The wealth management sector has seen significant market activity in recent years, with M&A transactions taking place at all levels of the market, writes Anthony Turner, partner at law firm Farrer & Co.
Participants in the wealth management sector use consolidation as a means to drive growth, promote innovation or take advantage of cost synergies. Acquisitions can also be used to expand access to specific asset classes, geographical locations, clients and the expertise of key managers.
While tighter market conditions may now prevail in the short term, we expect to see M&A interest in the UK continue as the underlying commercial drivers remain persuasive. In particular, the regulatory burden continues to increase, many buyers have healthy cash reserves, and the value of the pound relative to other major currencies will encourage inbound investment.
Price
Price is clearly a critical element of any transaction. There are a number of different bases of valuation, including a multiple of earnings before interest, taxes, depreciation, and amortization; percentage of assets under management (AuM); and discounted cash flow.
Different methodologies will suit different situations and specific valuation advice should be sought in each case.
It is crucial that at the same time as agreeing price, the wider costs and strategic aims of the parties are factored into the price and the deal structure.
For example, post-deal integration and client and asset retention are often cited as key risks in M&A, and if these are considered early, the pricing structure can be used to apportion the risk.
Deferred consideration
A key protection for buyers involves structuring the price using deferred consideration where the price paid is contingent on certain milestones of the target business following completion. This helps de-risk the overall price by allowing a proportion of value to be conditional upon certain post-completion metrics.
Deferred consideration is often based on the AuM/clients which actually transfer to the buyer’s control and which remain as clients for a particular period following the acquisition.
Earn-out arrangements can also be attractive to buyers, as the target business can effectively be used to fund future consideration payments.
However, earn-outs must be carefully structured in financial services transactions, as common metrics of valuation are often highly exposed to market volatility.
Linking value to key assets
Wealth management transactions can require active client consent in order to transfer clients to the buyer.
Even where no active consent is required, client transfers are often a significant administrative burden in onboarding the new clients and moving them onto the buyer’s standard terms.
Buyers often seek to link the transfer of clients to price to de-risk their position. This can be done by adjusting the price depending on the AuM/revenue which transfers as against the expectations pre-completion.
Buyers may also seek to avoid paying full value for clients that do not promptly (before or after completion) agree to move over to the buyer’s terms and conditions. This will encourage the seller to help with this process and reduce internal time and transaction risk for the buyer.
In the context of the potential gap between signing and completion, ‘collars’ (setting a minimum price for the transaction) and ‘caps’ (setting a maximum price), in conjunction with appropriate conditionality, can be used to provide greater certainty to buyers and sellers alike.
Regulatory consent and due diligence
Transactions will often require regulatory consent.
An entity or individual is required to obtain change in control approval from the Financial Conduct Authority and potentially also the Prudential Regulation Authority (depending on how the target firm is regulated), where it acquires ‘control’ of a UK regulated entity.
What constitutes ‘control’ varies depending on the regulatory classification of the target.
Proper identification and understanding of any significant liabilities is crucial. Historic liabilities in a highly regulated sector should be carefully considered, whether relating to structured products, defined benefit pensions or otherwise.
Remediation can be costly and management time-intensive and may bring reputational risk.
Warranties serve to apportion risk between buyers and sellers, whether identified at the time of exchange or not. Indemnities will be key in allocating liability for legacy product risks.
W&I insurance and contractual protections
Warranty and indemnity insurance can be a helpful tool for both buyers and sellers and is increasingly prevalent in financial services transactions. W&I insurance can be particularly helpful in the regulated sphere where liabilities can quickly become very financially significant.
Pre-completion undertakings should be provided in the purchase agreement to govern the way that the target is run in the interim period between signing and completion.
A material adverse change clause could also be sought by the buyer to ensure that the business acquired on completion is not materially different to the business agreed to be purchased at exchange.
This article was written for International Adviser by Anthony Turner, partner at law firm Farrer & Co.
