Expanding into Financial Services

By Brian Boyle

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Firms interested in expanding into financial services must consider all the potential options and expect to spend at least six to nine months planning before offering financial services. The biggest consideration and often the biggest hurdle for firms expanding into financial services is choosing a business model. Choices include building a financial services firm from scratch, acquiring an existing financial services firm, or joint-venturing with an existing financial services firm. Each model has advantages and disadvantages (see Exhibit 1).

Starting from scratch. Although this can be viable for larger companies, it is usually not the best option for small to mid-sized accounting firms. Starting from scratch is by far the most difficult and expensive approach. At least one partner will be consumed full-time in building the financial services side of the practice.

Firms should expect to spend at least $65,000 annually for things such as compliance, personnel, technology, and investment research (Exhibit 2). A business plan and realistic budget are essential.

Acquisition strategy. One of the most effective methods for getting into financial services quickly is to acquire an existing firm. An acquisition strategy may be more costly upfront but it can be attractive if the acquired entity’s existing cash flow can finance the cost over the term of the buyout.

The single most important consideration when acquiring another practice is its culture: How does it conduct business? Is it fee-based or transaction-oriented? What is its philosophy? The success of the acquisition depends on retaining acquired clients. If the culture of the targeted firm clashes with the acquirer’s culture, then the union cannot work.

Additional considerations when acquiring a practice are the different organizations’ brands, target markets, and client bases. For example, if the acquirer specializes in helping small business owners, it won’t want a financial services firm whose clients are predominantly teachers.

Once a good fit is found, financial matters can be considered. A practice that is mostly commission-based will generally command a lower valuation than a firm that is mostly fee-based. Generally, fee-based practices trade for approximately two times revenues, whereas commission-based practices trade for around 1 to 1.5 times revenues. The amount of expected client servicing can also affect the purchase price.

Financing can be accomplished in a number of ways, but “earn-outs,” which structure the acquisition so purchase payments are directly tied to client retention and future net revenues, generally work best.

Because acquiring a practice—and gaining potentially hundreds of clients overnight—is popular, patience is key. Finding the right practice at the right price may take years. The acquisition route should not exclude the pursuit of other strategies at the same time.

Joint venture. While building from scratch or acquiring an existing practice may make sense for companies with considerable time and resources, the model that has proved most successful for accounting firms involves developing strategic alliances with current financial services providers. Because this approach does not require committing thousands of dollars to personnel, compliance, and other start-up costs, a joint venture is generally the least expensive and most flexible option.

According to a study done by CEG Worldwide (cegworldwide.com), companies that use joint ventures as opposed to in-house services are substantially more profitable, regardless of size. Small companies offering services through joint ventures earned twice what small companies offering services in-house earned. For larger entities, the difference in earnings was 58%. Joint ventures produce very little overhead. Without the direct costs for personnel, technology, and research, nearly all of the revenues coming from financial services flow directly to the bottom line. The CEG study also found that, in addition to greater revenues through joint venturing, the services provided were much more expansive. If a client needs a particular solution or product, an accounting firm can simply find the right partner in that particular area. This is far more expensive for an in-house practice.

A typical joint venture entails a 50/50 split of revenues derived from financial services. Depending on the state of operations and the services the firm wants to provide, it may be required to obtain a securities and insurance license.

While a joint venture can help a firm expand into financial services quickly, a strategic partnership involves planning. Considerations are similar to an acquisition: How well do the potential partners’ philosophies match? Are the sizes of the practices comparable? Will the customer service be comparable? What is the experience of the strategic partner? What kind of marketing support is expected?

The best source of potential strategic partners is a company’s existing client base. Current clients can be asked for feedback about who provides their financial services and how satisfied they are with the relationship. With this information, the firm can contact potential partners to discuss a possible working relationship.

Getting Started

Once a CPA firm has decided to begin offering financial services to its accounting clients, the next level of planning begins. The following is a list of things to consider before deciding which model to adopt.

• Budget. Know how much can be spent.
• Services. Know what services, such as insurance and estate planning, are desired and whether they will be fee-based or commission-based.
• Target market. Identify the needs of current clients.
• Philosophy. Determine an investment management strategy—for example, index funds or active investment strategies.
• Involvement. Determine the level of involvement in clients’ financial matters.
• Marketing. Discuss how the firm wants to communicate its new services to its clients.
• Competition. Identify the firm’s competitors and the services and products that competitors currently provide.