Podcast: Business Financing 101 for Independent Financial Advisors and RIAs

Mike Langford:

Welcome to the Advisor Financing Forum, a weekly podcast presented by SkyView Partners. My name is Mike Langford, and as promised, Scott Wetzel, the CEO of SkyView, is with me again for a little business financing 101 session for independent financial advisors and RIAs. As Scott explained in last episode, commercial lending for financial advisory businesses is a relatively new phenomenon, and the team at SkyView Partners, along with their network of community banks, are charting new territory with their focus on serving the wealth management industry. In this episode, Scott and I dive in a little deeper on the ins and outs of the most common use cases for the commercial loans available through SkyView. We also take a little time to explain the differences between these commercial loans and SBA loans and seller financing for M&A transactions, and of course, Scott offers some guidance on how you can prepare to apply for funding through SkyView.

Before we get started, the protests that I mentioned in the previous episode were still going on during the recording of this episode. You can hear the faint sound of sirens in the background at one point. It's an important reminder that there are some challenges facing our industry at the moment and there'll be others to come in the future for sure, but just as you are there for your clients regardless of what the world throws at them, so too is the team at SkyView Partners for you and your business. If you have questions for Scott or the team, or if you have some suggestions for topics or questions for the show, please feel free to reach out to podcasts@skyview.com or find us on your favorite social media platform. I'd be glad to hear from you. Please make sure you like and subscribe to the podcast. You can find it on Apple Podcasts, Spotify, Google Podcasts, Stitcher. That way you can make sure you never miss an episode. Okay. Without further ado, let's jump into financing 101 with Scott Wetzel.

Hey, Scott. Welcome back, sir. It's great to have you again. Last episode you and I introduce the world to SkyView and it was a really vibrant conversation. We covered a lot of ground from the founding of the firm and to how the firm is structured and delivering lending solutions to advisors, but in this episode, I thought we might want to go a step removed even from SkyView in general and talk more about financing 101. Now many advisors, at least in my experience, are unaware that they actually can borrow money through a commercial lending process for their advisory business. So maybe we start there. What's the history for this wealth management space and conventional financing? How did we get here and what was there before?

Scott:

Well we've got very limited history of banks and conventional lenders extending credit to independent and registered investment advisors because of what we've run into quite frequently over the last three years as we've presented more bank board of directors than I care to count and been thrown out of 90 plus percent of them, even though I think we've really substantiated what we're doing ... and that percentage is going down. That's good news, but banks weren't interested in funding these practices because bankers to this day still prefer businesses that have tangible assets, and as we've explained to the banking community, that the wealth management practices have a tremendous amount of value and there's a significant number of buyers for every seller, and we felt very comfortable with the asset itself. It's not tangible, and at the end of the day, we'd walk into a meeting and our gauge of how things went is they were looking for silos or tractors, and if we can convince [inaudible 00:04:02] to just build a silo and have a tractor, we would have had financing a long time ago, because then banks have something to repossess, right? They like that tangible collateral, and clearly with a wealth management practice has tremendous enterprise value, but no need for fixed assets, which is a great thing.

Mike Langford:

Yeah, it is interesting to think about that, that when you look at an advisory business, almost all of them now are fee-based and they have such a high amount of recurring revenue with very low volatility in that recurring revenue, unless they're doing something dramatically wrong. If they've been running that business for 10, 20 years, you can see the stability in that business. So to me, it would be an attractive business to lend to.

Scott:

Well, for everyone within the wealth management industry, it makes a ton of sense, because we all understand the changes that have occurred in the department of labor, as an uncomfortable of a time period as that was, and really and forcing the hand of many advisors to do a more fee-based occurring revenue stream, it did provide for a recurring revenue that is easier to underwrite and actually able to underwrite, versus the transactional nature of the advisors, let's say in the '80s, that ... I think many bankers felt like most advisors were still doing their business like someone on the Wolf of Wall Street or something, either fabulous or horrible, depending on fear or greed in the marketplace, but weren't aware of the changes that have occurred in the industry. So prior to 2013, the only funding mechanism was a seller finance note, and you think about seller financing, it's really analogous to going up to someone's house that's for sale saying, "Yes, I'm very interested in purchasing your home, and you're going to take a contract for deed and I'll pay you back over time."

And of course we wouldn't be surprised if that seller had no interest in selling us their home. That's just not a great proposition, but historically independent advisors just hadn't sold because they had to hold the note for the transaction and hold all the risk. In 2013, Live Oak bank was the first bank in the country to start an SBA program funding advisory practices and established enterprise value from an underwriting standpoint, and because of that and their success with that SBA portfolio and the seasoning of the loans in that SBA portfolio, today we've seen the more recent evolution and that's the banks offering conventional commercial credit. So in essence, providing or extending credit without the security of the SBA guarantee that is provided with an SBA [inaudible 00:06:46], and for the borrower and seller, it just provides a lot more flexibility and better pricing across the board. The best worst analogy I can provide is like providing to your investors a fixed annuity in the SBA or managed money in conventional. If you can qualify for conventional or managed money, you certainly want that approach. The SBA is for a very specific borrower that the wealth management community is certainly not in today.

