When selling a business, it's only natural to want to negotiate for the highest price you can. In the context of the advisory business, this has led to a growing focus on the "going rate" valuation multiples of revenue or earnings (EBITDA), with advisors asking what they can do to maximize the overall sale price for their firm. Yet the caveat is that when it comes to the sale of advisory businesses, deals are almost never structured with the total purchase price paid at closing. Instead, deals are commonly structured with a significant component of the purchase price to be paid out years after the closing, and only if the seller meets certain milestones, which can be challenging to achieve. Sellers who gloss over or misunderstand these nuanced deal terms can receive less than they originally envisioned when negotiating the deal, such that what sellers "expect" to receive as a valuation multiple when the deal is struck may be substantively different than what they actually receive in the end.
In this guest post, Rich Chen, founder of Brightstar Law Group, explores how today's serial acquirers of advisory firms commonly include retention, earnout, and other post-closing contingencies that can materially shape what sellers will actually receive for the sale of their firm.
The first key to recognize in evaluating the offer letter for an advisory firm acquisition is that in today's environment, deals are rarely ever paid out fully in cash at closing. At best, only 80% of the deal may be paid when the transaction closes, and in many cases as little as 50% or even just 25% of the deal occur in cash. Which at the very least, means advisors must adjust for the time value of money, at a reasonable discount rate (that reflects the risk of being an implicit creditor of the acquirer!), for the fact that much of the proceeds may take as many as three to five years to be paid out.
However, scrutinizing deferred payments is not just about the fact that they are delayed, it's that depending on the terms, they may never be paid, as they are commonly subject to contingencies of how the deal itself proceeds after closing.
For instance, acquirers often defer payments based on retention requirements, that a certain number of clients (or more commonly, a certain percentage of revenue) must be retained after closing, for at least 1 year and sometimes as long as 2-3 years after closing. Which not only creates an outright hurdle for sellers to navigate – in staying onboard and engaged enough to ensure clients stick with the transition – but an additional challenge in that sellers don't necessarily control the environment that they operate in after the deal closes! Clients may have outflows due to taxes, or a divorce, or terminate due to dissatisfaction with the new acquirer, and the seller is at risk. A market decline could cause clients to leave, or simply depress revenue (calculated on assets under management), and while some firms do offer a "market-neutral" revenue retention clause (where changes in market returns are backed out), that adjustment can turn out to sting if the markets went up and might have otherwise preserved the retention payment against other client outflows!
An even greater challenge in many acquisition situations are earnouts, which require not just retention but a certain "threshold" rate of growth (typically calculated as a Compound Annual Growth Rate, or CAGR) for several years after the closing. Which is difficult both because of the challenges of compounding – a 20% CAGR amounts to a requirement that the seller must 2.5X the business in 'just' five years to meet the earnout (and if they could 2.5X the business that quickly, should they have even sold it!?) – and also because the seller must achieve growth goals in a firm that they no longer control (which could change its investment strategy, or its pricing, or its staff support… and the advisor simply has to do their best with the situation). And many acquirers also retain the right to terminate the advisor, with or without cause… potentially curtailing their ability to achieve the earnout targets at all.
The good news is that at least some retention, earnout, and post-deal employment terms (with restrictions on terminations without cause) can be negotiated with buyers. And awareness of the importance of the terms, and how they work, makes it easier to compare and contrast different Offer letters that may have different structures. Still, though, the key point is that it's not enough to 'just' focus on the valuation multiple the business is receiving in the first place, because what matters is not what the deal is worth "on paper" when it closes, but what the seller actually receives in their pocket in the end!
