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Partial Book Buyouts & Partial Asset Acquisitions
When an advisor is selling less than 100% of their client assets through an asset purchase.
Partial Book Buyout
Acquiring less than 100% of the client book an advisor manages.
Asset Tranches
Acquiring multiple client books over time.
Partial Asset Acquisition
Acquiring less than 100% of the assets of a practice which may include assets other than a list.
Converger Plan
Acquiring through two partial asset acquisitions sandwiching a transition period.
Partial Asset Acquisitions or Partial Book Buyouts
A Partial Asset Acquisition (PAA) is when the buyer is acquiring a partial client list, typically less than 50% of the seller’s assets, rather than acquiring the entire book or practice.
Advisors will often use PAAs outside of a succession strategy in order to make more room and time for larger more profitable clients. Larger advisors will sometimes utilize a PAA to sell off the “bottom” portion of their book to advisors who are eager to affordably grow their client base. PAAs provide many benefits to both the buyer and seller, and can also provide an ideal path of least resistance for beginning and implementing succession transition strategies.
Sellers may choose to parcel out different client tranches to multiple advisor buyers or use as a way for their “anointed successor advisor” to begin a gradual acquisition and client transition process.
Structuring PAAs are flexible and are individually tailored according to the seller’s succession and retirement timeline.
Client lists can be segmented into tranches and the tranches do not have to be equally segmented. Most advisors will initially carve out their clients with the lowest assets as a tranche and then segment by client asset tiers. PAAs can be structured to sell 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.
Ideal Succession Transition Method
Many sellers aren’t ready to completely sell out and retire right now but would like to solidify who their successor advisor will be and start slowing down over the next few years. PAAs allow sellers with longer time windows to work with and the ability to prepare their successor advisor both financially and professionally through partial and incremental transition tranches.
On the other side, there are many advisors who have years of experience (rather than decades) who would benefit from acquiring a principal’s practice over time as well. PAAs allow the advisor to more easily afford or qualify for a loan than 100% ownership transfers and provides valuable client transition and retention experience needed for larger acquisitions later.
A Mutual Test Drive
A PAA provides both the seller and buyer with an initial acquisition test drive. If the client retention is high, the client relationships are strong, and there is synergy with buyer and client service model and general investment philosophy, then the PAA can be determined a success.
If the PAA isn’t considered a “success” then the PAA served as an insurance policy against both buyer and seller remorse. The PAA gives buyers and sellers a strong indication if both are the ideal match for future client transitions with each other. If not, then the PAA allowed for the buyer, seller, or both, to look at other opportunities.
The PAA provides experience to the inexperienced. Both the buyer and seller are able to judge from the initial PAA experience if future PAAs, or acquiring the rest of the practice, is a prudent continuation of succession transition. If not, then any “remorse” is limited to just the partial client list sold and not the entirety of the practice.
Add Revenue Not Expenses
PAAs typically do not come with additional overhead and operating expenses for the buyer other than the debt service for the PAA. PAAs allow a buyer to acquire revenues without the additional overhead and operating costs that may be required in a 100% acquisition.
Adding revenues without adding additional costs, results in the buyer being able to best cash flow the PAA. One of the most critical qualifying criterion in achieving a loan is the Debt Service Coverage Ratio (DSCR) comparing net income with fixed debt. The higher the DSCR, the easier it is to qualify.
When the only additional expense incurred in a PAA is the loan payment, the acquisition is cash flowing right out of the gate and the acquired revenue cash flow can typically pay for itself in about five years.
Minimal Seller Financial Documentation
For 100% acquisitions, lenders will typically need the seller’s last three years’ tax returns, last calendar year and YTD financials, business valuation and a 4506-T form (allowing the lender to verify tax returns). A PAA doesn’t require any of these items.
The typical required documents for a PAA simply consists of a spreadsheet of the household clients being acquired with each client’s corresponding AUM, revenue, recurring revenue, years as client, age, and any client accounts under the household account.
Most lenders will also require a broker dealer or custodian report showing the total assets managed and revenues generated. This is required to prove that the PAA is not a 100% ownership transfer, or full acquisition.
Provides Experience for the Inexperienced
There is no other way to better prepare for a 100% acquisition then going through the experience of a PAA first. This applies to both buyers and sellers. Like many other aspects of the financial services industry, business in general and in life, there is no better teacher than experience.
