). If the retention provisions are met, then all of the proceeds will be delivered to the seller. However, if after the look back period the agreed upon attrition delta is triggered, then the seller receives the adjusted amount and the balance is “clawed back” and usually applied to the buyer’s loan balance.

How Escrow is Used

Attrition Offset Clawbacks: One common use of escrow in acquisitions is to manage potential attrition offsets. It involves setting aside a portion of the purchase price in the escrow account for a specified period. If client attrition exceeds predetermined thresholds, the escrow funds are used to offset the financial impact.

Seller Payment Distribution: In some cases, escrow accounts are utilized when the seller wants to receive payments over the next 2-3 years instead of all at closing for tax purposes. For example a purchase can be closed in December with down payment funded to seller and balance going into escrow with payments disbursed from escrow to the seller on January 5th for the next 2 or 3 years.

Purchase Price Adjustments: Escrows can also be used to account for adjustments to the purchase price based on certain conditions or contingencies, such as the accuracy of financial representations, resolution of pending lawsuits, or the satisfaction of regulatory requirements. The escrow funds may be released or retained based on the outcome.

Tax Deferral

Seller-financed deals present unique opportunities and challenges, particularly when it comes to tax matters. One critical aspect is the prevention of constructive receipt which can sabotage tax deferral advantages. To prevent constructive receipt in these agreements, sellers must relinquish any control or access to the sale's proceeds, even if these funds reside in an escrow account.

Key Considerations:

Escrow Beyond Basics: Merely placing the funds into an escrow account doesn't suffice. It's imperative that the seller is barred from exerting control over, or accessing, the escrowed funds.

Alternative to Escrow: While escrow services are common, an attorney-client trust account can also fulfill this role efficiently, potentially reducing both complexity and costs.

Unambiguous Agreements: The terms of the escrow account or any trust agreement should explicitly preclude the seller’s access to the funds. Vague terms can result in constructive receipt, thereby creating instant tax obligations.

Loan Risk and Sale Price: The presence of seller financing generally does not reduce the sale price of the asset. Instead, the risk factored into the loan is offset by the interest charged, distinguishing it clearly from the sale price.

Interest Rates and Risk: Setting a fair interest rate is essential, reflecting the risks the seller takes on. This separation between the purchase price and interest prevents confusion and reduces the likelihood of conflict between the involved parties.

Escrow Process

Establishing the Escrow Account: Typically, an escrow agreement is entered into among the buyer, seller, and an escrow agent (often a third-party entity or an agreed-upon financial institution). It outlines the terms and conditions of the escrow, including the funding amount, duration, and distribution provisions.

Funding the Escrow: The agreed-upon portion of the purchase price is transferred to the escrow account at closing from the lender financing the acquisition loan. This amount is held by the escrow agent until the conditions or contingencies specified in the acquisition agreement are met.

Distribution of Escrow Funds: The distribution of escrow funds occurs based on the provisions outlined in the escrow agreement. If the conditions are met, the funds are released in full or in part to the seller. If a clawback provision is triggered due to attrition or other reasons, the adjusted amount is paid to the seller, and any remaining balance is often applied to the buyer's loan balance or returned to the buyer.

Constructive Receipt

Avoiding constructive receipt implies more than just depositing the funds into an escrow account. The primary step is clear-cut: the fund cannot simply be placed in escrow. The next vital action ensures that the seller has no access to these funds, maintaining the tax deferment stance. This is where an escrow agreement becomes instrumental; however, it's often a misconception that a formal escrow company must be employed.

Many deal structures utilize the attorney-client trust accounts of the seller or buyer to act as an escrow agent. This alternative not only expedites the process but also proves to be cost-effective. Most importantly, the instructions for this account must be unambiguous to ensure that sellers cannot access the funds; otherwise, constructive receipt occurs, incurring immediate tax liabilities.

Earn-out Notes

An earn-out is a type of payment structure commonly used in financial advisor acquisitions. It involves the buyer making a partial payment upfront and the remaining amount being contingent upon the financial performance of the acquired business after the acquisition. Typically, a percentage of the revenue or net operating income (NOI) is agreed upon and paid to the seller over a specified period of time or until a predetermined amount is reached.

This payment structure is often preferred by sellers of high-growth businesses who believe that the value of their business exceeds what a traditional business valuation represents. Earn-outs are also more popular when the buyer is using cash for the down payment or when a bank loan is involved in the acquisition. In the latter case, the buyer obtains a loan for a portion of the purchase price, usually 50% to 75%, and the remaining amount is paid to the seller based on the future performance of the acquired business.