Mike Langford:

Pardon my ignorance, I guess what is the major difference between an SBA loan and a conventional loan?

Scott:

The primary differences I'd say is rigid eligibility requirements for an SBA obligation. Most notably, that the seller of a business needs to depart that business within 12 months, no questions asked, has to be completely out of the picture, which with conventional financing ... and they have to sell a hundred percent. With conventional, our advisors can sell 25%, 50%, a hundred percent, whatever number they would like, and they can stay on for whatever period they would like. So it really allows the more tenured advisors with that flexibility in the retirement that they deserve so it's not either it's a check today and you're gone tomorrow or seller finance, but instead it's, "Hey, you tell us how you would like to retire and you tell us on what blind path and when you'd like to receive [inaudible 00:08:22]," and we can match that up with the underwriting and the appropriate bank to fund the desires of that tenured advisor.

Mike Langford:

You just mentioned in that description partial sales, which is really interesting to me, given that I had not thought much about that as it relates to advisory businesses. I never thought that an advisor may want to sell 20% of his business or an RAA firm may want to sell 30% of their business. Talk to me a little bit about that partial sale process and how common it is, I guess, in the industry now and maybe going forward.

Scott:

So in 2018, our first full calendar year, we had only about 18% of our transactions were partial sales, and there's been a lot of education that out in the marketplace that it had to be a complete sale, which is not the case with conventional, and 2019, that went to 65% partial sales, because we find many advisors have built this practice and built the legacy that they would like to continue to work part time, half time, full time after they've received the liquidity event, and a transaction I can think of that really was pleasing to the junior advisors and senior advisors and the bank, those advisors selling 49% of his practice for $3.4 million to his two junior advisors in the office, the advisor at 60 years young wanting to continue working and that was a 2018 transaction.

I actually just spoke with him recently and he said he's working harder than ever and feels like he certainly has his junior partners working harder than ever as well towards the same goal, and he's got fresh liquidity to do so. And really, junior advisors ... what I've seen for the last 20 plus years with junior advisors, unless you are the son, daughter, or son-in-law or daughter-in-law of that senior advisor, you never really knew, you never really had that contract that the senior advisor was going to sell to you at the end of the day, and we've all seen examples of where they didn't and they went a different direction when the retirement came. The partial sale allows that junior advisor to at least have a piece of the equity, of the practice, and really being a first position to acquire that remainder of the practice when the senior advisor does decide on a complete sale at plan of retirement.

Mike Langford:

I think the other little benefit there, and you kind of hinted at it, was that senior advisor gets to take a good chunk of money off the table, enjoy it while he or she is still young and in an active with the business. So they get to take that liquidity and do what they will with it, and then as you mentioned, the junior advisors get to continue to grow with the business, knowing that they've locked in their stake and they have the opportunity maybe in the future to acquire the remainder of the business.

Scott:

Well, and it's something that we've done a lot of education on. It's really simple. It's eat your own cooking, because what a financial advisor has been advising their clients since they began their career, well, it's diversify away from concentrated positions, especially company stock.

Mike Langford:

Yeah.

Scott:

Whereas financial advisors, until very recently, did not have the ability to diversify their net worth away from company stock, and we find that most independent registered advisors have 80 plus percent of their net worth tied up in their practice and it's a very liquid option, where with conventional financing now it finally provides a liquidity mechanism for them to diversify their net worth in a similar fashion that they've been advising their retail clients for the past 20 plus years.

Mike Langford:

So smart. It's so smart. I mean that's a challenge for many private business owners, that they have this big asset, all their wealth is tied up in that private business, and at some point in time, in order to experience that wealth, and frankly protect it, you are going to want to take some money out in the form of liquidity and diversify. Let's talk about some other reasons why people may ... or use of funds, if you want to call it, that people may have for working with SkyView. So what are the other reasons for seeking capital?

Scott:

Our primary transactions, our M&A transactions for advisors, we also do a fair amount of refinance or debt restructuring work. Core advisors that have existing seller notes that are not at favorable terms, rates, or conditions, we can refinance those, or notes with their broker dealer that are oftentimes not as competitive as our bank partners can provide, or they have existing SBA loans outstanding, and we have refinanced a substantial amount of SBA loans since firm inception. I believe it's a 60 plus million dollars in SBA loans, where advisors seek a better rate and a better term, better conditions.

Mike Langford:

Going back to the M&A activity, what are some of the advantages of using bank financing for that process, for, I guess, both the buyer and the seller?

