Introduction: Wealth Management M&A
There has been a spate of acquisitions in the private bank and wealth management sector in the last few years. This has been driven by consolidation vehicles but also by product providers looking to enhance their technology or offering in this area or generally increasing their market share. High volume of M&A and potential for large valuation multiples has also attracted private equity/sponsors in this area which has also led to enhanced activity and competition.
Given the volatile economic shifts being experienced globally, the way individuals need support with their financial planning and investment decisions is also going to adjust over the next few years. 2022 has been one of the toughest for the wealth management industry due to a combination of high inflation and a sell-off both in stocks and bonds. Managers are facing challenge from investors on the value when it has been difficult to preserve and grow wealth through conventional strategies and portfolios. This is likely to lead to a shift in how wealth managers deal with their customers as the managers who are able to adapt investment strategies swiftly and spend the most time convincing their clients during such markets are the ones that will likely survive this downturn better. Such factors along with the enhanced regulatory focus on the wealth sector and the increasing effect of disruptive technology will continue to offer opportunities for M&A and consolidation activity in this market.
Eversheds Sutherlands’ dedicated financial services M&A group has been advising clients on various market leading transactions in this sector and have experience of dealing with all relevant issues which deal-makers typically encounter. In this article, we look at some of these key issues.
Value predominantly lies in the nature of the target, the relationships between its business offering and the clients, the state of its affairs and the post-acquisition synergies and strategy.
Common metrics used are multiple of EBITDA or assets under management/advice (AUM/AUA) or a combination. In growth or early stage wealth tech, the valuations could be more complex and be based on variety of factors such business projections, quality of the tech, usability, adaptability and/or portability, control over intellectual property etc.
Additional value dependencies encountered on transactions in this area are:
- risk of leakage of customers/AUM/AUA and effect on future EBITDA/growth (due to acquisition or through any planned change of strategy/branding/fee structures by the acquirer);
- cost effect of putting together incentive based retention strategy to manage risk of losing key personnel;
- issues with regulatory compliance and regulatory changes. For instance:
- since the introduction of the retail distribution review (“RDR”) in 2012, regulatory scrutiny on the wealth management sector has been consistent, heightened further by the losses suffered by British Steel pensioners as a result of unsuitable advice. This has resulted into heightened costs of compliance and horizon scanning. For further detail around the conduct issue arising from DB transfers, readers are recommended to read the useful insight pieces from Konexo UK, a division of Eversheds Sutherland:
Konexo - British Steel Pension Scheme: What's all the fuss about
Konexo - British Steel Pension Scheme: financial detriment
Konexo - Defined Benefit Pension Transfers; and
- the threat of regulatory investigation can have an impact on a business’s valuation due in large part to the powers of the regulators to require firms to pay redress to customers where it finds that a firm has mis-advised products (and the costs associated with such redress processes).
- extent of competition for the target; and
- costs of post-acquisition integration.
Earn-outs and purchase price adjustments are often used as tools to manage valuation gap between buyers and sellers. For sophisticated or large businesses, professional corporate finance/valuation advice from an expert adviser could be useful.
Transactions are commonly structured as share sales, asset sales or investments. Sometimes financial advisers are also acquired through dedicated commercial arrangements rather than a corporate or assets acquisition. Providers may be more open to JVs or minority investments in businesses rather than acquiring the whole business.
Asset sales which typically help in liability management need to be considered very carefully, in particular, in managing any regulatory risks associated with those asset transfers
Typical conditions to deal completion:
- Regulatory approval - wealth management businesses are regulated by the FCA in the UK and therefore any change in control of the business will require FCA consent. What this means in practice is that there will be a gap, which can be anywhere from three to six months (or even more), between the parties signing documentation, and completion of the transaction.
- Key customers/clients consent - depending upon the structure of the transaction and existing customer/client arrangements, consent from key customers may also sometimes be a condition precedent. This is particularly important where the wealth management business has a high client concentration.
- Key suppliers/third party contractors consent – depending upon the transaction structure and key dependencies on suppliers/third party contractors, their consent may also be a condition precedent.
- Securing full transfer of business/shares – corporate structures of financial planning/advisory businesses are often found with dispersed shareholding constituting of owners and previous and current employees/financial advisers. This is often a result of incentive structures put in place to retain key personnel. The desire to maintain confidentiality and smooth execution often requires the buyers to negotiate the transaction with the majority owners with the transaction being conditional on full sale. Parties often rely on drag and/or forced sale provisions/rights available in this context.
- Merger control and other trade regulatory conditions – parties would need to ensure they the transaction is reviewed from a merger control perspective to ensure no approvals or notifications are needed. Transactions could also fall within the purview of ever increasing investment controls if a foreign buyer is involved.
Generally, the transaction documents will stipulate what are each party’s obligation in respect of conditions. Typically it would be a buyer obligation to be responsible for making the change in control application to the FCA with seller’s assistance
Gap provisions and termination rights
Given the likelihood of a long gap period between deal execution and completion, a buyer would like to ensure the value in the target is protected. In contrast, management and sellers will not want to be unduly fettered in the running of the business particularly if there is a risk of the transaction failing. A combination of buyer veto rights and sellers/management undertakings are often negotiated while keeping in mind the risk of regulatory “gun-jumping”.
Parties often also negotiate appropriate termination rights to cover various key risks including regulatory breaches/issues, loss of licence or key customer/supplier relationships etc.
Warranties and indemnity protections and usefulness of W&I
Buyers will typically require a complete warranty package covering all key areas of the target business, however, warranties and pre-sale disclosures relating to compliance with financial services laws and regulations would likely be key. Parties often also seek specific indemnities around potential issues with legacy advice, matters discovered through due diligence and generally around tax matters.
Often the warranties and indemnities are provided by employee/management owners who are instrumental in running the target business post acquisition. Therefore careful planning around recourse to them on breach of warranties and indemnities would be required at the outset to avoid unnecessary future confrontation.
Buyers often use deferred consideration, escrows and administration of future incentive as tools of liability management for breach of warranties and indemnities. Buyers should also commit resources on detailed pre-sale due diligence exercise particularly in areas such as regulatory compliance to limit the risk of future claims.
Use of warranty and indemnity insurance (“W&I”) as recourse could also be a useful tool to an extent (especially relating to cover around warranties in respect of financial statements). However coverage on compliance with financial services laws or regulations is typically always excluded from W&I policies or if included, such coverage is typically very expensive. Therefore, the buyer will need to consider carefully the benefit, and cost, of putting in place a W&I policy that might not cover a key area of loss.
Post-completion of the transaction, there are various issues that will need to be worked through by the buyer, including:
- the messaging to clients in order to ensure they are retained including plans to change terms of business to buyers’ standard. Buyer is recommended to review seller’s terms of business carefully at due diligence stage to deal with any issues and plan for the process;
- cultural alignment, including management of change in strategy or business model of the target by the buyer (for example change in target clients, moving the target business from an advisory model onto the buyer’s own restricted model etc.);
- the integration of the target’s regulated business within the buyer’s own group, which might necessitate a post-completion restructuring of the target group in order to carve out the relevant business lines;
- suitability of existing supplier arrangements (pre-sale due diligence should be targeted to pick up the ability to terminate arrangements on short notice);
- retention of key staff, including the implementation of any long-term incentive plan; and
- the need for any transitional service arrangements from seller post-completion and for how long.