Acquiring A Wealth Management Firm? Use This Due Diligence Checklist

Successful financial services practice mergers or acquisitions require a great deal of behind-the-scenes preparations, with due diligence on both sides of the transaction being of utmost importance. Whether you're considering buying an existing practice or selling yours, you'll need to perform due diligence. The process can be overwhelming, making it smart to start with a due diligence checklist.

Use the due diligence checklist below to ensure that nothing is overlooked. This due diligence checklist is meant to prompt you along the way, covering the more common steps you'll need to perform throughout the transaction. It is by no means an exhaustive checklist, but rather a starting point. Since each transaction has its own unique circumstances, feel free to modify the checklist to best meet your needs, as well as add any relevant steps that would be beneficial.

Who Should Perform Due Diligence?

Both parties involved in a business transaction owe it to themselves to perform due diligence on the other party and even on their own company.

As the buyer of a financial services practice, you want to make sure you're making a smart investment.
As the seller of a financial services practice, you want to make sure your practice is positioned to command top dollar and that all potential liabilities are uncovered and corrected. Performing due diligence is also about qualifying the buyer to ensure a good fit for your practice -- especially if you're concerned about long-term sustainability and the future of your financial advisors and staff.

Regardless of which side of the transaction you are on, it's wise to get your attorney or CPA involved in the due diligence process. In fact, that's one of the first steps of our checklist.

Building a Due Diligence Team

Due diligence isn't something you need to do on your own. We suggest building a team consisting of the following members:

Your business partners
Legal counsel
Your accountant
Industry and regulatory experts/consultants

Preparing for and Making Data Requests

You and the other party will be sharing extremely sensitive information with each other, making non-disclosure agreements and document security top concerns.

Obtain non-disclosure agreements from each individual who will be receiving information from you.
Insist upon using secure channels to exchange sensitive documents. This could include signing up for a M&A data room, using a physical data room, or using encrypted email.
Create a list of documents you need to request. Commonly requested documents include: corporate records (such as articles of incorporation, bylaws, current board minutes, stockholder information, and equity interest agreements), financials (such as balance sheets, income statements, and annual reports), insurance coverages, litigation history, regulatory information, intellectual property, and contracts and leases.
Create a list of, and start gathering, documents you expect to share with the other party.

Business: Initial Review

Now it's time to analyze the viability of the business itself. Identify the following:

Client information -- This includes the number of clients, where clients live, length of relationship, and how the client was originally acquired.
Revenue -- List of revenue sources, types, values, and broker-dealer override. For investment advisors, what is the typical annual fee and broker dealer override? Are these fees charged in advance or arrears?
Gross income -- Does the reported gross income include non-recurring income such as bonuses or awards that won't be available after the transaction closes?
Business structure -- Is the financial services practice a corporation, LLC, or sole proprietor?
Business ownership and authority -- Who are the partners or owners? What percentage is their interest? Identify the decision maker/contract signer for the transaction.
Business documentation -- Review all business documentation (and amendments to) such as articles of incorporation, bylaws, partnership agreements, operations agreements, and similar documents as well as any shareholder, board of director, member, or committee related documents such as consents and resolutions.
Business and marketing plans -- Obtain and review the firm's business and marketing plans including sales collateral. Identify market niches and opportunities.
Employee list -- Obtain an employee/financial advisor list.
Policy reviews -- Review all policy and compliance manuals.
Listing review -- If you're the seller, review the accuracy of your listing form to make sure that it is accurate and current. Note any changes since the original listing date and include an explanation as to why the changes have been made.
Transition plan -- Define your client transition assistance/seller support requirements, typically from three to six months.

Note: Truelytics is a tool both parties should consider using to collect the above information and to help establish a fair valuation.

Client Base: Transferability

What about the business's most important asset, its client base? Are there any potential issues concerning transferability?

How portable is client information if a transfer between broker-dealers will take place?
Create (if you're the seller) or obtain (if you're the buyer) a detailed description of the client base including demographic and cultural characteristics and any potential family wealth and wealth transfer issues.

Accounting: Financial Information and Taxes

Now let's check to be sure the firm's financials and taxes are in order. You'll want to gather (if you're the seller) or obtain (if you're the buyer) copies of the following dating back at least three years (as well as year-to-date interim statements):

Federal, state, and local tax returns.
Credit report. In addition to checking the buyer's creditworthiness, sellers may want to check their own credit, too. This allows you to see what the seller sees and address any issues that may arise.
Audit/tax claim documentation regarding threatened or pending audits or tax claims.
UCC filings or tax liens.
Formal valuations (if available) of the financial services practice.
Written evidence of the buyer's ability to purchase the practice. Note: this burden is the seller's alone.

