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Plan now: Don’t let your books and records stall the sale of your RIA

RFP
The investment management industry is consolidating. The additional requirements created by legislation like the Dodd-Frank Wall Street Reform and Consumer Protection Act have increased costs, making it a smart move for asset managers to acquire other asset managers to achieve economies of scale. Other factors like aging management have also made it attractive for some asset managers to consider selling. To prepare for a potential sale, it makes sense to get your financial books and records in deal-ready shape.



A December 2015 Wall Street Journal article1 reported on the uptick in asset manager consolidation, describing recent deals that included Affiliated Managers Group buying a minority stake in Systematica, KKR buying a 24.9% stake in Marshall Wace LLP and Julius Baer upping its stake in Kairos Investment Management from 19.9% to 80%. In addition, Blackstone Group, Goldman Sachs and Credit Suisse have raised money and/or staffed up for future asset management acquisitions. According to the article, “The aim is to profit from the success of funds that are meant to be able to make money in all market conditions.”

There are important advantages to moving forward with your preparation for a potential deal. Being ready means there will be minimal delays or renegotiations, key employees will feel secure about keeping their jobs and customers can be prepared for the transition. By taking action now, the firm can keep running smoothly and profitably throughout a sale or even a public offering. Revising years of books and records can take considerable effort, however, and will require the help of experts.

… it makes sense to get your financial books and records in deal-ready shape. Are your books and records deal-ready?
In any transaction, the potential acquirer will require audited financial statements in accordance with U.S.
GAAP. Many investment managers report their management companies and general partner entities using the tax basis of accounting, however, since their focus has traditionally been on income tax reporting requirements.

To be ready for a transaction, you must first convert these records to the accrual basis of accounting to
be U.S. GAAP-compliant. This can be a highly complex and time-consuming process, especially when considering the conversion of the historical data required to generate accurate opening balances. Often
these entities will lack specialized staff experienced in the conversion complexities and require supplemental
accounting resources.

CASE STUDY
$15 billion asset manager prepares for sale

THE CHALLENGE
This major asset manager decided to sell the firm in Externally, they realized the M&A landscape in the industry was changing, and the firm might be more attractive as an acquisition target for a large asset management firm looking to diversify their offerings as an acquirer or limited partner. Internally, the firm’s leadership was aging and increased regulations were making the firm less profitable. They quickly attracted a buyer, who asked for three years of audited financial statements as a requirement for the sale.

WHAT THE TEAM DID
The Grant Thornton LLP team worked with the seller to convert three years of financial statements from tax basis to accrual basis. It actually took four years of statements because the opening balance needed to be determined for the first year. In addition, we worked with the client to develop 20 years of historical financial statements in order to strengthen their valuation. The complex process needed to cover a wide range of areas that included audit, tax provision, compensation, advisory and much more. Our Accounting Advisory Group provided loaned staff for the extensive conversion process.

OUTCOMES
The successful audit was streamlined through the work of the Grant Thornton team and completed with minimal comments from the external auditors. Our team helped the firm build the tools to use going forward. The CFO stated that “we should have been preparing for this over
the past 10 years — we appreciated the specialized help from Grant Thornton.”
Updating the books
Using the tax basis creates several issues, which must be corrected to prepare for a transaction:

  • Even if the books have been prepared using the accrual tax basis, they often lack required U.S. GAAP accruals.
  • Investments in related funds are likely not maintained in line with underlying fund financials.
  •  Fixed assets or deferred compensation are generally not tracked and recorded appropriately.
  • Footnotes and related disclosures need to be created in compliance with U.S. GAAP.

Adding to the challenge is the fact that many managers may lack the resources to compile all the financial data for the underlying funds (e.g., reconciling fund data to the management company and/or general partner records, converting noncoterminous year-ends to calendar year-end data, and determining financial information of managed accounts), especially when the bulk of this responsibility has been outsourced to a third-party fund administrator.

As part of this process, certain analyses may also be required. These include capitalizing vs. expensing costs, comparing the differences between accounting standards (i.e., U.S. GAAP vs. International Financial Reporting Standards [IFRS]) and a consolidation analysis in accordance with Accounting Standards  Codification (ASC) 810, Consolidation, to determine which underlying funds are required to be consolidated in the group financials and for what period.