PAAs can be utilized as “trial runs” for bigger PAAs down the line or to acquire the rest of the practice. The transition process, client transition meetings and procedures, time allocation, and retention best practices can be learned and lessons addressed to be applied to future acquisitions from both the buyer and seller perspectives.
100% Financing Typical
It’s common for lenders to provide 100% financing for PAAs. That is, the lender will loan the entire amount of the PAA price without the buyer having to make a cash injection or requiring the seller to finance part of the PAA.
Seller Financing Easy for a Lender to Refinance. Some sellers will be more willing to finance some or all of a partial acquisition if it is to their designated successor. For sellers who decide to finance part or all of a PAA, the seller note can be refinanced and rolled into a future loan from the same buyer.
Lenders like refinancing PAA seller notes because it is a legitimate business purpose loan and represents a prior successful acquisition between the buyer, borrower, and seller. Lenders like to lend to buyers who have already acquired a partial client list, have demonstrated a high retention rate, and can show all payments have been made on time.
Achieve Foresight from Hindsight
Hindsight has 20/20 vision as the saying goes. Use the perspective and experience from an initial PAA to provide the foresight in how to structure the continuation of the succession or to go in a different direction if the PAA wasn’t considered successful.
PAAs gives the seller the opportunity to examine the results of an initial PAA to determine if the buyer has proven themselves worthy of additional PAAs or a full acquisition. It also provides the buyer with the opportunity to determine if acquiring more of the same would be a dream or a nightmare. The 20/20 hindsight gives buyers and sellers the opportunity to recalibrate structure and improve the transition process moving forward.
Partial Book Buyouts & Partial Asset Acquisitions
Conventional Lending Considerations
Terms:
10/10 TERMS
10 Year term and amortization.
10/15 TERMS
10 Year term and 15 year amortization.
RATES
Current Range 7.5% to 9%.
PREPAYMENT
Yes, varies by lender, usually 1% to 2% for life of loan or first 5 years, or a higher penalty but only lasting the first few years. Each lender is different but most all will allow up to 10% to be prepaid out of free cash flow each year without penalty.
LIEN POSITION
Lender in First Lien Position.
LOAN AMOUNTS
$250,000 to $50 million. Many lenders get heartburn at the $10 million level. Most lenders will participate a larger loan exposure (over $10M) with other lenders.
SWEET SPOT
Most conventional lenders would generally prefer their acquisition loan amounts to be $1 to $7 million for the most efficient lending.
Criteria:
CREDIT
Typically over 700.
LTV
Most have LTV maximum of 75%.
DTI
Debt-to-income maximum is from 30% to 40%.
DSC
A historical 1.5 DSC for two years is typically required.
AUM
Direct or indirect minimum AUM is typically about $50 million.
REVENUE
Typically needs to cashflow based on recurring revenue.
EXPERIENCE
Typically 7 years and 3 years being independent.
LIFE INSURANCE
Life insurance assignment for the amount of the loan.
W2 & NEXT-GEN
For conventional partial asset loans this is very case-by-case basis but may involve a seller guaranty and a larger equity injection requirement. If there is no buyer revenue added to the seller’s revenue for cash flow then the seller may need to finance a larger percentage, sometimes on a one or two year standby note, all case-by-case.
Partial Buyout Considerations
DEAL GUARD RAILS
There are few guard rails in deal structure for qualifying deals as long as they make sense to the (experienced) lender.
SELLER CONSULTING
Ongoing seller involvement either in a W2 or 1099 capacity is generally encouraged and generally leave the limitations to the borrower and seller.
GUARANTORS
Sellers do not guaranty in partial asset acquisition loans or when 100% of the entity is sold as either an asset or equity purchase. The borrower plus any 20%+ partner of buying entity is a personal guarantor.
COLLATERAL
No personal property collateral but there is a UCC lien on all current and future business assets.
DSC CASH FLOW
Typical acquisition analysis is taking combined buyer and seller annual profits and dividing by annual debt service applied over each of the previous two years.
BANK ACCOUNT REQUIREMENT
For loans under $5 million we do not think an advisor borrower should be required to move their operating account to the bank. If the bank earns the advisor’s business later then great. Most will provide a discounted rate (25-50 bps) discount on rate depending on the loan amount and average operating account balance.
SBA Backed Lending Considerations
Terms:
10/10 TERMS
10 Year term and amortization.
RATES
Current Range 9.5% to 11%.
