First-Time Buyer Series: Due Diligence


The subject of granular due diligence is far beyond the scope of a short article. Obviously, you will want a valuation completed by someone used to performing the analysis. This could be by one of a number of firms in the marketplace that perform these reports, or a CPA, or even another advisor who has purchased several books in the past. In addition, any lending firm or bank you borrow funds from is going to perform a valuation, at least for purposes of projected cash flow. Take the data form from any of the above mentioned sources and you will have a good start. Or you can write to me at and I will send you the one we use for our own purposes, (no strings attached; just put “PMQ Request” in the subject line).

Keep in mind that your primary objectives are three-fold.

·         Determine the value of the firm to you.

·         Determine the likely cash flow that the firm or book will produce in your hands.

·         Predict the realistic percentage of clients and assets that are likely to move to you in a               transition.

A few tips:

Never pay for potential. You will no doubt encounter sellers who will say that while they have been slowing down in recent years and the revenue is consequently down, you should pay more for the book of relationships because you will be able to produce more revenue than the seller has. Do not buy that. You pay only for what the relationships produce, not what they could produce. Sure, you might buy the book for this reason, but it is not a reason to pay more for potential.

Look at each revenue stream individually and judge the likelihood of it continuing under your control. Ask how clients were sold and why the seller believes certain clients, especially HNW clients chose him or her. This is more than simply discerning between recurring revenue and transactional revenue. Sometimes a valuation algorithm cannot do the kind of dissection that you need to perform in order to figure out where the revenue streams come from. It might be a good start, but you have to look at product lines and where the revenue is likely to come from in the next few years. For example,

·         The seller may have a lot of alternative investments with his or her clients. When will                  they mature? How long will the asset be tied up? Do you have access to those same                    alts?

·         Is the seller advising on 401k assets? Do you have experience doing the same? 

·         Is the seller using products proprietary to his or her broker dealer? Or products where                the same internal fees are less to the seller than to you?

·         What platform fees does the seller’s managed accounts levy? Are these more or less                  than the platform fees with your firm? I am sure you know that the same clearing and                custody firm can be charging different fees in two broker dealers due the amount of                  business that that BD had with the custodian. You will have to decide if you will pass the            differential to your clients or if it will affect your expenses.

Some specialists lean heavily on the market approach to valuation. Some elements of this approach are perfectly acceptable. However, there is a difference in value between the business of a seller who manages the money and one who employs primarily 3rd party managers. Clients may prefer the former, because they feel the fees they are paying for the extra work is justified, or they may prefer an advisor because of his or her performance record in managing assets. As a buyer, you should prefer the advisor who employs 3rd party managers, (even if you do not). This is a book that is going to experience a higher transition percentage. Think about it. If clients come to you because of your personal performance record, what do you think they will do when you are no longer the advisor/portfolio manager? Correct! A lot of them will seek another advisor. On the other hand, almost any advisor can access the same 3rd party managers and if the clients are happy, they are likely to stick with an advisor who promises not to change anything right away. Make sure a specialist or valuation strategy you employ distinguishes between these two approaches to managing assets.

This next issue seems obvious, but some very smart people we have encountered have not given it sufficient weight in valuation. The closer a seller comes to the way you manage accounts the better you will do in the transition. Some years ago, we were asked to assist an advisor in completing a deal with a seller he uncovered. Our client was a heavy, (successful), technical analysis proponent. The seller was an 80-year old fundamental value investor who claimed he could teach Warren Buffett a thing or two. He performed deep research on every security he purchased. He also felt that technical analysis was “voodoo for people who don’t understand investing.” (A direct quote.) The odd thing was that in spite of our objections from the start, they danced around each other for 6 months. It was never about price. Each man thought he would be able to convince the other that some clients would prefer their way, so neither could bring himself to end the discussion. These were two smart successful men who just could not see that even if the sale took place, the transition would have been unsuccessful. The seller’s clients had been convinced for 50 years that his way was the best, (his performance was very good). At the end of the day, we were able to get the buyer to back off, but to this day, we think they still both feel they missed an opportunity to convert the other’s clients to their way.

The point here is to remember that an acquisition is only successful if you have a very high transition percentage. Our standard is 97%. This will never happen if you try to make a lot of changes to the manner in which client assets are managed. People do not like change. You do not have to be perfectly aligned, but if you are an active manager, do not waste your time with a group of clients who have been sold on passive investing, or vice versa. Don’t believe me? Try buying a committed DFA loyalist if you are an active manager. 

If there is no other take away from this article, we hope you will get that a valuation is just the beginning. In answering the important questions, the amount of examination you or your consultant performs can be the difference between an accretive transition and buying a silk purse, but transitioning a sow’s ear.


This series of articles attempts to help First-Time Buyers avoid pitfalls inherent in the process of advisory firm acquisition. Watch for new articles each week.