As a continuation of last week, we are here again as we hope to shed some light and help those of you out there that are First-Time Buyers.
In last week’s post, we discussed general criteria for an acquisition, with a focus on how many additional clients an advisor can service. Today, we look at criteria from the perspective of cash flow.
As a buyer, there are three questions that should top all other financial considerations when considering an acquisition.
• How much can I afford? (Or how much can I borrow?)
• When will I have positive cash flow on the acquisition?
• What is the likelihood that the accounts will transition?
The first and second questions are directly tied to cash flow. Here is a rule of thumb formula that should help. First, some definitions:
• Current Expenses and Revenue: The buyer’s expenses and revenue.
• New Expenses and Revenue: The seller’s expenses, (that will be assumed by the buyer) and revenue.
• EBOC- (Earnings Before Owner’s Compensation): The buyer’s comp after the acquisition.
• Current Expenses + Current Revenue minus Current and New Expenses = EBOC minus Buyer’s comp = Net Operating Income
• Now subtract any debt service and you can see when, if ever, you will be in the black.
These are just the basics. How you apply them to a book of relationships or a practice is dependent on a number of other factors, but if you have a few basics down, it can greatly increase your ability to acquire, what you are capable of acquiring or tell you that you are not ready to acquire.
For any criteria you set, you should model it. Determine how you intend to finance the acquisition and model the down payment, the payment plan, debt service, how you will service the added book of relationships and how much this servicing will cost you. It is like getting pre-approved for a mortgage to purchase a house. You determine what you can handle before you commence your search. Model books and practices of several different sizes to determine how soon you will become profitable in each instance. If you cannot calculate it yourself, find someone who can help you. This could be an accountant, or an M & A consultant, or even another advisor who has acquired before. You do not want to waste time engaging in serious discussions with sellers without a very good idea what you can make work on your end. Your research and forethought will differentiate you from other buyers and position you as a more attractive suitor in the eyes of the seller. It will also save you and anyone you engage to help and guide you a great deal of time and ultimately, money. In this case, knowledge really is power; buying power.
Casey M Corrie