Earn-outs involving conventional and SBA loans
Conventional loan - As long as the projected earn out terms cash flows, most conventional lenders accept earn-out structures. From a lender’s perspective, earn-outs provide some short-term protection for their borrower from a significant downside turn in revenues after the loan closing. And, as with a seller promissory note or escrow agreement provision, earn-outs provide some protection for higher than anticipated attrition. Also similar to seller financing, earn-outs provide the lender with a low LTV, while still being in first lien position with the earn-out subordinated to the lender.
SBA loan - The SBA prohibits earn-out structures. Earn-out promissory note structures are not allowed in SBA lending. If it looks like, or smells like a “revenue share” arrangement, the SBA lender won’t approve the purchase agreement. If a seller is set on having an earn-out structure and the buyer needs a bank loan for the down payment, they will need to qualify for a conventional loan.
Earn-out Note Subordination
In most cases, the earn-out note is required to be subordinated to the lender if a bank is involved in the transaction. This means that the seller's right to receive earn-out payments would be secondary to the lender's rights and repayment priority. The subordination ensures that the lender has first claim to the borrower's assets and cash flows, including any earn-out payments, in the event of default or financial challenges. This is similar to how a seller promissory note would also be subordinated to the lender's interests.
More complicated legal and tax considerations
Earn-outs generally have more complex legal structures compared to other payment arrangements. They involve detailed terms and conditions that are contingent upon future performance and can include various provisions, such as revenue targets, financial milestones, or clawback provisions for revenue attrition. The complexity arises from the need to define and agree upon specific metrics, timelines, and conditions for determining the earn-out payments. Additionally, legal documentation is required to outline the terms of the earn-out, including the calculation method and the rights and responsibilities of both the buyer and the seller.
When seller is retiring during the earn-out term
If a licensed financial advisor seller retires during the earn-out period, it is important to address this situation in the purchase agreement. The retiree's retirement may impact the terms and conditions of the earn-out structure. The lender's lawyer reviewing the deal would typically want to ensure that the retirement is accounted for in the language of the purchase agreement.
Depending on the advisor's model and affiliation, different rules and regulations may apply to a buyer paying part of the practice's revenue to an unlicensed individual, such as a retired seller. Custodians usually allow for this by qualifying the seller as a "solicitor," enabling ongoing payments even when the seller is not licensed. However, it is crucial to consult with the Independent Broker Dealer (IBD) and custodian early in the process to determine and account for any earn-out requirements in the event of the seller's retirement.
When seller is continuing to work throughout the earn-out term
If the seller of a financial advisor business is staying licensed throughout the earn-out period, there are generally fewer complications compared to when the seller retires. In this scenario, there would be no issue with the seller continuing to receive earn-out payments directly.
While most Independent Broker Dealers (IBDs) permit such direct payments, it's important to note that there might be certain IBDs that have specific rules and compliance requirements. Some IBDs may insist on establishing a team ID rep code, whereby a portion of the compensation is paid to the buyer's rep code and the remaining portion to the seller's rep code.
Buyer pre-qualification even more important with earn-outs
Borrower pre-qualification becomes even more important when the seller wants both a big down payment and an earn-out structure. In such cases, the buyer needs to be strong enough to qualify for a conventional loan to finance the down payment portion. If the buyer does not meet the criteria for a conventional loan, they may not be able to obtain financing for the down payment and, consequently, the entire deal may fall apart.
By going through the pre-qualification process for an acquisition loan beforehand, the buyer can determine the loan amount they can target and assess the deal structures that are feasible for them. This helps avoid situations where the buyer and seller agree on terms, sign agreements, and set an acquisition date before realizing that the buyer does not qualify for the necessary financing.
Earn-out workarounds
When using an SBA loan, earn-out structures are generally not allowed. However, there are workarounds that can be utilized to achieve a similar outcome. Instead of relying on an earn-out structure, advisors can explore alternative options to get the deal done. Here are a few possible workarounds when using an SBA loan:
1. Seller Promissory Notes: The seller can provide a promissory note, where the payment is structured over multiple years and can be adjusted based on revenue attrition. This allows the seller to receive payments over time, contingent upon the performance of the business.
2. Escrow Agreements: Similar to seller promissory notes, an escrow agreement can be structured to distribute payments to the seller over a period of time. Clawback provisions can be included to account for any revenue attrition.
3. Premium Price with Seller Note: The buyer and seller can agree on a premium price, where the difference between the business valuation and the purchase price is covered through a seller note. The seller can then receive a fixed dollar amount over time, adjusted based on predetermined benchmarks.

Current Revenue Multiple Ranges

AdvisorBox estimated multiple ranges based on internal experience and industry research. AdvisorBox is not a licensed business valuation firm and does not provide business valuations.

EBITA Multiple Ranges

AdvisorBox estimated multiple ranges based on internal experience and industry research. AdvisorBox is not a licensed business valuation firm and does not provide business valuations.

< $500 MILLION AUM

Range is about 4x to 6x EBITDA

$500M - $1B AUM

Range is about 5x to 9X BITDA

> $1B - $5B AUM

Range is about 7x to 11x EBITDA

Recurring Revenue

2.25x - 3.5x

Recurring Revenue: Revenue generated on a regular basis without selling something again and again. Based on a management fee which is a percentage of assets managed or taking the ongoing trail compensation from annuities and mutual funds instead of upfront.

Fees
Annuity trails
12b-1s
Renewals
A share mutual fund trails*
SMA / Third-Party Managed

* Slightly More Premium Value

Semi-Recurring Revenue

0.50x - 1x

Semi-Recurring Revenue: A segment of transactional commissions which can be shown as consistent and predictable revenue and therefore has value.

Consistent = Over the last 3-5 years.
Predictable = Within 10% each year.

This might include more consistent commission business from stock and bonds, REITs, and UITs.

Commission Revenue

0 - 0.25x

Commission Revenue: A product is sold and a commission payment is received in full at the time, and no other ongoing compensation is earned from the transaction.

