Exit planning: Documenting the deal

(November 2007) Many advisors engaged in the process of buying or selling their book of business tend to focus exclusively on valuation and the final purchase price. In reality, the terms you negotiate and document, along with plans for managing client retention overall, are far more important and far more valuable.

Once sellers and buyers have concluded their negotiations, they need to document the terms of their agreement. Although no two deals are identical, there are a few key documents that are generally required for most practice transactions.

As a rule, the following components are required to document sales for buyers and sellers:

• an asset or stock purchase agreement; • a non-competition and non-solicitation agreement; • a consulting agreement for help after the transaction closing date; • a promissory note; • a personal guaranty; and • a security agreement.

An asset or stock purchase agreement This is the basic starting point for most buyers and sellers. To structure the deal, both the buyer and the seller should get advice from a tax specialist before choosing between an asset sale and a stock sale. There are different tax implications for both, depending on the structure of the transaction and the tax allocation of the purchase price.

Non-competition and non-solicitation agreements If selling your practice, most transactions involve an agreement that you will not compete with the buyer or solicit any clients included in the transition. Generally speaking, the length of a non-competition agreement is three to five years or until the purchase price is paid in full.

There are a few ways to strengthen non-competition and non-solicitation agreements:

• Acquire the seller’s employee(s), their software, their marketing systems, business name and phone numbers.

• Use an earn-out formula to pay for the acquisition. Earn-out formulas adversely affect sellers who breach non-competition agreements, since the amount of money paid to the seller is reduced if business cash flow is diverted.

Buyers should always include a non-competition agreement, since they are generally enforceable, unlike similar agreements between an employer and an employee, but it is essential that these agreements are reasonable in time, scope, and geography. Agreements also need to be specific about the business activities they address. It is worthwhile to consult with an attorney who has experience in litigating on these issues before signing or relying on these types of agreements.

Consulting agreement A major part of every purchase secures the seller’s help in retaining clients. Every deal should have a written post-closing transition plan to outline and coordinate efforts to make sure client needs are appropriately addressed.

A consulting agreement also helps to document the seller’s specific duties and clarifies expectations regarding the work to be completed, the person in charge and the value to be paid for the functions and duties performed.

Indemnification and hold-harmless clauses In addition to having a clearly defined and written transition plan, both parties should understand that every deal has a period of time after closing where both the buyer and seller are responsible, to some extent, for the clients in transition. In purchase and sale documents, use of indemnification or hold-harmless clauses protect buyers and sellers from any misrepresentation, inaccuracy, incorrectness, breach of any representation or warrantee made, non-performance or non-fulfillment of any covenant or agreement.

These should also be supplemented with a dispute-resolution clause and a requirement that prevailing parties in any arbitrated dispute can recover attorney fees and costs. A buyer may also want to include a clause that gives them the right to use damages to reduce any ongoing payments to the seller.

More Exit Planning

• Build your retirement plans • Transitioning best practices • Knowing what you want • What is your practice worth? • Reaching qualified buyers • Doing your due diligence • Bidding and final negotiations • Documenting the deal

Security and collateral Since acquisition financing is not always available by way of commercial financing, most transactions are dependent on seller financing. This means the sale requires a high degree of cooperation and flexibility. This type of financing arrangement also means the seller will typically look for more than a high purchase price. At a minimum, every transaction should be personally guaranteed by the buyer, and occasionally by their spouse. The amount of security required, and the type of collateral used, depend on the buyer, how the transaction is structured and the type of practice being acquired.

Once contracts are prepared in draft form, each party should review all documents with their own legal counsel and accountant. This approach, when combined with an accurate, straightforward valuation, allows a sale to be completed quickly, professionally and without any surprises.

When approaching a transaction, many buyers and sellers make the mistake of focusing on valuation without considering underlying terms of the deal, even though a proper deal structure can assist in correcting valuation mistakes. Recording the fine points of the deal is good for understanding, but also because it is a necessary step towards getting the tax benefits that result from a properly structured transfer of assets.

Cindy Jenner Cowan is chief operating officer at Worldsource Financial Management. With more than 17 years of experience in the financial services industry, the expert in relationship management and value-added coaching recently developed FRAMEWORKS, a training program for Worldsource advisors, focusing on advisory practice life cycles. For more information please visit www.partnerwithWFM.com. You can also contact Cindy directly at (604) 376-9119 or cjennercowan@worldsourcewealth.com.

(11/23/07)