Industry figures give their views on the benefits and potential drawbacks of financial services providers buying into intermediary firms and look at the wider implications for the market
Investment Week brought together a range of individuals representing organisations with an interest in the implications of providers taking stakes in IFA companies. Two independent IFAs who are looking at options for raising capital were present, along with Aegon, a provider that has been active in buying stakes.
Companies involved in putting the deals together were also represented. A law firm and an accountant that have been involved in a number of deals gave their views on the varying rationales behind the deals are done, as well as the benefits and potential drawbacks.
IW: What is the motivation from an adviser's perspective of allowing a third party to take a stake in its business.
KN: Mainly that consolidation gives advisers access to a source of capital to grow their business. At the top end of the IFA market, we are seeing a lot of big names facing potential collapse. Their revenues have plummeted and their fixed costs are high. However, in this market, different IFA businesses will have different reason for consolidation.
For Bates, capital can come from many different sources and we are not rushing into consolidation. The most important aspect in a consolidation is building brand. Most IFAs want to retain their brand. The motivation to sell has got to fit the company ethos and allow the ability to grow an adviser base and a back office system to strengthen the business.
FP: It is not about whether you can consolidate and grow your business but whether you want to do it. An entrepreneurial advisory business like mine takes on a heavy burden when it comes to compliance and administration and it would be good to have another set of people to develop the business. After all, I cannot be an expert in everything. Consolidation allows for the merger of back office systems, which is cheaper and leaves you with more cash to expand the business.
It is important there is a cultural fit, with existing staff feeling they are still an important part of the team.
KN: This has become a dynamic industry and there have been many changes. In the past 12 months, people thought the multi-tie structure would prevail in the market but this thinking is starting to change. In the next 12 months, the industry will alter dramatically.
IW: Kerry say Bates got £3m to spend from a consolidation deal. What would your spending priorities be?
KN: It would be building our back office system. The framework of these systems is costly.
We would also invest in advisers, not only bringing in more advisers but bringing in the right quality of advisers. Offering our clients the choice and flexibility of advisers is important so we would spend on adviser training as well as developing our research capabilities.
IW: How would you value your business?
FP: Different people have different ways of valuing their businesses. In the case of a merger, it would be the method with which the buyer and seller are most comfortable.
Traditionally, IFA businesses have been driven by turnover rather than profitability. As a result, profit is not as important for the merger. Turnover would measure the value of the brand but it is not only about profitability at the point of a merger but the potential for profitability going forward.
RC: I would say profitability is crucial for the business. The smaller a business is, the more challenging it is to turn it into a large, profitable business.
FP: Yes, but the industry does not have a history of profit so the value of a business has to be based on turnover.
KR: If you look at the market, consolidations have not been driven by current profits but by potential profits. We are not looking at running an adviser business because we have no expertise in the area.
We are looking for companies that are strong locally and have the ability to move forward. We offer to reduce their fixed costs by taking out the back office system costs and research and HR functions.
IW: Isn't there a danger IFA firms will lose influence over their culture if they are sharing the HR function?
KR: IFAs do not want the HR function because they have to deal with issues like European directives. A lot of them have asked us to take their clutter away because they know it would enhance their sales and profitability. What is crucial to the IFA is keeping their brand.
There are different types of businesses out there. Some are running on technology business solutions and some on fee business solutions. There's a payroll department and a commission department and their service becomes more effective through reconciliation.
KN: Consolidation could be an issue from a client point of view as well as from the management perspective. People need to look at how the company will integrate itself at board and senior management level, as well as the day-to-day functions. There will be fear across the board within the company that it will lose its individuality and its voice.
KR: It comes back to the cultural issue. You need to have a good cultural fit between the IFA and the investor; the issues surrounding appearances at board meetings, for example, and areas in which the investor can work together with the IFA.
We have known all the businesses we have acquired for years. The companies we are working with genuinely welcomed having an independent view of their business. One of us sits as an non-executive director and that is a role we value. It is important for us to treat that role properly.