Challenges in converting to the accrual basis
General challenges include:

  • Lack of accounting staff
  • Determination of accruals
  • Reconstruction of the books of cash basis entities that are not regularly maintained
  • An extensive amount of detailed work to compile financial data
  • The potential need for detailed quarterly reporting
  • Determination of eliminations of intercompany activity
  • Compilation of a high volume of supporting documents for external auditors and related ongoing audit support
  • Investment accounting-focused (ASC 946) experience that may not be sufficient

In addition, there may be complex technical challenges that are far beyond the experience level of internal staff, including:

  • Current and historical policies on revenue recognition and expense treatment (particularly for incentive/performance fees/allocations)
  • Business combinations and related valuations
  • Consolidation analysis
  • Asset capitalization analysis
  • Determination of the difference in accounting standards (i.e., U.S. GAAP vs. IFRS)
  • Decisions about whether to expense vs. capitalize
  • Tax provision preparation
  • Preparation of financial statements and required note disclosures

Complying with ASC 805
Another technical hurdle in tax to accrual conversions is the determination and recognition of a business combination. Any transactions that could be treated as the acquisition of a business in accordance with ASC 805, Business Combinations, will require an analysis and create additional accounting requirements that potentially include the recording of intangible assets, goodwill and earnout liabilities. A valuation of these business combinations and earnout liabilities will be required for each transaction to determine the value of the business, which in many cases will involve the use of specialists. This will also trigger at least annual assessments of these components in order to comply with U.S. GAAP.

Reconciling and eliminating intercompany activity
Investment manager groups are often structured with many interconnected or consolidated entities that are managed as a group. This is common because of various legal and tax benefits, but introduces significant complexity in tracking and reconciling intercompany activities. This will be of particular importance when preparing for a sale to ensure that the balances accounted for are post all appropriate consolidation eliminations and, additionally, these legacy accounts have been cleaned up from a compliance and governance perspective. Examples of these include intercompany receivables/payables, management and incentive fees collected from underlying funds, expense reimbursements, general partner interest in funds, loans to employees and special purpose vehicles, and earnings.

Preparing U.S. GAAP-compliant financial statements
Investment managers often have not been routinely audited, so they have not built up a reporting capacity that includes U.S. GAAP adjustments to financial statements. Necessary components include cash flows and changes in equity, as well as various potentially complex disclosures. Unfortunately, many fund administrators or their third-party administrators are not set up to assist with these more complex tasks as part of their normal responsibilities. Additionally, potential buyers often require supplemental financial information to enhance the transparency of management company-specific and general partnerspecific data.

Adopting best practices: 10 tasks for an efficient accounting basis conversion

  1. Determine upfront the extent and limits of existing data and the capabilities of current systems and personnel. Use this to frame options for performing the conversion (within or outside the existing system).
  2. Determine if a current year or retrospective audit should be completed and for what period that may be needed and factor in the relevant timing — opening balances present particular difficulty.
  3. List entities where audits are performed to identify areas where work can be leveraged for the group audit (i.e., any underlying funds or other related-party entities).
  4. Complete a consolidation analysis (including any deconsolidations) in accordance with ASC 810 to determine which entities are consolidating into the group financials.
  5. Ensure all valuation considerations are addressed for identified business combinations at acquisition and annually as they relate to impairment analysis.
  6. Analyze first-quarter cash disbursements/receipts, as well as known data and company officials, to resolve cutoff issues related to conversion and help identify appropriate year-end accruals.
  7. Identify and analyze trial balance accounts that might not be tightly controlled or maintained, have a wide variety of unrelated transactions flowing through or have contra accounts.
  8. Compile capital asset and software additions data, if applicable, to determine whether costs were capitalized vs. expensed appropriately.
  9. Prepare a tax provision to identify temporary and permanent differences between tax and book to assist in recording tax expenses and payables, as well as deferred tax assets and liabilities.
  10. Establish a process to document accounting policies and maintain records and supporting files electronically in an organized manner every step of the way.

Conclusion
Investment advisers are opening their eyes to the advantages of M&A transactions as a viable exit or growth strategy. Those that are well-prepared can efficiently navigate the process. Ensuring the accounting records are up-to-date and compliant with U.S. GAAP is an important consideration to address in advance because the process can be complex and time-consuming. If not handled correctly, this can present obstacles to executing a favorable deal in a timely manner.

Investment managers should start preparing now. This should include designing a plan and performing various pretransaction accounting tasks. If you lack the resources and experience in-house or need supplemental assistance in key areas such as assessing technical guidance applicability or reviewing information gathered for potential hidden surprises, you may consider engaging an experienced public accounting firm.

Grant Thornton’s specialized Accounting Advisory Group has extensive experience in the asset management industry and the specific needs of investment advisers in preparing for a transaction. Our team understands the intricacies of the process, and we stand ready to serve as a resource for developing and implementing your succession plan.

Download the PDF.

Contacts
Michael Patanella
Audit Partner
U.S. Asset Management
Sector Leader
T +1 212 624 5258

Brian Rocco
Audit Partner
Partner-in-Charge, Accounting
Advisory Services
T +1 732 516 5547

Brad Pietras
Audit Senior Associate
Financial Services
T +1 212 624 5288





1 Fletcher, Laurence. “Hedge Funds Join the M&A Boom,” The Wall Street Journal, Dec. 7, 2015.