Considerations when buying a financial planning business

Financial planning dealer groups looking to expand their advice footprint face a range of shifting commercial and regulatory issues. Understanding these issues, together with proactive steps at the due diligence and post-completion integration stage will drive a successful expansion strategy.

With merger and acquisition activity in the financial planning sector showing no signs of slowing down, financial planning dealer groups looking to expand their advice footprint face a range of shifting commercial and regulatory issues  in a highly competitive market for quality advice businesses.

These issues, together with proactive steps at the due diligence and post-completion integration stage can drive a successful expansion strategy.

Recent high profile acquisitions in the financial planning sector have included Axa Asia Pacific by AMP, Count Financial by CBA and DKN Financial Group by IOOF. While these household names have been grabbing the headlines, other moves have also been taking place at the medium to small end of the market with dealer groups targeting individual practices and advisers with attractive packages to entice them to join.

Purchasing a financial planning business, as with any financial services business, has added dimensions by virtue of the highly regulated nature of the sector. This is further complicated by the shifting nature of the regulatory environment, largely due to the Future of Financial Advice (FOFA) reforms, which is giving rise to commercial uncertainty and added transaction execution risk. Particular issues for purchasers include the target business’s compliance processes, succession arrangements, incentive plans for advisers and the availability of grandfathering under FoFA to preserve existing revenue streams.

The trend towards institutionalisation of financial planning has been positive from a compliance perspective as it  has subjected practices to the rigour of formalised compliance processes which are standard among large wealth management organisations.

However, for a large organisation performing due diligence on a potential target, it is necessary to consider the adequacy of the target’s current compliance systems which if deficient, expose the practice, and potentially the purchaser, to the consequences of regulatory and civil action in the event of a breakdown in the advice process.

Under the Corporations Act, the Australian financial services (AFS) licensee is strictly responsible for the conduct of its representatives. If the target practice is operating under its own AFS licence, any historical liabilities are likely to transfer with the business after acquisition and could therefore impact the value of the business for the purchaser. Alternatively, even if the practice is transitioning from a vendor dealer group’s AFS licence to the purchaser’s AFS licence, there may be trail exposure to claims if the vendor has recourse under the terms of the practice’s appointment as an authorised representative. The purchaser’s due diligence should therefore also cover any appointment agreements to identify how claims may run in that scenario.

The staffing profile of a target advice business is also a key concern for a prospective purchaser. Research shows the average age of a financial planner is in the mid-50s. The medium term viability of the business is therefore likely to hinge around what, if any, succession arrangements are in place to safeguard against clients leaving when advisers retire. This is partly a question of assessing what training and development programs are provided to bring through new adviser talent, and also how the advisers participate financially in the business. This is particularly relevant where the principals hold equity in this business alongside the purchaser. A purchaser should consider how, post-acquisition, the shares of departing principals can be dealt with to ensure alignment between the owners of the business and those involved with its day-to-day operations.

‘Buyer of first resort’ and ‘buyer of last resort’ models have been developed by some dealer groups to facilitate the purchase and recycling of equity stakes from departing advisers. These models can provide positive outcomes. They give certainty to the principals that they will be able to realise their investment in the business and also the opportunity to incentivise up-and-coming advisers through a stake in the business to which they are contributing. From the purchaser’s perspective, an effective succession plan can safeguard the longevity of the practice and therefore the purchaser’s own financial interest.

While there are numerous ways for a purchaser to determine the market price for a practice, multiples of recurring revenue (RR) or earnings before interest and tax (EBIT) are popular. Either way, a practice’s revenue streams are likely to be at the heart of valuation metrics. Given the profound changes to revenue arrangements which will result from the ban on conflicted remuneration arrangements under the FOFA reforms, the extent to which a practice can rely on the grandfathering relief is critical. A purchaser will need to model the revenue streams at the due diligence stage and identify which streams may be compromised by the reforms. Where the continuity of revenue from certain books of business is a concern, the purchaser may have to apply an appropriate deductible amount to the practice’s valuation. Given the current state of play with the reforms, much turns on how the grandfathering provision will work in practice. The amendments to the Corporations Act are expressed in broad terms. They provide that (except for benefits given by platform operators) the ban on conflicted remuneration will not apply to an ‘arrangement’ entered into prior to commencement of the ban. This will potentially preserve a range of lucrative trail commission arrangements. However, if the arrangement is impacted by the acquisition or restructured at the implementation stage, the consequences of any change will need to be considered carefully to determine whether in substance the arrangement is still the same. If not, the grandfathering may be lost and the arrangement would need to be cancelled to not contravene the ban. ASIC has said it will provide guidance on the practical operation of the ban on conflicted remuneration and how it will be administered. Meanwhile, revenue and grandfathering remain live issues for the due diligence and implementation stages of a transaction.

The recent acquisition activity in the financial planning sector is the latest wave in a broad-based industry consolidation. As a consequence, there has been a structural shift in the market positioning and ownership of financial planning groups. The sector is now dominated by a few large financial institutions. Given that one impact of the FOFA reforms is to increase the compliance burden for advice practices, we may not see an end to the steady institutionalisation of this sector for some time.

Jon Ireland

I constantly strive for technical excellence and commercial outcomes that add real value for my clients.

Jon Ireland Partner

Jon has extensive experience in corporate and financial services law, specialising in complex transactions, funds management and investment distribution. Jon also advises on regulatory issues relating to the use of technology in financial services.

Jon provides advice to leading Australian and international financial services clients on the full range of corporate, commercial and regulatory issues facing these businesses. He has considerable experience advising them on establishing, buying into, selling and restructuring their businesses.

Jon regularly advises on funds management issues including fund structuring, disclosure, investment management and outsourcing arrangements. He has particular expertise in the area of investment distribution and has advised on key projects for platform operators and advice providers.

Recently, Jon has advised on the establishment of a fully digital investment platform, the negotiation of a material outsourcing arrangement for a global investment bank and a scheme modernisation project for a leading Australian fund manager. Jon has also recently advised on the establishment of the Australian operations of a global diversified financial services business, including regulatory and corporate issues related to its expansion.

Jon's clients value his advice on recent law reforms, including around product disclosure statements and the digital provision of financial services. Jon is consulting to the Committee for Sydney and is a regular participant on Financial Services Council working groups.

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