IW: Peter Hargreaves of Hargreaves Lansdown says this kind of presence at board meetings is a problem. He argues life companies have enough trouble running their own businesses and have nothing to add to the running of what is a totally different type of business. You could come into a serious disagreement about the policy or the way a company is run, and damage relationships and the business.
KR: My biggest role at the moment is to act as a gatekeeper for well intentioned people in the Aegon group who want to apply internal audit from a corporate group perspective. I try to keep as much interference away from the business as possible.
It is important understand how small companies operate and know you do not need 15 internal audit people going through the business. We could very easily strangle the life out of the business we bought just by applying governance in a way that is inappropriate.
I know the fixed asset value of an IFA business relative to the overall value is small. The value is in your individual staff, your clients, how you interact with your clients, your brands and how you deal with all these things. If we alienate the people who make up the business, we would of completely wasted about 90% of what we have actually bought.
FP: I think it is all part of being responsive to cultural fit. It would absolutely strangle our staff to have someone sitting at our backs every week going through things. We wouldn't have time to do anything else.
IW: Keith, what percentage of Aegon UK revenue do you think your section of business is going to produce? Will it be worth all the management time for Aegon in the long term?
KR: We anticipate that within five years, it will generate in excess of 10% of UK revenue, so it is set to be an important part of our business. We have already invested a substantial amount of money in it and the amount of management time at executive level we have put in is also significant.
IW: Do you have a specific turnover in mind when you decide in which companies to invest? What is your rationale for deciding who to buy?
KR: We have never openly declared a minimum turnover or minimum-sized business. It is more about travelling the breadth of the consumer market than sticking to a certain size.
However, we made the decision not to get involved in hundreds of small companies as it would have taken up a disproportionate amount of management time. On the other hand we have not gone down the road of saying you must have a turnover of a set amount as some providers have.
IW: There seems to be a roughly even split between providers who do see a business case for buying into intermediary firms and those who do not. Some see a parallel between the investment in estate agents in the late 1980s, when providers competed with each other to get into a market that turned out to be a real drain on their resources.
KR: I would like to think the rationale for investing is much more sensible now than it was then. There are not the same excesses in the market as there were then.
IW: Richard, as a lawyer involved in these sorts of deals, what are the rationales of different providers?
RC: There are different strategies for different providers. Aegon has taken majority stakes and minority stakes with options to buy 100%. So even within Aegon, there are different strategies for different businesses at which they are looking.
Some providers like Standard Life have taken the view they are so big and have such loyalty there is no need for them to invest in distribution. I think this is a 'they need us more than we need them' type of mentality.
Others are looking at it from the perspective of having a market share that needs to be protected so feel they need to have some control over distribution.
IW: There is a question as to whether buying a stake will increase providers' market share because if there are disclosure rules, IFAs may decide they have to demonstrate their independence by steering clear of parent company products.
KR: I think this is where the Aegon strategy, which is all about improving distribution rather than selling products, really starts to help IFAs. If the IFA we acquired never ever sold another Scottish Equitable product, it would not be a problem.
If the business is contributing to our profits, I am happy. My counterparts at Scottish Equitable would be distraught at me saying this but that is their problem. They have to get their manufacturing excellence right so their product, if it stacks up in the market place, is capable of being sold.
IW: As IFAs, do you believe having to explain the business is 12% owned by one company and 3% by another will have an effect on how you interact with your clients?
KN: We would operate on the basis that we make decisions that whatever goes on to our panel of products goes on its own merit. This would continue whether we had an inward investor or not.
If you start to change the factors on which you make decisions on what goes on the panel, you loose the fundamentals of your business and your reputation.
IW: How would ownership issues affect an IFA's relationship with a provider?
KR: We are definitely able to understand the IFA business better as we are more closely involved with it. What has been very apparent to me is that no matter how close a provider thinks it is to an IFA traditionally, it is as only close as the IFA will let it get. However, when you have contractual relationships, you know more about how the business operates, which will help when it comes to dealing with that business.
IW: Which means of raising capital other than selling stakes to providers have you considered? Is merging a sensible alternative?
FP: Yes. We have looked at a complete range from private investors who are very wealthy to foreign companies that are semi-related to the financial sector to companies in the financial sector but not in personal finance.
