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The volume of M&A transactions involving registered investment advisors (RIAs) has increased tremendously in the past five years. This allows founders and other shareholders to monetize the value of their ownership stake and potentially join another firm to supercharge the growth of their practice. For sellers, it’s an opportunity to add clients, talent, and service offerings to promote growth of their RIA firms.
But the process of RIA M&A transactions is complex. It behooves buyers and sellers to familiarize themselves with the steps involved if they are interested in exploring such transactions. In this article, I provide a high-level overview of the various stages of an RIA merger, sale, or acquisition transaction and detail key considerations for buyers and sellers during each stage including a discussion of the key legal documents that are typically prepared and negotiated in connection with such transactions. For a discussion of how to navigate the sale of a minority interest in an RIA, click here.
Assuming there is interest between the buyer and seller, after preliminary discussions the parties typically enter into a mutual non-disclosure agreement (NDA) to allow for more in-depth discussions and due diligence to ensure that there is a good fit for a potential transaction. The NDA is crucial for protecting the interests and proprietary information of both entities involved in the negotiation because both sides will be sharing sensitive information. Typically, the NDA will restrict the parties from using or disclosing confidential information shared by the other party for a purpose other than in connection with exploring the potential sale, merger, or acquisition. Important things to negotiate in an NDA include what is included within the scope of “confidential information” protected from use and disclosure; the length of the restrictions on the use and disclosure; and what the parties must do with the disclosing party’s confidential information after termination. Even if the parties have signed an NDA, the seller may not be permitted to share certain information about its clients, depending on what is contained in the seller’s privacy policy.
After the NDA is signed, the parties can then share much more in-depth information about their firms including, among other things, information about the RIA’s finances, operations, compliance program and history, employees, clients, and material business arrangements. The buyer and seller must conduct extensive due diligence to better understand the risks and opportunities associated with a potential transaction.
Sometimes, if the parties have preliminarily agreed upon terms for the transaction, including the valuation of the target firm, they will enter into a letter of intent, term sheet, or memorandum of understanding (LOI) that outlines the tentative terms of the transaction. For an article discussing how RIA firms are commonly valued for merger or sale transactions, click here. In many instances, the parties will enter into the LOI even before they engage in extensive due diligence. Depending on whether the transaction is an asset sale, equity sale, or merger transaction, the LOI will typically include details of key terms such as the structure of the transaction, the agreed-upon purchase price and payment schedule, any purchase price adjustments or earn-outs, contingencies for closing of the transaction, anticipated timeline for signing key documents and closing of the transaction, restrictions on non-competition or non-solicitation applicable to the seller, and, if applicable, key terms of the employment of the seller’s personnel following the transaction. While typically these terms are not binding, an LOI includes several terms that are binding including a so-called “no-shop” provision, which restricts the seller from exploring transactions with parties other than the buyer for a period of time. The “no-shop” provision is important to the buyer because, otherwise, the buyer may not have the incentive to spend the time and resources required to conduct more fulsome due diligence on the seller’s business. Nonetheless, the LOI affords the parties the opportunity to walk away from the transaction if they do not wish to move forward for any reason after the expiration of the “no-shop” term.
If the parties agree that the transaction should move forward after conducting due diligence, they will have counsel prepare the transaction documents for the deal. With respect to asset sales, typically this will be an asset purchase agreement. With an equity purchase, the transaction document will typically be a membership interest purchase agreement or stock purchase agreement for the buyout of the equity of the RIA. In addition to spelling out the key terms of the transactions, the primary transaction document will also include numerous representations and warranties to be made by the seller with respect to its business that are designed to assure the buyer that the seller has operated its business in compliance with all applicable laws, rules, and regulations, among other things. The buyer and seller also agree to indemnify one another from certain “bad acts” should something go awry after the closing of the transaction. Other transaction documents could include, as appropriate, an escrow agreement (if certain amounts are held in escrow pending future events), a promissory note (if a portion of the purchase price will be funded through a loan from the seller), a bill of sale (to evidence the sale of assets or firm equity), an assignment and assumption agreement (where the buyer assumes certain contractual obligations from the seller), an employment agreement (if the seller’s personnel will join the buyer’s firm as an employee after the transaction); a joinder agreement (if the seller will be acquiring equity in the buyer’s firm as a result of the transaction), and certain closing certificates and attestations from both parties. Upon signing of the transaction documents, the parties may then publicly announce the transaction and notify clients of the transaction.
But even if the transaction documents are signed, the parties may have to fulfill certain obligations prior to the closing of the transaction. Most notably for RIAs registered with the SEC and certain states, this entails arranging for the assignment of the investment advisory contracts of its clients. For reference, section 205(a) of the Investment Advisers Act of 1940 requires registered RIAs to include a contractual provision in their investment advisory agreements prohibiting the RIA from assigning the client’s investment advisory agreement without the client’s consent. Depending on whether the seller must obtain affirmative consent (i.e., written consent) or negative consent (i.e., the failure to object to the assignment), the process will take different amounts of time. For a discussion of the most common mistakes I see in RIA investment advisory agreements and why they can be costly, please click here.
Once the investment advisory agreements and other closing logistics, if any, have been accomplished, the parties can move to close the transaction which typically entails funding of any upfront purchase price amount from the buyer to the seller and the signing of various documents by the parties, which could include employment agreements, promissory notes, joinder agreements, and other transaction documents.
Even if the transaction is closed, however, there is still much work to be done by both buyer and seller. For buyers, the work of integrating the seller’s firm and personnel begins, and often this can be a lengthy process due to a variety of factors including operational and other issues that must be addressed. For sellers, depending on the circumstances, appropriate regulatory filings may need to be made to reflect the transaction. For instance, if the seller will effectively cease conducting advisory business through its firm following the transaction, it will typically need to arrange for the filing of a form ADV-W to withdraw its investment adviser registration. The seller, however, may also need to arrange for the retention of its books and records for a period of time after the closing of the transaction. The seller may also need to make certain corporate or tax document filings as a result of the transaction.
RIA mergers and acquisitions are complex and require attention to a significant amount of detail, and therefore, buyers and sellers should retain an attorney as soon as practicable to assist them in the event they are interested in exploring the potential sale, acquisition, or merger of their RIA firms.
The process of selling or merging an RIA requires careful thought and consideration and involves numerous steps and documents. Nonetheless, RIAs that are armed with information on how to navigate such transactions can prepare effectively to achieve their goals.
Richard Chen is a managing partner with Brightstar Law Group, a law firm that serves investment advisory firms by providing proactive business-minded solutions pertaining to corporate and securities law-related matters. Among other things, our firm provides counsel with respect to securities and compliance matters (including representation in SEC examinations), private fund formation, corporate formation and structuring, business transactions (including M&A and joint ventures), contract drafting and negotiation, employment law matters, operational due diligence, and succession planning. For more information, please visit our website at www.brightstarlawgroup.com or call us at 917-838-7398.
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