Data & Research September 11, 2014

Acquisition Best Practices Can Boost ROI

Financial advisers looking to purchase or merge with another practice must implement some key best practices to ensure the acquisition is successful, according to NFP Advisor Services.
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NFP Advisor Services provides technology support and asset management platforms to financial advisers, including registered investment advisers (RIAs) and hybrid RIAs, and is a business segment of National Financial Partners Corp. The firm recently published a white paper, “Alpha Acquisitions: Maximizing the Return on your Practice Investment,” describing how advisers can maximize their return on investment (ROI) during the acquisition process.

“An aging adviser population means many mergers and acquisitions can be expected in the adviser space,” explains James Poer, president of NFP Advisor Services. “In order for these acquisitions to be successful, a diligent implementation of best practices is required. By taking control of the process, buyers improve their chances for an ‘alpha acquisition,’ and their clients experience smoother transitions.”

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Indeed, recent research from Schwab Advisor Services placed the volume of RIA merger and acquisition activity for the first half of 2014 at a healthy $32.6 billion in assets under management (AUM). Transaction activity picked up somewhat in the second quarter of the year, the research shows. Sixteen deals were inked in Q2 2014, totaling approximately $19 billion in AUM, compared with 13 deals totaling $14 billion in AUM completed in Q1. This second quarter activity nearly reached the record high levels of Q3 and Q4 of 2013, according to Schwab.

It’s likely that at least some of this acquisition activity will have less-than-ideal results, according to NFP research, which defines an “alpha acquisition” as one in which advisers say they are “very satisfied” with the ROI coming out of said acquisition. Strikingly, only about 25% of acquisitions enacted recently by advisers surveyed by NFP were found to be alpha acquisitions.

Key steps to achieving an alpha acquisition include carefully identifying a suitable practice to be purchased, ensuring client retention during the ownership transition, and agreeing on a practice valuation that meets the needs of both the seller and purchaser. These steps will challenge even the most skilled acquisition teams, NFP researchers admit, but they are critical for ensuring suitable ROI.

After reviewing and analyzing recent acquisition activity, NFP Advisor Services offers several steps that financial advisers should take to overcome these challenges and produce an alpha acquisition. These include:

  • Take your time to find the right match. Of advisers who have achieved an alpha acquisition, 32% looked for a target for three or more years, compared with 13% and 20% of advisers who made near-alpha and non-alpha acquisitions, respectively. Notably, 70% of non-alpha acquirers searched for an acquisition for two years or less.
  • Use a holistic, realistic valuation approach. The valuation process is seen as somewhat or very difficult across the board. Alpha acquisitions cost an average revenue multiple of 1.55x, compared to 1.34x and 1.27x for near-alpha and non-alpha acquisitions, respectively. NFP says alpha acquisitions are more likely when due diligence teams favor assets under management, client service model, revenue mix, business longevity and cash flow over other potential valuation metrics.
  • Manage the transition for success. The NFP research found that the most successful acquisitions required one year or less for the transition period—thereby minimizing client stress and confusion. Further, nearly 50% of alpha acquisitions involved one or several meetings with new clients to brief them on the change and transition. In 52% of alpha acquisitions, the previous owner left the practice in one year or less. However, it’s important to consider retaining staff, NFP says. In fact, 57% of alpha acquisitions retained all staff members versus only 19% of non-alpha acquisitions.

“The study confirms that advisers can achieve successful acquisitions, but a carefully planned approach is needed,” Poer adds. “Often, a seasoned professional with experience—such as your broker/dealer—can help navigate the many challenges that face buyers and sellers.”

Other recent research from CLS Investments suggests sellers have a tendency to significantly overestimate the value of their practices—which can make price-point negotiations significantly more difficult for purchasers.

Financial research firm Aite Group conducted a survey of 401 financial advisers for the NFP white paper, of which 100 advisers have recently made a practice acquisition. A full copy of the white paper, along with other NFP research, can be downloaded here.