IW: What about networks as an alternative?
KN: Networks do serve a purpose with smaller companies who are looking for the consolidations that don't really hit the radar for investment sightings. Medium-sized companies don't fit into the network structure so well and joining could damage their niche position.
IW: Fiona, what do you think is the most likely outcome for your business?
FP: I'll know it when I see it. There are many different options that I have been looking at, so it can give us an idea of what is right and what is wrong. When you get to the right option you will know it, the fit will look right.
IW: Richard, when you get involved in consolidation and merger deals, have you noticed any patterns in what providers seem to want from companies in which they are buying stakes?
RB: We have seen quite a wide variety of acquisitions. We have been involved in deals ranging from smaller companies being bought by providers to the top end of the scale. We were talking to a lot of companies about mergers. Sometimes we underestimate the difficulties and complexity of these deals. One of the deals we did with Aegon was with two complementary groups that had come together through a merger within the previous 12 months. The reality is that they are still coping with integration issues, so consolidation adds another layer of difficulty and these deals often take a long time to push through.
RC: I think it is a sector in which the soft aspects of getting the deal done have an importance of their own that can add a lot of complexity to deals. Acquisitions need to be done and some of the areas we have been discussing have a very soft, fluffy aspect to them. I would agree these issues are important but providers are driven by money and it is interesting value has not so far been such an important aspect of the discussion.
The proprietor's perspective will often be different from that of the adviser, particularly when advisers are self-employed or employees. There are an awful lot of dynamics to take on board. If providers are not careful, they could find themselves buying a business at which the staff is so unhappy they can not keep hold of them once they have bought it.
KN: In any business, the proprietors want to keep their people happy. A salary or equity consideration is a key factor in ensuring they are able to do so.
KR: Most of the businesses we have become involved in already had well established incentive schemes. There are Aegon-related benefits that come into play ' share options schemes and that sort of thing. Deals with Aegon have not been done because of the share options; they were done because they were the right deal for the company.
RC: One of the costs of doing deals is the unforeseen price of sorting out incentive arrangements. Sorting out inappropriate incentive arrangements that have either been put in place and ensuring they are tax effective needs detailed advice.
IW: What other factors can affect the outcome of consolidation deals?
RC: Compliance is crucially important. I have seen buyers walk away at a very advance stage because they have looked at compliance from an IFA company with which they are not happy.
RB: Surely compliance should be at the forefront of any deal to avoid this situation?
RC: Compliance and due diligence are not the sort of things that are done in five minutes. A scandal may crop up like the split caps, at which point it could become a problem.
RB: One of the reasons you have not seen many foreign players come into the market is that they may be frightened off by many aspects of the market, such as mis-selling.
IW: Do you think it is likely US players will come in when the market is in a more stable phase and try to build up a significant presence of distribution?
RB: Where there is uncertainty there is opportunity but right now they would rather think of it as a risk. Due to the market conditions, generally you are not going to get people looking at in an optimistic way.
KR: One of the things that worries me when we look at, say, how the Australian model works compared to that of the UK, is that in my 30 years' experience models don't transfer very easily. Look at AMP's purchase of Towry Law, for example. The IFA had its own internal tensions and sensibilities about merging the business. AMP came can along and introduced its own management style, which was totally different to theirs.
RB: One thing that comes across from all of this it that no deal is a walk in the park. It is not a question of saying, 'here's the money; this will work'.
The people who are looking for investments and cash as drivers are usually strong individuals who have had a very strong belief in what they want from their business, even if they are planning to act quickly. There is a lot of moving around and making sure the fit is right.
IW: Keith, how far do you see your interest in the intermediary market going? Now your holdings in the market are fairly modest, will you actively seek a much larger share of the distribution market going forward?
KR: Right now we are not actively seeking further acquisitions. It would be wrong for me to speculate too far into the future. Currently, we are trying to make sure the acquisitions we have made fit into the business and that we can offer the right resources to the companies in which we hold a stake. How much further we go into the market will depend on what comes out of the consultation papers and legislation.
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