There are many challenges in navigating a successful advisory firm merger or acquisition, from ensuring that the firms align on investment, financial planning, and service philosophies, to finding an agreeable valuation and terms to the transaction, and navigating the post-transaction integration process. Yet in practice one of the biggest blocking points is simply figuring out how to effectively align the advisory fee schedules and fee calculations of the two firms - for instance, when one advisory firm charges substantially more or less than the other - to the point that one of the biggest blocking points of an otherwise-well-aligned merger or acquisition is simply whether it's feasible to integrate their billing processes (especially when the firms have differences in their underlying business model, such as an AUM firm acquiring a retainer-fee firm).
In this week’s #OfficeHours with @MichaelKitces, my Tuesday 1PM EST broadcast via Periscope, we discuss the major issues to consider when integrating advisory fee schedules and billing processes, from strategies to adjust when one firm has an advisory fee schedule that charges more (or less) than the other, to reconciling differences in billing timing (i.e., billing in advance versus in arrears), and the unique acquisition problems that arise when trying to acquire retainer-fee firms.
For most, though, the biggest challenge is simply reconciling differences in fee schedules between the two firms. In situations where the acquirer charges more than the firm being acquired, there's typically a desire to lift the newly acquired clients up to the fee schedule of the existing firm - which can make the transaction a strategically positive deal for the acquirer, if it can generate more revenue from the same clients, but also increases the risk that clients will reject the new fee schedule and not transition at all (which means it may be a good idea to leave the original fee schedule in place for a year or two, to allow clients the time to adjust, and build a relationship with the new firm). On the other hand, when the acquirer charges less than the firm being acquired, it gets even messier, as if the acquirer pays "full price" for the new firm's revenue and then immediately cuts their fee schedule, the acquirer faces a substantial loss on the transaction (unless they can bring down costs in the merger business by even more than the loss in revenue!).
Even where advisory firms reasonably align on fee schedules, though, it's also necessary to consider whether they have the same billing timing - in particular, whether both firms consistently bill in arrears or in advance. Because differences between the two firms in their billing process can lead to substantial disruptions in cash flow for either the acquirer, or the newly acquired clients! After all, if the acquirer needs to switch the new firm from billing in advance to billing in arrears, the firm could be forced to wait up to six months without receiving any new revenue from the new clients! And if the acquirer needs to switch in the other direction - from billing in arrears to billing in advance - then the first invoice to the clients may have to be a "double-billing" of the last arrears fee and the first advance fee all at once (which increases the transition risk for the acquiring firm!). In fact, even differences in the billing calculation process - such as when one firm bills on end-of-quarter balance, and the other uses average daily balance - can create billing gaps between expected and actual revenues!
And of course, this all assumes that both the acquiring and selling firms were both charging AUM fees in the first place. In the case where the acquiring firm charges AUM fees but the acquired firm charged retainers, it can be even more challenging to transition the retainer clients onto the AUM firm's fee schedule (especially since many retainer-based firms proactively "sell against" the disadvantages of AUM fees, which effectively chases away potential buyers who may want to convert the business to their own AUM fee schedule). In turn, this means the marketplace of potential acquirers for retainer fee firms is drastically smaller, and retainer fee firms may have more difficulty finding an acquirer that will pay them a "fair" price - particularly for firms that charge retainer fees to clients who do have assets and "could" pay AUM fees (as the situation is different when using retainer fees to serve younger clients, or other "non-AUM" types of clientele).
Ultimately, though, the key point is simply to recognize how important differences in advisory fee schedules and billing processes can be when you’re looking at a potential merger or acquisition. As a result, doing detailed due diligence on advisory fee schedules is crucial. In particular, advisors should be evaluating any differences in the level of fees charged to clients, the timing of those fees, how those fees are calculated, and whether two firms have fundamentally different approaches to billing altogether. Of course, fee schedules don't need to be identical in order to successfully navigate a merger, but approaching a merger with a clear understanding of the potential risks and opportunities involved is crucial!