Stocks
Bonds
REITs
UITs
Life Insurance*
Fixed Annuities*

* Least Amount of Value

Business Valuations When a Bank Loan is Involved

When in the loan process the valuation is needed
Valuations are NOT needed before the acquisition loan gets rolling. There are of course circumstances where the advisor will want the valuation sooner than later but banks will almost always approve the loan without a valuation but requiring it as a closing item. In scenarios where the valuation is not expected to be an “issue” it’s not unusual for an advisor to wait until they receive loan approval before they order (or have the bank order for SBA loans) the valuation(s).
Circumstances where a valuation should be ordered early instead of later in the loan process include:
SBA loan buyer: where buyer’s estimated value is right at or close to the needed value required not to make a cash down payment. Any advisor with $300,000 in GDC with no business debt will value enough for a $5 million SBA acquisition loan. But an advisor with $100,000 acquiring a $2.5 million practice should value high enough but it’s not a given. In this case a valuation should be ordered right away on the buyer’s practice because you don’t want to find out at the end of the loan process that you’ll have to come up with $250,000 cash down payment or renegotiate the price of the deal.
SBA or conventional loan seller: where the price appears to be at such a premium that there is reasonable doubt that the third party valuation won’t be as high as the purchase price. For SBA loans the loan amount for the acquisition cannot exceed the valuation amount. For conventional loans, in most cases, the valuation can be less than the purchase price if it seems reasonable and doesn’t trigger the lender’s LTV requirements.
Which comes first loan pre-qualification or the valuation?
The loan pre-qualification term sheet absolutely comes first. While it is nice to have the valuation before an offer is even made that’s not the norm. For the buyer who needs a loan for the purchase it doesn’t really matter what a seller’s practice values at if they can’t get a loan for the purchase price.
For most buyers, before they start bidding on practices they should first find out how big of a practice they can get a loan to buy. It’s smart to get an Loan Pre-Approval letter that shows how much in acquisition loan dollars the advisor can qualify for and if they would qualify for a conventional or an SBA loan.
When a valuation is required on the buyer:
SBA Loans
For most SBA acquisition loans where the buyer already has an advisory business there is a valuation completed on the buyer’s business. The short explanation is that in an advisor expansion loan scenario where the buyer already owns an advisory business and is buying another advisor’s business they don’t have to pay a cash down payment. But the value of the buyer’s advisory business minus any business debt must value at just over 10% of the purchase price. To “prove” this the bank orders a valuation on the buyer.
To explain further, the SBA has a an equity injection rule for 100% ownership transfer acquisition loans. The buyer can pay a minimum of 10% cash down payment on the total amount of the purchase (not the loan amount) or the advisor can use “assets other than cash” option the SBA allows. The “asset” the advisor has other than cash is the value of their advisory business.
The lender needs to justify the value of the buyer’s practice to meet the equity injection requirement. In most acquisition scenarios with SBA 100% financing loans, third party valuations on both the buyer’s and seller’s practice will be required.
Conventional Loans
Requirements vary by lender but not usually for loans under $5 to $10 million (again depending on the lender).

Ordering the valuation(s)
Conventional lenders will typically accept any recent business valuation created by a known valuation firm in our industry like FP Transitions, Succession Resource Group, Key Management Group, and Truelytics.
SBA lenders however, must be the ones that order the valuation and do so using only the valuation firms who are on their SBA certified valuator vendor approval list.
The SBA also requires that the lender orders the valuation and that the valuation is prepared for the lender. The SBA specifically prohibits a lender from using a valuation that was prepared for the buyer or seller. For SBA loans be prepared to pay a deposit to the lender before they’ll order the valuations.
Who pays for the valuation and how
SBA Loan
The SBA lender is required to order the valuation. Most SBA lenders will not do this without a deposit from the borrower. The buyer can pay the deposit (usually around $2500) to the lender when they execute the term sheet or after they receive the approval. If the buyer wants the valuations completed sooner than later the deposit is paid early instead of later in the process.
Conventional Loan
Conventional lenders typically do not order the valuation and do not care if the valuation was paid for by the buyer or seller. If the seller already has a recent (less than 6 months old) valuation in hand then this can be accepted. If there is no valuation in place then one needs to be ordered.
Who orders and pays for the valuation for conventional loans is on a case-by-case basis decided upon between the buyer and seller. Sometimes the seller will pay for the valuation considering that if the buyer can’t qualify they will have the valuation they can use for a different buyer. Sometimes the buyer pays for the valuation to expedite the process with confidence they will be able to qualify for the loan to purchase it.
When the valuation is below the asking price
While conventional lenders have flexibility for this scenario, SBA lenders will not lend for an acquisition amount that is higher than the valuation. If the valuation is lower than the purchase price then the buyer needs to decide if they are still willing to pay the purchase price. If they are willing then the difference needs to be paid in cash (rarely happens) or the difference can be paid through a seller promissory note (almost always what happens). Depending on the size of the difference gap the seller note may be able to be for one to three years or for a longer period like three to seven years depending on the impact to the deal’s cash flow.
For conventional loans it is usually more about the impact to LTV or loan to value. Since the value of the buyer and seller’s practice is combined when LTV is calculated the discrepancy between the valuation and purchase price would have to be significant to throw a monkey wrench into the approval.

Assessing Financial Performance:

Start by closely reviewing your financial statements, tax records, and relevant documents. This will help you understand your practice's revenue streams, expenses, profitability, and cash flows, highlighting any discrepancies or areas for improvement. Strong financial health is crucial, especially if buyers plan to seek bank loans for the acquisition.

Operational and Technology Infrastructure:

Review your firm's systems, processes, and technology to showcase their efficiency and scalability. Reliable back-office operations and robust cybersecurity measures are essential for attracting buyers and ensuring smooth integration post-acquisition.

