Try before you buy

If you’re preparing to shell out large dollars to buy a practice, the thing you want to be most certain about is that you get what you pay for.

Wes McMaster of Financial Services Business Brokers (FSBB) in Melbourne helps to broker the sale and purchase of financial planning practices. He says whenever a personal services business like a financial planning practice changes hands, both parties take a risk.

“One of the risks for the buyer is that the clients won’t like the purchasers and won’t deal with them. Another risk is that the seller might poach the clients back.”

In an attempt to mitigate those risks, most purchasers measure the recurrent income of the business at the date of the purchase agreement and pay only a portion of the agreed price upfront and the remainder after they’ve had 12 months experience with the business.

“They enter into an agreement that they will pay 100 per cent of the purchase price provided the income is at least the same,” McMaster says.

“If it has fallen, the purchaser will adjust the figure down. So it is an attempt to only pay for what they actually receive.”

However, according to McMaster, this measurement is flawed.

“The reason it is flawed is because the seller might successfully transfer all the clients but the seller has no control over whether or not the clients withdraw funds. It’s not fair to penalise the seller like that.”

A fairer way, says McMaster, is for the purchaser to pay 50 per cent of the purchase price upfront and the remainder on retention of clients.

“In the first few months usually what happens is that the buyer and seller hold joint meetings to talk about changed arrangements,” he says.

“At that meeting the buyer should encourage the client to sign a new client agreement indicating they’re prepared to do business. If the client signs and agrees then the purchaser has retained the client. It’s easily measured.”

To further protect the purchaser’s interests, McMaster says a sale agreement should also include a restraint of trade clause.

“As a minimum, the restraint generally has an effect where the seller agrees not to do business with any clients for a specified period of time. Most clauses go beyond that and say that they won’t behave as financial planners within a certain region over a certain period.”

Restraint of trade agreements, he says, need to be very proscriptive.

“One of the key things I find where these transfers and acquisitions run into problems is where they’re not proscriptive.”

Including a restraint of trade agreement in a sale agreement is one thing. Whether or not it is enforceable is another.

In all circumstances, says lawyer Peter Townsend, there is aprima faciecase that restraints of trade are unenforceable. Courts simply don’t like them.

“However,” says Townsend, “the courts will enforce them under strict conditions and they must be complied with. But if the court regards the restraint to be excessive to the smallest extent, it will strike it out.”

For this reason, says Townsend, restraint of trade agreements need to be very carefully worded.

“… the wording may say either one party cannot approach, solicit or act for clients. If they agree not to approach or solicit, they can still act for the client if the client approaches them. However, if they sign a contract saying they will not act for the clients — then they cannot act for the client under any circumstances — not even if the client wants them to.”

The restraint of trade agreement must be reasonable, Townsend says, or it will be thrown out of court.

“Our obligation is to ensure restraints are not unreasonable,” he says.

“That means that you have to draft them in accordance with a clear view in mind of what it is you are trying to protect.

Townsend says the questions that need to be asked are things like: ‘What have I paid for?’ and ‘How do I ensure it can be delivered?’

“If you have bought a client base and you’ve paid only two-times trails with respect to a client base, then the restraint only relates to those clients. But if you’ve paid for more than that — and the purchase price calculations include trails, an averaging out of upfronts; if they include some sort of valuation method, something that’s called ‘goodwill’, then the vendor wants more than just a figure for trails, he wants a goodwill figure.

“So the restraint of trade needs to be broader than just clients because you’re buying not only the client base but also the potential of the business to continue to trade and improve over time. So a restraint of trade might be related, for example, to a geographical area.”

Townsend says that once you’ve decided what it is you’re restraining then you have to decide how long the restraint is to remain in place.

“There is no right or wrong answer to that,” he says, “but it must be a reasonable period of time.”

The clever way to draft a restraint of trade clause, says Townsend, is to have what he calls “cascading time periods” that list different time restraints such as three, two or one year periods.

“That kind of clause, together with a couple of additional things, gives courts alternative periods if they believe the one in place is too long.”

If a vendor breaks a reasonable and enforceable restraint of trade agreement, the court, says Townsend, “would take a very dim view as that is a clear breach of his obligations”.

The catch is that the courts don’t have the power to force people to use particular financial planners — they can, however, do several other things.

“The aggrieved party can get an injunction to prevent a planner from acting as a financial planner for Mr & Mrs X,” Townsend says.

“But the courts could still say that Mr & Mrs X have the right to choose. On that basis the courts would be likely to award damages to the purchaser that would include handing back of monies, which might include damages relating to set-up costs, and not making revenue. If the revenue was down to a level that it wasn’t worth buying, then the vendor might be looking at having to refund the complete purchase price of the business.”

In a worse case scenario, the court might also award exemplary damages — to make an example of the vendor to others for behaviour that it views as inappropriate.

“If a financial planner sold a business and promised to give a restraint and then went about stealing clients — most barristers would certainly have a crack at exemplary damages,” Townsend says.