Compliance September 11, 2014

Signature Authority May Trigger ERISA Fiduciary Status

A company CEO’s signature authority for payments from the company’s bank account may make him an Employee Retirement Income Security Act (ERISA) fiduciary.
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In denying a motion to dismiss by Mihir Taneja, the CEO, secretary and director of Geopharma, U.S. District Judge Virginia M. Hernandez Covington of the U.S. District Court for the Middle District of Florida noted that ERISA’s definition of fiduciary includes those “exercising any authority or control over the management or disposition of plan assets” (italics added). She agreed with U.S. Department of Labor Secretary Thomas E. Perez that since employees’ contributions toward payments of their benefits were commingled with Geopharma’s general assets and never remitted or used to pay claims, Taneja allegedly exercised fiduciary authority or control over both Geopharma’s assets and benefit plan assets simultaneously.

In addition, as Geopharma’s CEO, secretary, director and signatory on Geopharma’s bank accounts, Taneja plausibly had a fiduciary duty to monitor the actions of Geopharma and those appointed to act as fiduciaries on behalf of Geopharma, the judge concluded.

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According to the court opinion, Perez contends that, for payroll periods between October 3 and December 26, 2009, and between January 2 and October 9, 2010, Geopharma withheld employee premium contributions to the company’s Group Welfare Plan from payroll in the amounts of $115,707.19 and $101,751.29, respectively, failed to segregate the contributions from company assets as soon as it reasonably could do so, and failed to use the funds to pay claims. In addition, Geopharma received Consolidated Omnibus Budget Reconciliation Act (COBRA) premium payments totaling $16,507.24, failed to segregate the premiums from the company assets as soon as it reasonably could do so, and failed to use the funds to pay claims.

Perez also asserts that the named defendants in the case, as fiduciaries and parties in interest to the plan, violated their respective duties under ERISA by: (1) participating knowingly in an act of another fiduciary, knowing such act was a breach, (2) failing to monitor or supervise another fiduciary and thereby enabling a breach, or (3) having knowledge of a breach by another fiduciary and failing to make reasonable efforts under the circumstances to remedy the breach.

Taneja argues that the complaint does not sufficiently or plausibly allege facts necessary to establish that he is a fiduciary of the plan since it fails to establish that he performed any function or exercised any authority with respect to the “particular activity” of remittance of employee premium contributions to the plan. Taneja further emphasizes that the mere fact that he allegedly possessed signature authority on Geopharma’s corporate bank accounts is insufficient to make him a fiduciary, saying “[i]f this alone were sufficient to trigger ERISA fiduciary responsibilities on the part of corporate officers, it would transform nearly every member of senior management of any corporation into an ERISA fiduciary.”

However, Perez emphasizes that the plain language of ERISA permits a person to become a fiduciary by exercising authority or control over the management or disposition of plan assets without requiring “discretionary” authority or control. He argues that, because Geopharma was named the plan administrator and fiduciary within the plan itself, Geopharma had a duty to monitor the actions of those administering the plan on its behalf. Likewise, as Geopharma’s CEO, secretary, director, and signatory on Geopharma’s bank accounts, Taneja allegedly had a fiduciary duty to monitor other fiduciaries as well as Geopharma’s management and administration of the plan. Perez asserts that Taneja knew or should have known that Geopharma was having cash flow issues and was using employee compensation and COBRA payments to fund operations instead of using the funds to pay medical claims, and such knowledge should have triggered an investigation to determine whether Geopharma and its fiduciaries were administrating the plan in accordance with ERISA and the terms of the plan.

According to Hernandez Covington, “in light of these factual allegations, the court can reasonably infer that Taneja exercised authority or control over Geopharma’s Plan assets as an ERISA fiduciary when employee premiums were commingled with Geopharma’s general assets.”

She also found the plain language of ERISA reasonably supports Secretary Perez’s position that a person can become a fiduciary, even without discretion, if he or she exercises any authority or control respecting management or disposition of its assets, but declined to decide whether a person with authority or control over plan assets must also exercise “discretion” over those assets in order to become an ERISA fiduciary, saying that “determination is more appropriately decided at the summary judgment stage of the proceedings.”

The opinion in Perez v. Geopharma, Inc. is here.

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