Client Base and Relationships:

Take a deep dive into your client demographics, retention rates, and any client concentration risks. This analysis will enhance your practice's appeal by showcasing the strength of your client relationships and service levels while highlighting cross-selling opportunities.

Conducting a Self-Diligence Analysis on Your Practice

Conducting a thorough self-diligence analysis of your advisory practice is a smart and empowering step for any seller within the AdvisorBox ecosystem. This process ensures you present your business in the best light to potential buyers, showcasing its credibility and value, which is key to securing favorable terms and successful transactions.

Employee Contracts and Compensation:

Examine your employee contracts and compensation structures to assess workforce stability and address potential liabilities. This analysis can facilitate smoother transitions and bolster buyer confidence in your practice's stability.

Legal and Regulatory Compliance:

Conduct thorough reviews of your compliance with licenses, registrations, contracts, and any existing legal or regulatory issues. This preparation reassures prospects that there are no hidden challenges, safeguarding your practice's integrity.

Identifying Potential Synergies:

Use this opportunity to highlight the synergies your practice offers while honestly addressing any operational or cultural differences that may arise during integration. Transparency can ease the acquisition process and support long-term success.

About Equity Injections

Equity injections are basically skin in the game from the lender's perspective for an acquisition loan.

The equity injection has nothing to do with an asset or equity structured purchase, it is referencing the equity of either cash, assets, or a seller note injected into the deal.

An equity injection can be provided by the buyer through a cash down payment or waived based on their current book of business value.

A seller can inject equity into the deal by providing a seller promissory note for a portion of the purchase price.

And equity injections can be satisfied through a combination of buyer down payment and a seller note.

What is an equity injection?
This is basically skin in the game from the lender's perspective for an acquisition loan. The equity injection has nothing to do with an asset or equity purchase, it is referencing equity to mean that either cash or assets are injected into the deal. An equity injection can be provided by the buyer through a cash down payment or waived based on their current book of business value. A seller can inject equity into the deal by providing a seller promissory note for a portion of the purchase price. And equity injections can be satisfied through a combination of buyer down payment and a seller note.
It's all about the LTV - Loan to Value
While a borrower's personal financial situation and credit scenario impacts this the primary equity injection requirements from conventional lenders comes down to the LTV. Conventional lenders have maximum LTV requirements typically at 75% but some can go to 85%.
Given that LTV is calculated by combining the value of the buyer's and seller's practices, acquisition deals generally bypass LTV qualification hurdles. However, LTV ratios become a crucial challenge in conventional loans when the buying advisor’s practice is valued at or below 33% of the selling practice’s value. In such scenarios, the loan agreement could breach the LTV maximums set by conventional lenders, pushing the need towards an SBA-backed loan.
For SBA loans, the threshold of concern is when the buyer’s practice is worth approximately 11% of the seller's; this figure is a trigger point for exceeding conventional LTV limits, necessitating the pursuit of an SBA lender for financing.
Understanding the New SBA Equity Injection Rules
The SBA equity injection rule stipulates a ten percent equity injection on loans that lead to a change of ownership. This rule applies to the total project costs and not the loan amount. The 10% equity must come from a source outside the business's existing balance sheet.
Change of Ownership Loans
These loans entail acquiring a business, assets, or equity, where the ownership is entirely transferred from the seller to the buyer. These loans include new business purchase loans, expansion business purchase loans, and complete and partial partner buyouts.
In terms of Equity Injection for a Business Purchase, there are three ways to meet the equity injection requirement: 10% Cash, Full Standby Note, and Partial Standby Note. If choosing a Standby Note, the borrower will have two loans: an SBA loan with the lender, and a promissory note with the seller.
For changes of ownership resulting in a new owner (complete change of ownership): At a minimum, SBA requires an equity injection of at least 10 percent of the total project costs, (all costs required to complete the change of ownership, regardless of the source of funds) for such transactions.
Seller debt may not be considered as part of the equity injection unless the seller’s loan does not include a balloon payment and, for the first 24 months of the 7(a) loan, the seller debt is on either (a) full standby; or (b) partial standby (interest payments only being made) and the Applicant’s historical business cash flow supports the ability to make the payments, and at least a quarter of the SBA-required equity injection is from a source other than the seller.
What are change of ownership loans?
A loan resulting in a change of ownership is when you are purchasing a business, assets or equity, whereby 100% of the ownership transfers from the seller to the buyer.
These include:
A new business purchase loan
An expansion business purchase loan
And complete and partial partner buyouts.
Equity Buy-in Equity Injection
The partial partner buyout is when a borrower is purchasing part of the equity owned by a partner. The partner who is selling will remain on as a partner since they are selling just part, and not all, of their equity.
This loan also requires a ten percent cash injection unless two key requirements are met.
A Maximum Debt-to-Worth of nine-to-one (9:1). This is determined based on the business balance sheet over the most recent year and quarter.
Any remaining owners of the business who have twenty percent or more in equity, are subject to the SBA guarantor requirements. This includes the personal guaranty and the property collateral requirements.
Calculate the 9:1 ratio
The 9:1 ratio for equity injection in SBA SOP for partner buyout loans is a measure of a business's financial health. This ratio compares the business's debt to its equity, which represents the amount of capital invested in the business by its owners. A lower debt-to-equity ratio indicates that the business has more equity and is less reliant on debt, while a higher debt-to-equity ratio suggests that the business is more heavily indebted.
Calculating the 9:1 Ratio: To calculate the debt-to-equity ratio, divide the business's total debt by its total equity. For example, if a business has $500,000 in debt and $100,000 in equity, its debt-to-equity ratio would be 5:1.
Interpretation of the 9:1 Ratio: The SBA considers a debt-to-equity ratio of 9:1 or higher to be indicative of financial risk. When a business's debt-to-equity ratio exceeds this threshold, it may be required to inject additional equity into the business to demonstrate its financial stability and reduce the risk of default on an SBA loan.
Example of a Business Below the 9:1 Ratio: Suppose a business has $750,000 in debt and $150,000 in equity. Its debt-to-equity ratio would be 5:1, which falls below the 9:1 threshold. In this scenario, the business would not be required to make an equity injection as it is considered financially stable.
Example of a Business Above the 9:1 Ratio: If a business has $1,200,000 in debt and $100,000 in equity, its debt-to-equity ratio would be 12:1, exceeding the 9:1 threshold. In this case, the business would likely be required to inject additional equity into the business to lower its debt-to-equity ratio and meet the SBA's requirements.
Equity Injection If Cash Payment
The equity injection can be paid by the borrower in cash, preferably wired to the lender a week or two before the loan closing. The money can come from savings, investments, a Home Equity Line of Credit (HELOC), or as a gift (with a gift letter as proof). Lenders usually require the most recent account statement for verification.
Full Standby Note
The SBA made a big change to the full standby seller note. Now the seller can finance the full ten percent of the equity injection requirement.
No principal or interest can be paid during the first two years standby period.
This option enables the borrower to purchase a business with no money down.
Partial Standby Note
A partial standby is where interest only payments can be made for the first two years but not principal payments.
The seller can finance up to 7.5% in a partial standby note.
The SBA requires 2.5% to come from a source other than the seller.
Adequate cash flow has to support the partial standby option.
Advisor Expansion Through Acquisition
Expansion Loans
Business Expansion Loans do not require an equity injection. When an existing business starts or acquires a business that is in the same 6-digit NAICS code with identical ownership and in the same geographic area as the acquiring entity and they are co-borrowers, SBA considers this to be a business expansion and not a new business.
Expansion Acquisition
When an existing business purchases another established business.
There is no down payment requirement for one business purchasing another business if three conditions are met.
1. The target business to purchase is in the same industry
2. The target business to purchase is in the same geographical area as your current business
3. The exact same current ownership structure will be applied to the purchased business.
If all three of these conditions are met then no equity injection is required. If all three conditions are not met, then the ten percent equity injection rules apply.
What down payment sources qualify for SBA loans?
Savings
Liquidating from investment account(s)
Gift (gift letter must be provided)
HELOC
What is the process of making payment?
For SBA loans the typical way it works is the down payment is wired to the bank. The bank is required by the SBA to see statements that show the amount was in that account for two full months before the down payment was sent. If the money was pulled from multiple accounts then multiple account statements will have to be provided.

