The private bank and wealth management sector has seen significant market activity in recent years, with M&A transactions taking place at all levels. These deals reflect a market which is consolidating in an attempt to reduce back-office administrative and regulatory costs and increase profitability and which is seen as a growth opportunity as wealth, and an appetite for independent financial advice, grow. In a post-lockdown seller’s market, it is increasingly important that potential buyers focus from the very beginning of a deal process on how to achieve the best possible value.
In this article we examine how to structure M&A deals in this sector to maximise value, and set out some of the key factors that we believe are most likely to affect value and pricing during the course of a transaction. We also present some key points to consider at various stages of an acquisition and illustrate how they can influence the final price paid for a target.
Starting on the right track: getting valuation right
The starting valuation should be approached in a manner appropriate for the intended deal structure and the buyer’s strategic aims. The valuation metrics used will be an important factor for both parties and will be the most crucial aspect of value in a transaction, whether based on a multiple of EBITDA, AUM or another more suitable metric. Independent corporate finance advice will be important in determining the appropriate metric and the multiple to be applied.
In a recent case, the High Court determined that the fair value of a stake in a London based wealth management company should be decided not by reference to AUM but by reference to EBITDA on an EV / EBITDA basis. In that case, this resulted in a significantly lower valuation than would have been obtained by reference to AUM and the decision was predicated upon the business in question being significantly less profitable than otherwise comparable businesses. Clearly we do not expect that the value of a target from an M&A perspective would be decided by a court, but this approach highlights the necessity of considering the most appropriate valuation approach for the target and for the deal, and how that may quite materially affect price.
Of course, a valuation is only a starting point. The final price paid will be a blend of valuation, risk appetite and negotiation.
Integration of target and buyer: heading off key transaction risks
One of the key risks associated with M&A in this sector is whether or not the target can be efficiently and easily integrated into the buyer’s business. A target which cannot be easily integrated is likely to be less valuable to a prospective buyer than one which can. Buyers should balance any potential difficulties around integration against the potential to obtain the scale and synergies which often underpin a decision to acquire, and this may directly affect value.
There are broadly two stages to integration. Completion integration – where clients need to be moved seamlessly onto the buyer’s platform, and longer post-deal integration – where the target needs to be integrated into the wider business of the buyer.
Getting key employees of the target on side is vital to integrating successfully and a failure to do so can see a target with unmotivated employees and quickly departing clients.
The first step is for the buyer to analyse who the “key employees” are from its perspective, which will be inextricably linked to the rationale for the deal. In general, those with relationships with key clients will be important to a successful transition. This is particularly important for an asset sale where more active client consent may be needed.
Once this decision has been made, key employees should be incentivised under transitional and future plans and, within the confines of confidentiality, this should be communicated to them early. This incentivisation may be a combination of financial reward for completion of the transaction (and a successful transition of clients), which may be paid for by seller or buyer (or a combination), and future remuneration packages, which may also be linked to client retention over the period following the transaction. Usually, it is in both the seller’s and buyer’s interest to incentivise a successful transition and therefore there is scope for funding to be made available for this as part of the commercial deal.
Diligence should be undertaken to understand the seller’s wider incentive package (and on an asset sale this may need to be analysed in detail in respect of what must be offered to any employees who transfer under TUPE) to allow a buyer to offer something attractive to the key employees. These financial incentives should be factored into any decisions about price.
Thought should also be given to integrating the core team of the buyer’s existing business with the key employees of the target as early as possible once a deal has been agreed. Where cost rationalisation is part of the transaction, understanding what this means for a deal structure, the timing and the cost, is important as it too may have a bearing on the price structure early on in the transaction.
Material third party service contracts should be requested and reviewed during due diligence and any key contracts should be checked for notice periods and any change of control provisions. A high value contract with no ability to terminate early can be a significant barrier to integration, and expensive in the long run. Likewise, a key contract which may be terminated by the counterparty on completion of an acquisition could leave a target unable to offer services or meet its contractual and regulatory obligations without meaningful additional cost.
This should be a focus of legal due diligence and any relevant consents from third party providers should be sought prior to exchange or as a completion condition. Warranty or indemnity protection is unlikely to be available for these issues.
Keeping hold of clients: retaining value
A significant risk factor is whether clients will transfer to the buyer, and then remain with the target business following the acquisition. The approach to take differs depending on whether the transaction is an asset sale or a share sale, but both require a focus on treating customers fairly, adhering to other regulatory requirements and ensuring that a buyer only pays for what is eventually transferred.
An asset sale will often require the consent of clients to their business (and information associated with it) being transferred from the seller to the buyer. The FCA requires that clients’ consent in writing to the buyer’s terms of business is obtained, and this may need to be sought from clients individually where transfer provisions in the target’s terms of business are insufficient. This therefore involves an element of risk for the transaction, where some clients will transfer and others may not, and there will always be clients that do not respond to communications. A buyer may also want the clients to sign up to their standard terms of business as part of the transfer rather than deal with this post-completion, and price may be linked to that too.
Transfer provisions in existing customer agreements should be reviewed at an early stage to assess whether a transfer is allowed, what process will need to be followed, and where the transition risks lie. Any scope for clients to refuse to consent to the transfer of their business should be analysed and a plan should be put in place for clients to continue to be contacted for a decision either way both between exchange and completion and post-completion. This can be a burdensome process.