Scott:

So for the seller, it's the obvious that liquidity flow, and really releasing that risk of holding a seller note, and really the risk is on the buyer to complete the transaction and move the clients over. Oftentimes we are structuring transactions with an escrow account, 20 to 33%, let's say, that 70% of the purchase price is paid upfront to the seller, but then another 30% held back to hit some additional hurdles post-transaction that keeps buyer and seller on the same page post-transaction to ensure that those assets and those clients are moved out, and then for the buyer, I would just caution that going out and trying to acquire practices utilizing the sellers of balance sheet to finance it is ill-advised. You're not going to buy anything, because sellers clearly historically have not had an interest in that structure and have only done so 2% of the time.

So at the end of the day, you're just not going to be successful in an M&A acquisition strategy, trying to go out and pitching seller notes for the sellers to take all the risks. As the buyer, you are acquiring a practice. You're required to take some risk in doing so, and the bank would argue they're doing it right alongside you in a very calculated and methodical manner as you approach sellers, but it allows you to get the deal done, and then also most seller financing is only over a four to five year time horizon, where we amortize all loans over a 10 year period. So our buyers have appreciated the fact that when they're using seller financing, they're oftentimes in the red the first couple of years and they're doing a bunch of extra work, and granted the pain is over in four years, but extending it over 10 allows them to be in the black in the first month or a year when they're doing all this incremental work and they're actually appreciating some incremental net income at the end of the day.

Mike Langford:

Yeah, and that makes a lot of sense. You get to roll into the process and say, "All right, I'm ready to buy. I have bank financing lined up. We don't have to negotiate the terms of the earn-out as aggressively as you normally would," and the seller, as you mentioned, if they're looking to sell, they're looking to get out, they're looking for an exit. They don't want to have to feel like they have to hang on and be overly involved in the business, kind of watching you over your shoulder to make sure they get paid for years to come, I would imagine.

Scott:

Well, and that can be a source of some contention amongst buyer and seller over the course of years, that you do have the seller that wants to ensure that they get that note paid, and maybe placing a heavier hand on the practice than necessary for the seller note, and we've seen those relationships not work out as favorably as when we can really structure with bank financing and have that partial buyer sale, where really the seller is not at risk for the note or repayment of the loan.

Mike Langford:

Talk to me a little ... you mentioned a 10 year term. What are some of the other common deal structure components that you're seeing right now?

Scott:

So we have a uniform seven year term and tenure amortization schedule, and we made that uniform for a couple of reasons. Number one, our bank partners, as we went out to the banking community, were not interested in extending beyond a five year time horizon, and the advisory community, you can get a 10 year amortization schedule. I promise I'm not being arrested today. We have a peaceful protest out front, and it's not protesting advisor financing, but we really found a happy medium with banks and with the advisory community, and that's on a seven year term and ten year am.

Mike Langford:

Makes sense, makes sense. So in wrapping things up here, Scott, I assume many advisors are hearing this and saying, "Yeah, I want to explore financing for a partial sale, for an M&A, restructuring debt, maybe take some cash off the table for myself." What's the process for preparing for bank financing through SkyView?

Scott:

We first and foremost always recommend that our advisors, even if they don't have an M&A transaction that is imminent or in the near future, that they reach out to our banking consulting team for our team to help understand better their M&A goals and initiatives, and make an introduction to one of our banks long in advance of a prospective transaction. Bankers are like anybody else, they like doing business with people they know and like, and our advisors are ... in fact, the advisors are usually pretty likable folks. So we found that making that introduction early on so the bank understands your business and what you do and gets a little bit better familiarity with your firm has been very conducive to making the underwriting and funding and financing process more efficient when it comes time to actually fund a transaction.

Mike Langford:

It seems so obvious, have a relationship with a bank and a lender prior to needing money. That's just kind of really obvious. Well Scott, this has been really informative. I expect that many advisors and teams at wealth management firms that are considering capital for their M&A activity or for, as you mentioned, partial sales, or maybe even taking some liquidity out really appreciated this and will be in touch. So thank you, sir.

Scott:

I appreciate your time.

Mike Langford:

Thank you for joining Scott and me for this episode of the Advisor Financing Forum. It's our goal to continuously provide you in the greater community of independent financial advisors and RAAs with the information necessary for you to achieve your business goals. If you'd like to explore financing options for your business, please reach out to SkyView Partners by visiting the website at skyview.com. Click that get pre-approved button, or you can call (866) 567-6282 or shoot off an email to info@skyview.com and someone will get right back to you. Tune in for our next episode, as I'll be joined by Katie Bruner, managing partner at SkyView, for a lesson in how to prepare to buy another financial advisory business. It's going to be a great one. You're going to love it. Until next time, please stay safe and be nice to each other.