Seller Primary Items & Information Needed

Sometimes sellers do not want to provide potential buyers with tax returns or P&Ls until they know the buyer is indeed pre-qualified for a loan for the purchase amount. Sellers always have the option of providing their documents direct to AdvisorLoans or direct to lenders instead of sending confidential docs to the buyer to forward onto the lender.

LOI or Deal Terms
There doesn’t need to be an executed LOI to get a term sheet. The outline of the key terms that will be in a LOI are needed. Price and loan amount are the key variables. If seller financing is involved, then how much and for how long also needs to be known.
Pro Forma
The buyer usually has to show projections. The bank wants to see that after combined revenues, and expenses, there is enough cash flow to make the loan payment and have room left over. Provide the buyer with any significant add-backs from your P&L that the buyer would not have as an expense after the acquisition is closed.
AUM and Revenue
The lender wants to see a custodian or broker dealer generated report showing assets managed and trailing 12 months revenue.
For a partial client/asset acquisition an SBA lender needs to verify that the assets being acquired is indeed a partial (less than 50%) of your client assets.
Tax Returns, P&L, and Balance Sheet
Last 3 years tax returns.
If 2022 tax returns are on extension then a P&L for 2022 is needed. A P&L is also needed for 2023 YTD.
Some lenders will want to see a YOY (Year Over Year) YTD P&L comparison as well.
4506-T
Execute IRS form that allows bank to pull tax transcripts.

Wiring Instructions
The bank wires seller funds directly to the seller at closing.
Lien Payoffs
Payoff notices for any existing seller debts with a lien on the business.
Purchase Agreement
Executed purchase agreement and any seller notes, seller subordinations, exhibits and escrow agreement (if applicable).
Equity Documents:
Stock Certificates
Resignation Letter (if 100%)
Articles of Incorporation or Organization
Bylaws or Operating Agreement
Partnership Docs  (if applicable)
Interim Financials
Banks will need to see YTD financials typically within 120 days of closing.

Next-Gen Succession Equity Buy-ins

Tranches Through SBA Lending

5% now, then 76% to 94% in 2 years, then the last shares whenever final retirement happens

This is not an official SBA program but how we work with the SBA rules to achieve desired outcome of a next-gen advisor going from no equity to 100% ownership over time based on financing timeline benchmarks. This structure outline can work for a senior partner or partners who are ready to slow down but not retire, who want to sell most but not all of their equity to firm employees and next-gen advisors, wants to help position these employees for SBA financing, and does not want to guaranty their loans.