This risk is reduced on a share sale as the contract between clients and the target will remain unchanged, but it remains important to communicate to clients that the service they receive will not be detrimentally affected by the transaction and to ensure that the transaction does not cause clients to move. Voluntary notifications should be made to clients, and clients may also need to be made aware of changes to custody arrangements.
At all stages, clients (including non-responding clients) must be treated fairly. It is important that a communications plan is carefully structured to mitigate any of these risks.
Structuring price to secure value
Structuring consideration payments in wealth management acquisitions can be complex, especially when some clients have consented to transfer their business and some have not, or when there are outstanding potential or actual liabilities uncovered during due diligence. Generally the agreement of the price and other commercial terms takes place a long-time before the transaction completes, and it will often be sensible to deal with this at an early stage and link elements of the price to a successful transition of clients, and allocation of liabilities.
A buyer protection against non-transferring clients is to structure the consideration to reflect the actual business at the date of completion. In many cases, this should be self-adjusting, for example where the deal is based on AUM, this should only be the AUM that actually transfers to the buyer. This ensures that at no point will a buyer be left paying for clients or assets which have not transferred.
The pricing structure may be more nuanced, and a buyer might want to set a cap on what it will pay (if AUM increases) and an AUM floor (so that the price may change if the business has at completion AUM below a certain critical level which makes the deal a different one from the buyer’s perspective). There may be other deal specific reasons for reducing the price and a buyer will want to link this to the overall rationale for the deal. If certain clients, or types of client, are important and they do not transfer, that may affect the commercial rationale of the deal and therefore price. As an alternative to price, a buyer may not want to proceed with the purchase in these scenarios, and retain the right to terminate the transaction.
Keeping a retention for a period in order to protect the buyer against any issues which have arisen during diligence can be effective. Again, this should be flagged early.
An earn-out based upon the performance of the target for a period following completion can be attractive to buyers who can, in effect, use the success of the target to pay for itself. However, any earn-out adjustment can be risky in this sector, and anything linked to AUM particularly so given the potential for market volatility to skew figures.
Pricing structure will be a heavily negotiated element of any deal and the outcome will likely reflect a commercial compromise. Buyers should be clear on the potential effect of any identified or suspected risks on the value of the deal and should seek a structure which reflects that value. In all cases, pricing and the rationale for the transaction should be closely aligned.
Due diligence and regulatory risk
When dealing with a regulated target, analysis of the level of risk from any prior or continuing regulatory breaches is central to pricing and to achieving value in a transaction. Dealing with the FCA and / or FOS and providing any necessary remediation to clients who have suffered loss as a result of previous breaches may be time consuming, costly and can be reputationally damaging, all of which affects the value of the target.
We would advise particular caution around any evidence of exposure to advice on long-term products such as film financing, life insurance and DB pension transfers. The value of any potential remediation related to these products should be assessed and if possible, indemnity protection should be sought via the transaction documents.
Buyers should also be aware that there may not be any cover for issues arising post-completion which are linked to pre-completion conduct. If protection cannot be obtained in respect of these issues, or is limited, then this should be factored into pricing and wider deal structure.
Finally, it can be difficult to assess the risk of any regulatory issues arising in targets with poorly kept records, or where institutional knowledge has been lost. Unknown risks such as these are difficult to cover except through broad warranties, which the seller is likely to resist. Buyers in this situation should consider keeping a retention or decreasing the offer price to reflect the reduced value caused by the uncertainty.
Between exchange and completion: maintaining and preparing to maximise value
The majority of deals in this sector require an interim period between exchange and completion, to await FCA Change of Control consent or to give clients time to consent to the transfer of their business to the buyer.
This period can be utilised for planning to integrate the business and bringing together key personnel, which can aid with the success of an acquisition in the long run.
Pre-completion undertakings should be provided in the purchase agreement to govern the way that the target is run in the interim period and to prevent the management of the target from doing anything not in the ordinary course of business.
A material adverse change clause could also be sought by the buyer to ensure that the target purchased on completion is not materially different to the one expected at exchange. However, these provisions are unlikely to be easily accepted by sellers, particularly where the transaction is made public at an early stage. It can be difficult to define what is material in this context and there are often fairly protracted negotiations around the risk allocation brought about by these clauses.
We recommend that the purchase agreement provides for the formation of a committee populated by senior representatives of the buyer and seller. This committee serves as a forum at which issues relating to the fulfilment of any conditions to completion can be discussed, any issues with the transaction’s progress towards completion can be shared and, crucially, any complex operational decisions can be addressed.
This process allows senior people at the buyer to become familiar with the target whilst also overseeing anything which could affect value in the interim period. It may also assist with the integration of key employees at the target.
Any issues which remain outstanding at completion should be dealt with by a Transitional Services Agreement (TSA). It is very likely that the Interim Committee will have identified services which the target will need to access on day one following completion which cannot be set up immediately. A TSA should be put in place to give access to services such as custody services for less liquid assets, IT support and access to client files, to govern the extent to which the seller supports the buyer and both parties provide reasonable support to give effect to the deal. The TSA should include, or be accompanied by, an IP Licence which allows the buyer to use the seller’s IP insofar as it relates to the target for a specified period following completion.
 Signia Wealth Limited v Vector Trustees Limited  EWHC 1774 (CH)
If you require further information about anything covered in this briefing, please contact Anthony Turner, Andy Peterkin or your usual contact at the firm on +44 (0)20 3375 7000.
This publication is a general summary of the law. It should not replace legal advice tailored to your specific circumstances.
© Farrer & Co LLP, January 2022