Conflicts Of Interest In M&A Consulting Are Normal, But Advisors Must Understand The Process, Ask The Right Questions And Watch For Red Flags
As the strong current of financial advisors selling their practices continues, advisors need to understand the conflicts of interest that investment bankers or M&A consultants may have. While conflicts of interest are unavoidable, any person or firm giving M&A advice should be thoroughly transparent about any and all potential conflicts of interest.
Conflicts Of Interest In Compensation
Compensation is one of the most obvious potential conflicts of interest, since it creates a conflict that advisors are familiar with in the context of the relationship between advisor and client. The M&A consultant or investment banker could be compensated on an ongoing retainer basis, meaning that they don’t need to conclude a sale to be compensated, or they could receive compensation based on achieving certain results. Hybrid combinations of both compensation structures also exist.
The advisor must consider the potential drawbacks to these compensation structures, because each one creates certain incentive structures that drive behavior in a different way. A retainer-based consultant may not work as hard to close a deal in a timely manner, but a sales-based structure may incentivize the consultant to close deals too quickly.
A sales-based compensation structure also runs the risk that the consultant may repeatedly go to only a few buyers because they know they can get the deal closed, even if the seller would be better suited for a different buyer.
Probing For Conflicts Of Interest
An advisor must actively ask questions to discover the conflicts of interest the M&A consultant or investment banker has, including, as discussed above, the compensation structure, who is paying and how payouts are structured.
The advisor must also learn how the consultant sources potential buyers and how many potential buyers may exist. A good rule of thumb to estimate the total universe of a particular consultant’s potential buyers is the number of buyers the consultant has worked with in the past three years. The consultant should also provide an estimate of how many buyers are expected to inquire about the advisor’s business.
Next, an advisor should understand whether the consultant is using external contractors or has sufficient in-house resources to provide all services. In a related matter, the consultant should provide a robust set of information about data protection and privacy, including external contractors, how it is protected, who can access the advisor’s data and which parts are accessible. The advisor must understand the data protection policy not only during, but long after any sale closes.
While there is nothing wrong in asking the consultant for references, confidentiality concerns restrain many consultants from giving information about most prior clients, so if references are difficult to provide, don’t consider it a red flag.
The Most Significant Transaction Of Your Life
At the end of the day, conflicts of interest are unavoidable. The seller’s most important task is finding an investment banker or M&A consultant who will share information on conflicts with full transparency and welcome questions. If, on the contrary, the consultant shows signs of impatience or evasiveness when you ask due diligence questions, that is a red flag.
The consultant needs to provide a clear and detailed explanation of the M&A process from start to finish, and in particular the communications with the seller during that process. The advisor must take the time and spend the resources required to understand all information provided, especially the engagement agreement and other legal documentation.
Your business is likely your largest asset and its sale is the most significant transaction of your life – and there are no do-overs. Make sure your consultant consistently advises on transactions with other businesses that look like yours, specializes in the wealth management industry, including a clear understanding of its regulatory landscape, and can help you cast a wide net to find a diverse sets of buyers in order to determine the best fit for you, your staff and – most importantly – your clients.
Scott Leak is Director of Business Development and Senior Consultant at M&A consultancy FP Transitions.