1. Minority 5% Equity

Some small amount level of equity like 5% is transferred to next-gen advisor(s). This can be paid in cash or provided as services rendered or converted from phantom stock or the promise of equity into actual equity.

An SBA loan can be done for this initial piece but a seller guaranty from all 20% partners would be required.

2. Wait 2 Years

The next-gen advisor receives K1s for ownership for two years. At anytime after 2 years the next-gen minority partner(s) can purchase can pursue full financing to buy out another 76% to 94% partial equity purchase.

Other partners with less than 20% do not have to personally guaranty the loan.

3. 76% to 94% Equity Sell

Next-gen advisor(s) purchases a sum equity that can range from 76% equity which leaves seller with 19% to 94% equity which leaves seller with 1%. This is now a partial partner buyout loan. No seller guaranty required.

4. Retire When Ready

Senior advisor maintains minority partner status owning from 1% to 19% of equity. Can sell the rest at once or in tranches to the same advisor or to whomever the partnership agreement allows for.

1.15 DSC: The deal structure needs to cash flow at better than 1.15 DSC.e deal

9:1: The business balance sheets for the most recent completed fiscal year and current quarter must reflect a debt-to-worth ratio of no greater than 9:1 prior to the change in ownership.

Why it may matter what kind of loan your buyer qualifies

External financing is likely to play a key role in your buyer’s ability to finance the acquisition of your practice.

Your buyer is likely going to use a conventional or SBA loan to finance the purchase. Each one has different qualifying requirements and restrictions in acquisition or equity buyout structures.

While sellers and buyers have a lot of flexibility in how a deal is structured, if financing is needed, the flexibility can’t expand beyond the allowable limits of the specific loan program and lender.

Buyer’s loan’s impact on payment structure options
Your buyer is likely going to use a conventional or SBA loan to finance the purchase. While sellers and buyers have a lot of flexibility in how the deal is structured, if bank financing is needed, the flexibility can’t expand beyond the allowable limits of the specific loan program and lender.
Payment structures allowed with a conventional loan vary from those allowed with a SBA loan. SBA loans have defined guard rails on acquisition structure types and provisions. This means that the type of loan (conventional or SBA) the buyer gets, and usually the specific lender being used, will dictate the types of payment structures available to the seller.
If it’s important to you to have an earn-out structure, or want to sell equity in tranches over time, or want to stay in a key role years after the sale then you need the buyer to be able to qualify for a conventional loan, which has a higher qualifying bar than with an SBA loan. None of these are allowable with an SBA loan.
When how you get paid is as important as how much
For many sellers, it is important not just how much money they are selling for, but also how it is paid. Most sellers want as much as possible upfront at closing. Some will want part of the payment to be received over multiple years. Others will want to include an earn-out where they receive an ongoing percentage of revenues or profits for multiple years.
All of these payment structures are common in wealth management M&A. However, if the buyer is going to need external bank financing in order to purchase your premium priced practice, not all of these payment structures will be available to all buyers.
Consider buyers that qualify for the loan that allows for the deal structure you want
If a specific loan program doesn’t allow for the structure the seller is looking for, they should consider if their potential buyer qualifies for the loan program allowing for the desired deal structure. Unfortunately, most prospective buyers don’t know.
While there are a lot of buyers out there looking, the vast majority haven’t taken the time to prequalify for external financing. Most first-time buyers don’t know for sure if they can qualify for a conventional loan, an SBA loan, or any bank loan at all.
Just because a “larger producer” is interested in acquiring your practice, it doesn’t mean they would automatically qualify for a loan that will allow for your desired payment structure. Some advisors and firms with sizable AUM and revenue can also have oversized overhead and debt service from previous acquisitions that limits the amount of additional debt they can qualify for.
Just because your potential buyer has had multiple prior acquisitions they financed, doesn’t mean they would be automatically be qualified for another loan for your acquisition. Some advisors in heavy acquisition mode are now leveraged enough from previous acquisitions that it might be another year or two before they could get approved.
If you’re considering selling your practice, consider narrowing your selection of prospective buyers to those who are pre-qualified for financing for not only what you want to get paid but how you get paid as well.
Seller guaranty
If your buyer is doing a conventional loan and does not qualify on their own then a seller guaranty may be required.
Internal successors who do not currently own sufficient equity or clients assets and employee based successors will typically require a seller guaranty. For SBA loans there is no seller guaranty but a 10% down payment.
See Guarantors & Liens page for more details.

COMPONENT: SELLER CONSULTING

Retaining the Seller Post-Acquisition

Consulting Period Duration

The duration of the consulting period can vary depending on the specifics of the sale agreement and the needs of both the buyer and the seller. However, a typical consulting period after the sale of a financial advisory practice ranges from one to three years. The purpose of this period is to ensure a smooth transition, facilitate client retention, and provide ample time for knowledge transfer and integration.

Retaining Institutional Knowledge

The seller as a consultant can help bridge the gap between the practice's past and future, preserving important institutional knowledge that may not be easily transferable through documentation alone. They can provide guidance on client preferences, historical perspectives, and other critical information that contributes to the practice's continued success.

Employment Contracts

With an employment contract, the seller remains with the company in an advisory capacity.

This arrangement is advantageous as the seller continues to receive employee benefits such as health insurance, an expense account, and possibly a company vehicle. Payments to the seller are treated as business expenses for the buyer, maintaining a favorable tax position. However, sellers must ensure they provide sufficient value in their new role to avoid scrutiny from tax authorities like the IRS.

