Are high rates affecting the market for books of business?

Despite the rising costs of borrowing, financial advisors contemplating retirement and the sale of their businesses have reason to be optimistic — at least in the short term.

George Hartman, president and CEO of Toronto-based Market Logics Inc., said the value of a book of business is holding steady — even with the prime rate sitting at 7.20% at most Canadian banks.

There are simply too many buyers for interest rates to significantly drag prices down, he said.

“I’m still of the belief that it’s very strongly a seller’s market,” he said. Higher rates might scare some buyers away, but he’s still seeing “40 to 50” buyers for every book that comes on the market.

Melanie Russell, founder of Kalex Valuations Inc. in Toronto, said any impact of higher borrowing costs on valuations is subtle. It’s not like taking out a mortgage on a rental property, where a couple of percentage points can be the difference between a profitable venture and a loss-making endeavour.

“A practice is a little different, because you’re looking at more than one thing,” she said. “Maybe I’ve got some extra capacity in my staff, or in the premises, [and] I can actually get some extra benefits from doing this acquisition.”

Brett Evans, a partner at Capital Markets Advisors LLC in Toronto, is blunter in his assessment of the impact of higher borrowing costs on valuation.

“Nobody has said boo about interest rates,” he said. “Nobody has ever said to me that’s going to change my decision on buying some book.”

A ticking time bomb

But the current seller’s market has a built-in expiry date, Evans said. With a significant number of advisors nearing retirement, the market could soon be “awash in books” as they look to get out.

Many advisors will be forced into retirement for health reasons, if nothing else, and too many are putting off serious succession planning, he said. He believes there won’t be enough labour and talent to properly take care of all the business.

“If I was selling a book, I’d be doing it sooner than later because, obviously, the more books for sale the less the value,” Evans said.

Hartman turns to his wine cellar for a metaphor on timing.

“You can take a good bottle of Bordeaux wine and lay it down in your cellar, and open it 20 years later, and it’ll be even better than when you put it down,” he said. “But there’s a certain point at which it starts to turn. It passes its peak and starts to deteriorate in quality. And the same thing happens with advisory practices.”

With all things being equal, a practice with an average client age of 60 is worth more than one where that figure is 70 — “because there’s more runway to do more work, more assets to be managed,” Hartman said.

“An aging advisor population has come to the realization that the value of their practice may have reached its optimum, and this might be a good time to get out,” he said.

Financing the deal

One way to steer around higher interest rates is through internal financing, Hartman said.

“The bank-owned firms, for example, will finance an internal transition using a forgivable loan over some period of time,” he said. “There’s some interest assumption built into that, but it’s probably not 7% or 8% or 9%.”

These internal transitions are also a way to ensure advisors at bank-owned firms don’t go independent or switch firms at the end of their careers, he said.

“Technically, their advisors are employees and can’t sell their book of business,” Hartman said. “But they’ve come to recognize that if they don’t offer these departing advisors some compensation for their 25 or 30 years of loyalty, that advisor [could] move across the street in the last five years of their career.”

For internal transitions, the selling price won’t be the full value of the book, but rather 75%–80% value, he said.

Russell said it can be surprisingly difficult for non-bank advisors to find institutions with a lot of knowledge about financing these sales.

“If you just walk into a [local bank] branch, they probably can’t deal with it,” she said. “I was trying to find a couple of names for some clients who were looking at buying and selling, and I could only find two or three lenders that were sort of focused on this area or had a specialty in lending on succession of practices.”

For large practices, the buyer pool can be limited simply because of the dollars required to obtain it, she said. Russell has seen advisors split their books in situations like that to make it more palatable.

“Or, even, someone may say, ‘You know, I want to slow down. I’d like to keep a certain number of clients and deal with them. But these other ones are too much for me to handle and I’d like to transition those,’” she said. “I’ve seen splitting it, or a step purchase where it’s done over time.”