PREPAYMENT
Not for terms 15 years or more.
LIEN POSITION
Lender in First Lien Position.
LOAN AMOUNTS
$100,000 to $5 million. Up to $7 million w/$2M conventional pari passu.
SWEET SPOT
The average SBA loan by Live Oak Bank and Byline Bank who fund 2/3 of advisor SBA loan dollars have averaged just above or below $1 million as average SBA loan amount.
W2 & NEXT-GEN
SBA loans shine in these scenarios. Loans can be approved with no equity injection to 10% which can be seller financed. If there is no buyer revenue added to the seller’s revenue for cash flow then the seller may need to finance a larger percentage, sometimes on a one or two year standby note, all case-by-case.
Criteria:
CREDIT
Typically over 640.
LTV
Equity Injection “equates” to a 100% to 90% LTV.
DTI
Instead, SBA uses a 1:1 personal DSC minimum.
DSC
SBA has a 1.15 DSC minimum, most lenders at 1.25+.
AUM
No minimum, can qualify W2 advisors and even wholesalers.
REVENUE
No minimum other than the loan needs to cash flow.
EXPERIENCE
Less than 3 years experience is difficult to get done.
LIFE INSURANCE
Life insurance assignment for the amount of the loan.
Partial Buyout Considerations:
DEAL GUARD RAILS
Key guard rails are earn-out structures are ineligible. The inability to maintain seller as an employee post-sale isn’t relevant in partial asset acquisitions.
SELLER CONSULTING
Ongoing seller involvement must be in a 1099 capacity and not full-time longer than a year. Not an issue with partial asset acquisitions.
GUARANTORS
Sellers do not guaranty in a partial asset acquisition loan or when 100% of the entity is sold as either an asset or equity purchase. The borrower plus any 20%+ partner of buying entity is a personal guarantor.
COLLATERAL
Personal property can be required for loans over $500,000 and when having 25% equity in the property.
DSC CASH FLOW
Typical acquisition analysis is taking combined buyer and seller annual profits and dividing by annual debt service applied over each of the previous two years.
BANK ACCOUNT REQUIREMENT
Moving your bank account to the lender providing an SBA loan is not typical but most will provide a discounted rate (25-50 bps) discount on rate depending on the loan amount and average operating account balance. It’s a case-by-case basis.
Partial Book Buyouts
Comparing SBA & Conventional Equity Injections
An equity injection can be provided by the buyer through a cash down payment or from the seller by providing a seller promissory note (subordinated to lender) or satisfied through a combination of buyer down payment and a seller note. Conventional and SBA loans have completely different rules for equity injections, with conventional being more consistent for all loans but also significantly higher than what SBA loans allow for.
0% SBA EQUITY INJECTION
EXPANSION ACQUISITION
0% injection required if expansion requirements met.
Expansion Loans
When an existing business purchases another similar established business. There is no down payment requirement for one business purchasing another business if three conditions are met.
The target business to purchase is in the same industry (same six digit NAICS code)
The target business to purchase is in the same geographical area as your current business (footprint for advisors)
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.
10% SBA EQUITY INJECTION
NON-EXPANSION
COMPLETE ASSET OR EQUITY ACQUISITION
10% injection required which can be satisfied in one of three ways:
1 - Cash: Paid in cash by the borrower.
2 - Full Standby Note: Seller promissory note for the 10% whereby no principal or interest can be paid during the first two years standby period.
3 - 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.
25% CONVENTIONAL EQUITY INJECTION
25% is the typical equity injection for conventional loans.
While a borrower's personal financial situation, experience and competency, and credit scenario impacts if a bank may require an equity injection, all loans will have a primary equity injection policy and for conventional lenders it is based on Loan to value - LTV. Conventional lenders have maximum LTV requirements typically at 75% but one or two will go to 85%.
For acquisitions, LTV is calculated by combining the value of the buyer's and seller's practices, resulting in most conventional acquisition deals meeting the LTV requirement. If a $1M value practice acquires a $1M value practice then $1M loan/$2M value = 50% LTV. When a $333,000 value practice acquires $1M value practice then $1M/$1,333,000 = 75% LTV. Rule of thumb if both practices valued at same multiple, the buyer’s value needs to be at least 33% of the seller’s value to meet a 75% LTV.
See equity injection section for more details.
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