Additionally, employment agreements should be formalized separately from the business sale agreements to ensure the sale remains unaffected if the employment relationship encounters issues.

Buyer's Knowledge Transfer

The seller's expertise and knowledge accumulated over years of running the practice can be invaluable to the buyer. By serving as a consultant, they can transfer their insights, best practices, and in-depth understanding of the practice's operations, client base, and industry dynamics to the buyer, facilitating a seamless transition.

Relationship Transfer for Client Retention

The seller's continued involvement as a consultant can help ensure a smoother transition for clients, as they can maintain their existing relationship with the familiar face of the practice. This can increase the likelihood of client retention and minimize any potential disruptions or uncertainties.

Common Seller Post-Acquisition Roles

Client Transition and Retention: Assisting with the transfer of client accounts, introducing the buyer to clients, and working to retain clients during the transition period.

Knowledge Transfer: Sharing insights, best practices, and industry expertise with the buyer, helping them understand the nuances of the practice and its client base.

Staff Support: Collaborating with the buyer to provide training, guidance, and support to the practice's staff members during the transition.

Compliance Assistance: Providing guidance on compliance requirements, regulatory issues, and risk management to ensure continued adherence to industry standards and regulations.

Other Specific Agreed-upon Tasks: Depending on the needs and agreement between the buyer and the seller, additional responsibilities and tasks may be assigned to the seller during the consulting period.

SBA Specific Rules

No More Employee Status for Sellers: Sellers in 100% ownership transfers or asset acquisitions cannot remain as employees post-sale under SBA financing.

1099 Contractor Only: Previously allowed employee options are eliminated. Post-sale consulting agreements must be structured as 1099 independent contractor agreements.

SBA now has a stricter no-employee clause pushing all post-sale agreements to be contractor and not employee structures.

Selling advisors going forward have different rules about this than selling advisors in the past.

Post-Sale Engagement of Seller

When selling a business, the transition typically does not signify the end of the seller's involvement. Most buyers prefer the former owner to stay on temporarily to provide guidance and ensure a seamless handover. This continuity is crucial for maintaining the business's momentum and sustaining established relationships with employees and clients. To facilitate a successful transition, post-sale roles are often clearly defined. The two most common roles include employment contracts and consulting arrangements.

How the new rule changes post-sale consulting structure:

Consulting Agreement

Consulting arrangements offer the seller more flexibility compared to employment contracts. In this setup, the buyer compensates the seller for a specified number of consulting hours.

This means the seller is available on an as-needed basis rather than being fully integrated into daily operations.

This arrangement grants freedom while still allowing the seller to provide valuable insights and support during the transition period.

Restrictive Covenants:
Non-Compete and Non-Solicitation Agreements

Restrictive covenants such as non-compete and non-solicitation agreements are critical components in advisory M&A transactions to protect the investments and continuity of service to the clients post-acquisition.

Non-Compete and Non-Solicitation Provisions

Non-compete provisions: Non-compete provisions restrict the seller from engaging in a similar business or offering similar services within a specified geographical area and for a defined period after the acquisition. This protects the buyer from direct competition and preserves the value of the acquired firm.

Non-solicitation provisions: Non-solicitation provisions restrict the seller from soliciting or enticing clients or employees of the acquired firm to terminate their relationship or join a competing business. They safeguard client relationships and prevent the seller from poaching valuable clients or employees.

Key Considerations for Provisions:

Scope and Duration: The scope of non-compete and non-solicitation provisions should be reasonably tailored to protect the buyer's legitimate business interests without excessively restricting the seller's ability to earn a living. Considerations include the geographical area covered, the duration of the restrictions, and the specific activities or clients covered by the provisions.

Geographic and Temporal Limitations: To ensure enforceability, non-compete provisions should be geographically limited to a specific radius or market area. The duration of the restrictions should also be reasonable and proportionate to the industry norms and the nature of the business being acquired.

Protecting Client Relationships: Non-solicitation provisions should clearly define the prohibited actions and specify the types of clients covered. They should also address any restrictions on the solicitation of employees, ensuring the continuity of the acquired business and preventing employee turnover.

Enforceability: The enforceability of non-compete and non-solicitation provisions varies across jurisdictions. It is essential to consult with legal professionals familiar with local laws and precedents to ensure compliance and maximize enforceability.

Seller & Buyer Red Flags

Here are the most common red flags in acquisition lending. They are divided into the seller red flags a lender looks for and the buyer red flags a seller should look out for. In this context a red flag doesn’t necessarily mean it is a deal killer but something requiring a closer look and more scrutiny. See “Obstacles & Red Flags” page for other barriers to acquisition loan approvals.