Legal: Contracts and Agreements

Next, review all applicable contracts and agreements the firm has entered into. This includes:

Real property leases.
Personal property leases such as for office equipment, voice and data systems, T1 lines, and so forth.
Partnership and joint venture agreements.
Marketing agreements.
Insurance policies.
Vendor agreements.
Agreements with directors, officers, shareholders, and any affiliates.
Restrictive agreements such as non-compete and non-disclosure agreements.
Operating agreements or bylaws for companies where the seller, or the seller's family, holds an interest.

Licensing and Regulatory Compliance

Now it's time to examine the other party's licensing and compliance status. Depending on what you discover, you may need to investigate further to determine whether it makes sense to proceed with the transaction.

Obtain and review the following:

Securities and business licenses and permits.
FINRA status -- Form U-4, and if applicable Form ADV, for principals and employees. Review proof of filing and view disciplinary actions via FINRA.org.
Peer review and regulatory audit documents and dates. Examine how any deficiencies were resolved.
Complaint or dispute-related documents.
Regulatory reports and filings as applicable.
Descriptions of all current, pending, or threatened litigation, inquiries, investigations, or administrative proceedings involving the other party or its subsidiaries.

Operational Assets and Personal Property

The practice's operational assets and personal property included in the deal will need to be evaluated.

Asset management -- You'll need an inventory of all office equipment and personal property that will be included in the transaction. This includes copies of receipts, warranties, and instructions.
Recurring costs - Examine maintenance records and service agreements to determine ongoing costs to maintain the firm's assets.
Check each personal property asset for any UCC filings to determine if any creditors have an interest in it.

Cybersecurity Risk Assessment

As a buyer, the other party's information technology goes beyond hardware and software; you'll also want to evaluate the system's security and potential vulnerabilities. If the firm's security needs an upgrade, it could be at a higher-than-expected risk for hacking or a security breach. In addition, you'll want to determine if the two merging companies' systems are compatible.

As part of the cybersecurity risk assessment, work with an IT security consultant to evaluate the following:

Physical and virtual security systems in place across the entire infrastructure.
Privacy and data security policies covering all platforms including desktop, cloud, web, and mobile systems and devices.
Social media policies.
Third party vendor contracts and service agreements and related documents concerning their stance on cybersecurity.
Information about all known security breaches.
Audit and compliance records.
Business continuity plans and systems.
Identification, location, and protection of critical, protected, and/or sensitive information.
Data retention and lifecycle management plans.
IT management and oversight.
Employee security awareness and training.

Human Resources and Employment Information

Now it's time to do due diligence on the practice's human resources. You'll need the following:

A count of all employees with aggregate data such as licenses held, job roles, average salaries, benefits, bonuses, and job sites.
Employment agreements.
Labor / collective bargaining agreements.
Bonus agreements.
Stock ownership / profit sharing plans.
Employee policy manuals.
Non-solicitation / non-compete agreements for all employees.
Current, pending, or threatened employee-related litigation or administrative issues

General Terms of the Transaction

Finally, assuming everything else is in order, you'll want to review the general terms of the transaction such as the following:

Down payment.
Financing terms.
Collateral.
Promissory note or earn-out terms.
Non-solicitation / non-compete agreements.
Referral compensation agreements for any referrals made after closing the deal.
Life and disability insurance.
Licensing continuity.
Market volatility stipulations.
Transition expectations including duration, responsibilities, and scope.
Dispute resolution.
Closing date.

The Due Diligence Report

Finally, after the team conducts its due diligence, a process that could take several months, you'll need to create a final due diligence report detailing the team's findings. This report will summarize all of the potential issues found and highlight the positives uncovered.

In general, the due diligence report will come to one of three possible conclusions:

The deal is sound and should move forward.
The deal has solvable issues that will need to be addressed if it is to move forward.
There is at least one deal-breaker that suggests the deal should be abandoned completely.

Whether you're buying a financial services practice or selling one, it pays to perform due diligence on both your own firm and the other party's. Examining your own organization early in the timeline allows you to remedy any potential issues before they interfere or devalue your firm's worth.

By performing due diligence on the other party, you will gain deep insights into the other party's business structure, business health, management team, employees, practices, revenues and revenue sources, client base, opportunities, risks, assets, liabilities, and more. These insights are necessary to make a well-informed decision so that you can either continue on or scrap the deal based on real information and not emotion. Either way, using this due diligence checklist will help you make a smart decision with confidence and put you in a much stronger bargaining position.