The sale of financial advice portfolios is on the rise and both buyers and sellers are finding new ways to allocate risk. In this post, we put the current deal trends under the microscope.
Following the Royal Commission, and as we move towards the deadlines for new FASEA requirements to be implemented, it’s become a buyers’ market. Buyers are keen and empowered to limit their exposure and risk to changes to remuneration and poor advice. One way they’re doing this is by imposing more stringent warranties and indemnities in their portfolio transfer agreement.
Buyers are asking for deeper warranties
A warranty is a promise by one party that a particular statement is true and may be relied upon by the other party. For example, a seller may warrant that certain compliance requirements have been met (for example, opt-in and Fee Disclosure Statements), or warrant the levels of recurring revenue to support the purchase price/value of the sale.
Following the Royal Commission, buyers are more vigilant than ever about the quality of the portfolios they acquire. They are conducting a more extensive due diligence process and asking for better warranties than they have for similar transactions in the past. Buyers also want more certainty around the payment of any PI claims, especially with so many advisers leaving dealer groups who are shutting down their FP operations entirely.
Buyers now expect warranties to cover things like:
To mitigate their risks, buyers are also asking sellers to give personal (owner/director) guarantees for these types of warranties.
The rationale behind these requests is to push the risk exposure back onto the seller as much as possible for poor advisory and compliance practices, allowing the buyer to reduce the purchase price for any adverse impact on recurring revenue and retention of the acquired client base. This isn’t entirely unreasonable given the seller is the one who ‘knows’ the clients, the business and its risks.
Sellers can still limit their exposure and risk
Sellers can counter warranty extensions requested by buyers to limit their exposure and risk. My recommendations for this include:
Indemnities are also gaining favour with buyers
Indemnities are a contractual obligation by one party to reimburse the other when an agreed event happens. In the current risk-averse landscape, buyers are seeking to impose catchall general indemnities for any liability arising from the seller’s activities. A better compromise is for the indemnity to cover any breaches of the law, legal negligence, or claims involving clients. Arguably, some of these indemnities are excessive and go beyond what is really needed to protect the buyer, so sellers should resist these and only agree to specific indemnities.
Specific indemnities are items identified or disclosed in the due diligence process that can’t be resolved because the issue is ongoing where the potential loss is not quantifiable at that time. If the issue can be finalised before completion or dealt with by adjusting the purchase price then it should be done through a reduction to purchase price, rather than relying on indemnities.
In every sale transaction, counterparties obviously have competing interests. The key is understanding these interests and appropriately addressing them in the sale agreement. As a buyer, you want to have certainty about your rights to claim against the seller and the seller’s financial resources to meet indemnity and warranty liability. It is essential that the buyer has confidence in the PI insurance arrangement for the seller’s exposure in the period after the sale. Without this, the indemnities are worthless because there will be no safety net for these risk exposures. Equally, as a seller you want to know what your liabilities and obligations to the buyer are and when they will end.
If you’re negotiating or preparing to sign a portfolio transfer agreement, you should seek legal advice to make sure you’re mitigating your risk and exposure under the agreement. If you would like any other information on tricks and traps for undertaking divestments, mergers and acquisitions, please get in touch. We’d be happy to help.