SELLER RED FLAGS

State of financials
If your financials are completely unorganized, if your P&L is handwritten out or is so basic it appears only seconds were spent creating it, it will give the lender pause. If there are back tax issues that have resulted in previous year tax returns not being filed, the process can be further delayed until straightened out.
Too fast of an exit
It makes a bank nervous if the seller wants to close ASAP and doesn’t want to stick around to assist in the client transfer process. Except for scenarios such as death and disability, banks would prefer to see at least 6 months of seller’s commitment in client transfer.
Too many add-backs
Some add-backs are always going to be included (like your salary and/or distributions) but banks don’t like a ton or small dollar amount add-backs. Getting the financials cleaned up before a sale is helpful in maximizing what the bak will recognize as free cash flow.
Too premium of a price
SBA lenders will only lend up to the business valuation price. Any amount over this would have to be paid in cash by the buyer (hardly ever happens) or put into a seller note (typical) that is subordinated to the bank.
Some conventional lenders can lend for an acquisition amount that is higher than the valuation if the LTV (Loan To Value) is still within their parameters (usually 75% to 85%).
Too much client concentration
If more than 50% of your assets and/or revenue comes from your top 10 clients then the bank may have concern about client concentration risk and want to see that the buyer has accounted for this risk specifically in a clawback provision.
If one, two, or three clients make up a significant part of the revenue you’re selling then the lender will typically request or even require that those specific clients have a clawback period that extends beyond the first year. Typically two to three years in these cases.
Too much transactional revenue
Many lenders will discount some or all of the commission revenue and only focus on recurring revenue for their cash flow analysis.

BUYER RED FLAGS

Wants too much in seller financing
The often quoted 50 to 1 buyer to seller ration would be 1,000 to 1 if seller’s just seller financed all of the deal.
Deals where the buyer only comes up with 20% to 30% cash and the seller finances the rest was common 10 years ago but not today. In full disclosure at AdvisorLoans those kinds of deals we wouldn’t see anyway.
There are plenty of buyers who have the cash or the ability to finance the acquisition with a bank loan without you seller financing most (or any) of the deal.
If a buyer has the cash to pay for your business why would you take on most of the risk seller financing? If a buyer can’t get a loan in today’s lending world to buy you out without seller financing (or a smaller amount like 10%-25%) then perhaps their level of experience or personal money management skills is insufficient for you to trust with a seller note.
In today’s environment sellers by large do not need to seller finance any portion of the purchase price. So if a seller doesn’t have to do this a seller should have solid reasons of why they would be willing to do so.
Wants clawbacks for years
Some inexperienced buyers will try to get three to five year clawbacks not because the deal warrants it but because they are being extra cautious and are nervous about buying a practice that is so big (at least to them).
Most clawbacks only go out for the first year. If there is a client concentration issue like $10 million of your $50 million in AUM is with one client then the clawback provision for that single client should exceed one year.
Too many disclosures
We all know many of the disclosures on an advisor’s BrokerCheck are bogus. The advisor didn’t do anything wrong but a client lost money and a lawyer told them they could try to get it back for them.
However, there are disclosures that should cause concern and a seller will know what they are when they see them.
A seller should always look up a buyer they are considering on BrokerCheck to see what’s there. The bank is going to some portion of your clients will as well.
Multiple recent high dollar settlements can be a concern. While banks don’t care if the buyer got arrested for public drinking 30 years ago in college, a DUI 6 months ago can be an issue with a lender.
Any disclosures that reveal unethical behavior, especially towards their clients in the last 10 to 20 years can give a lender pause and if you don’t personally know the advisor well and well for a long time, should give you pause as well. Not necessarily killing the deal but exploring further to understand that this does not accurately reflect who the advisor is today.
Can't qualify for a loan
If an advisor can’t get qualified for an acquisition loan then we don’t think it is too bold to state this might not be the right advisor to be the new owner of your business.
There is a small percentage of 1099 advisors with a book who wouldn’t qualify for all or nearly all of an acquisition.
Here is an eye opener, a 1099 advisor with $250K in GDC can get a $5 million acquisition loan with no down payment required if they meet all of the other minimum criteria.
In our biased opinion, making room for exceptions to the rule, if a buyer can’t qualify for the loan then it’s best to find another buyer who can qualify (they’re everywhere) than to become the bank yourself and seller finance the deal.
Too different from you & clients
While this is an obvious red flag, many sellers don’t dive deeply enough into this screening of a prospective buyer.
If part of your purchase price is going to be determined from a clawback based on attrition, then selling to an advisor that has a completely different investment philosophy, personality, and age bracket should be carefully navigated.
No service model synergy
Every advisor approaches client servicing slightly different and there are multiple right ways to do it. However, if there is a night and day difference to the side that the buyer’s service is far inferior than what you have provided, then there will likely be higher client attrition.
If you’re client s are used to in-person meetings twice a year and your buyer does Teams/Zoom calls (instead of in-person meetings) once a year there is going to be client attrition.
Make sure that your buyer’s service model is semi-similar (or better) to what your clients have been receiving from you.

Retention of Key Employees

Early identification:

Recognizing important staff and communicating the critical role they play in the acquisition's success.

Open-door policy:

Encouraging honest feedback and creating an environment where concerns can be openly addressed.

Personal discussions:

Addressing individual aspirations and concerns through direct conversations.

Mentorship:

Pairing key employees with experienced colleagues to foster a smooth learning curve and growth.

Supportive transition:

Providing the necessary tools and training for an effortless adjustment to new systems and processes.

Recognition and celebration:

Acknowledging and celebrating the contributions of key employees during the acquisition process.

Role transparency:

Clearly outlining future roles and opportunities available post-acquisition.

Involvement in process:

Engaging key personnel in decision-making and planning tasks, increasing their sense of ownership and buy-in.

Incentive structures:

Offering specific incentives to key personnel to emphasize their value and commitment to them.

Continuous development:

Offering continuous learning opportunities for growth and advancement, leading to higher employee satisfaction.

Thinking About Selling?

What's my timeline?

How do I want to get paid?

What are the different ways to sell?

How are deals structured?

What to start collecting