Is there value in impaired client lists?

Advisers looking to scale up their business quickly often look to client list acquisitions as a simple way to achieve this, however, high-quality lists are in high demand. Businesses with high-quality lists are characterised by higher average recurring revenue per client, excellent electronic records, and compliant recurring revenue streams.

According to financial services lawyer Fiona Halsey, director of Halsey Legal Services, these lists are the equivalent to a well-renovated house.

“The owners of those businesses can realistically expect to sell those lists and businesses for a multiple of around 2.8 times recurring revenue. However, as is the case in the residential housing market, there are different types and qualities of client lists and businesses,” Ms Halsey said.

“There is another segment of the market and other class of client lists and businesses that have received little attention and can be likened in the terms of the housing market to the idea of a ‘renovator’s delight’. We refer to those client lists as ‘impaired’.”

Several factors can impair a client list, ranging from poor compliance practices, an owner that has received a banning order from the Australian Securities and Investments Commission (ASIC), a previous botched sale process that spooked clients, to a business entering administration.

Founder and director of Forte Asset Solutions, Steve Prendeville, said that the first thing a buyer will look for while doing a risk assessment on a business or client book is whether there have been compliance issues in the last three years.

“If there’s been a complaint, you need to understand what it is and what the outcome was, if the PI insurance was used, but more anything else, is it a one off or do we have a systemic risk,” Mr Prendeville said.

“Now the other part of the systemic risk is it can be combated because every client must know, particularly if it’s outside the existing dealer group, new SOAs must be done for each client, so they can address it.

“There’s a lot more due diligence and what you’ll see is the price and terms will change if there’s a perception of risk. Instead of the traditional 70 per cent payout and 30 per cent deferred, it could be that if they think there’s a risk of losing clients that it might be 50-50, not 70 upfront.”

The way that purchase price is calculated is through a multiple of recurring revenue and it is generally paid with part upfront and part deferred. For example, a business with recurring revenue of $500,000 per year that is valued at a multiple of 2.8 would fetch a price of $1.4 million. If it were paid at the standard 70/30 split of upfront and deferred, the initial outlay is $980,000 with the remaining $420,000 paid over the next couple of years.

Mr Prendeville added that another key lever for managing risk is reducing the multiple of recurring revenue that’s applied.

“If you’ve gotten a lot of clients that are in their 80s, or to a lesser extent their 70s, that brings a higher mortality risk,” he said.

“What a buyer is likely to do is to change both the upfront and the multiple, and what may happen is you’ll actually have a segmentation of those clients that are 80-plus might be on a two times basis. If it’s over 70 and it’s more than 30 per cent, it could be at 2.5 times. It depends on what the assessment of risk is within each of the businesses.”

Ms Halsey said that buyers could get even more creative in their purchase structures, including a reduced need for finance.

“These impaired lists present opportunities for astute purchasers. With skilful compliance and legal assistance, and an innovative approach, astute purchasers can make super profits from these impaired client lists and businesses. There can also be a much reduced (or nil) requirement for finance,” she said.

“The key can be an innovative and effective arrangement by which the seller can provide as much assistance as possible, and the buyer pays the seller based on the actual value of client revenue generated in the years after the sale.

“There are many variations of these arrangements. A common arrangement is that the buyer pays a percentage of annual revenue from these clients for an agreed number of years. Other arrangements can involve staggered or long handover periods to bond the clients as closely as possible for the entire period of payment of the purchase price.”

Mr Prendeville added that on the seller’s side, they will often look to make fixes where possible to get their business into reasonable shape for sale.

“Often, people don’t want to buy other people’s problems, so business owners actually have to fix it up before they come to market,” he said.

“You’ve got to bring it to market in its best shape. So, if there’s remedial actions being done, do it prior to coming to market so you’re not punished when you’re at market.”

Potential purchasers are finding it increasingly difficult to access funding to acquire client lists and businesses, Ms Halsey said, due to tightening lending from banks. This makes transactions that require smaller upfront costs a lot more attractive.

For sellers, she added that it’s important not to let the value of their business dwindle.

“The owners of these impaired businesses or lists should be alive to the opportunities for selling such a list. They can feel defeated and effectively let the value evaporate,” she said.

“However, these owners should actively consider whether there is any value which can be obtained from these impaired businesses or lists.

“Often an intelligent approach to sale can mean that the sale proceeds can be contributed to the vendor’s superannuation fund, making an even better commercial and tax outcome.

“We have clients actively seeking these businesses and client lists, and others who have impaired lists which they want to sell.”

Significantly impaired businesses are not easy to find, Mr Prendeville said, as most were expelled from the profession with increased education requirements and the ceasing of grandfathered revenue.

“I see very, very few that are impaired because everyone over the last five years has now got engaged clients, they have changed their tech stack and changed the value proposition. Most have moved to fixed fees, each client is profitable,” he said.

“We’ve built better businesses over the last five years. Businesses that were impaired, they were part of that mass exodus from the industry that we’ve experienced over the last few years. They’re the ones that really couldn’t change or in some cases weren’t allowed to.”

Similarly, Ms Halsey pointed out that ageing advisers that have not already exited the industry could be looking for an out.

“In addition to the retiring advisers, a significant cohort have simply had enough of the profession because of their experiences over the past 10 years,” she said.

“The current compliance demands and endless negativity about the financial advising industry have sapped their enthusiasm, and they no longer want to be in business.”