Defined benefit transfer. Three of the riskiest words in the financial services M&A lexicon. Or are they? Two or three years ago, we’d have said yes. But the sands have started to shift and financial advice businesses with DBT exposure in their books are – relatively speaking – becoming less toxic.

Why? It’s complicated…

What is DBT and why is it becoming less risky for buyers?

There’s no single reason why DBT exposure is being derisked by buyers, and it’s important to note that the trend seen by Gunner & Co. and Thistle Initiatives in our most recent market update could yet reverse. But we don’t think it will, and here’s why.

DBT exposure was brought to the fore following the British Steel Pension Scheme restructuring in 2017. The Financial Conduct Authority (FCA) found that employees had received non-compliant pension transfer advice and risked suffering financial loss as a result. Redress was apparently owed to over 1,000 consumers who had opted out of the British Steel defined benefit pension in favour of defined contribution schemes on the basis of poor advice.

At the time, it wasn’t known how much redress would be sought or how the FCA would calculate the numbers. It also wasn’t known how sharp the teeth in the regulatory jaw would be. Buyers were left with little option but to assume the worst, not just about BSPS, but also about any DBT on the books. Many simply put a freeze on buying financial advice businesses with DBT exposure. Those that didn’t intensified their due diligence regarding DBT and other ‘high risk product’ exposures.

More recently, the position has become more clear in terms of the risk position for buyers in respect of BSPS exposure. At the end of last year, the FCA published its final rules for the redress scheme, clarifying that it “expects the average redress payout in the scheme to be lower than originally estimated, at £45,000.” It also set up a calculator, reviewed by the Government Actuary’s Department, allowing firms to calculate their exposure in financial terms. That calculator, in conjunction with a prescribed remediation process where clients had to specifically ‘opt out’ of a review, has meant the vast majority of those who transferred out of the BSPS scheme pension will have had the option of an advice and redress review before the end of the year.

The BSPS situation is also reaching a closure point, with points of redress set to be finalised early in 2024. Anecdotally, there appears to be a generic softening of attitudes to DBT risk during the due diligence process. In 2020, we asked if DBT could be a fad based on a market panicked by uncertainty; it’s possible that we’re seeing the tide turning on some overcorrection.

Essentially, buyers have been calmed by more detailed analysis of DBT exposure and its potential risk. But that doesn’t mean sellers with DBT exposure are out of the woods. Far from it. DBT may be less toxic than it once was, but you need to manage your book to reassure a buyer taking the risk.

Five-point plan for selling a business with DBT exposure

When selling your financial advice business, DBT is still going to be very much at the top of a buyer’s due diligence checklist. The tolerance of this risk may have softened, but it is still a risk and a potential dealbreaker. In addition, the way DBT exposure is assessed by a buyer has changed. We know there are things you can do ahead of going to market that will make a difference to a buyer’s perception of your business value and sway their decision about how and whether to proceed.

To help you navigate this process, we’ve come up with a five-point plan for selling a business with DBT exposure.

1.  Know what DBT exposure is on your books

How well do you know your back book in terms of DBT exposure? Honestly? You might have a percentage figure, but you will need to take a more forensic approach as you plan your entry into the market. You will need to think about the story the paperwork tells and how that might be improved by updating it. Does the adviser’s version of events match that told on paper? If not, can additional detail be added to the file to better rationalise the advice given? In the FCA’s eyes, if it isn’t documented in the file, it never happened.

You will also need to make sure your DBT register and your complaints register match. If a buyer finds a single entry in the complaints register about DBT advice that isn’t also detailed in the DBT register. they will immediately become suspicious about what other surprises are lurking in your back book.

This is a question of simple administration to make sure the numbers stack up and you have details of what advice has been given – to whom, how, why and when.

2. Be honest about your DBT exposure

When advising clients about the due diligence process we always champion transparency and honesty – and this applies to DBT too. You may be tempted to fudge your exposure in the hope of making your financial advice business more appealing to buyers, but the reality is that in the (likely) event of a buyer finding you out during the due diligence it will sour the deal.

It’s better for a potential buyer to know exactly what’s on your books and to walk away before entering negotiations than to think they know and find out otherwise during the process. Potential liabilities are unlikely to go away – they need to be addressed. A flash report detailing the level and nature of your exposure is a helpful early indicator of management information relating to DBT.

3. Look at the DBT book from a buyer’s perspective

DBT risk assessment has evolved from a binary ‘yes/no’ to a more nuanced evaluation of the risk. You should be able to class your DBT exposure to simplify things for a buyer ahead of going into due diligence. That means being able to break down DBT exposure by date (pre 2015 advice is unlikely to scare the horses, for instance) and by client age (younger clients should have received advice that accounts for large scale life changes such as additional children, divorce, remarriage and property ownership changes). In addition, knowing the data round how many of those clients you advised to transfer are still your clients, in an ‘ongoing advice’ arrangement is reassuring for buyers to know.

Lately, there has been a shift from the suitability of the advice given to the makeup of the client book. We have already mentioned age, but what about ceding scheme and/or client concentration? If your book is made up of a heavily concentrated set or sets of clients – particularly ones that may be unionised or professionally affiliated – how does that affect the liability risk for the buyer? A claim in isolation is unlikely to cause a buyer to lose sleep, but the idea of contagion will be less appealing.

Understand how this applies to your specific situation through a confidential market overview call: Book here

4. Mitigate DBT exposure in advance of due diligence

If you know the complete picture a buyer will be looking for in your financial advice business, you should be able to prepare yourself for the inevitable slew of questions during due diligence. That’s a great start, but we recommend you get even further ahead – as a way of anticipating what will make buyers edgy and softening the impact from the outset.

This starts with conducting a post-advice review of your DBT clients. The review can be completed internally, but it will be much more reassuring if it is done by an independent external party, such as Thistle Initiatives. It should use the most recent version (June 2023 at the time of publication) of the FCA’s Defined Benefit Advice Assessment Tool (DBAAT) and a post-DBAAT interview with the adviser can be tagged on for additional context. It’s worth noting that should an external review form part of a buyer’s due diligence requirements, you will probably be asked to pay for it, so it makes sense to invest in advance and get the buyer’s goodwill thrown in for nothing.

Your files will also need to be updated to reflect post-advice assessment, and to ensure the client is explicitly aware of the objectives and aware of having their objectives monitored. It is also vital to make sure that clients are happy with their decision and abreast of their options. In a scenario where a client is nudged (or urged) to investigate the propriety of the advice given, the chances of them raising a complaint are vastly reduced if they feel happy with the advice they are currently receiving.

As much of this as possible needs to be expressed on paper, where it can be seen in black and white by a prospective buyer.

You should also have action plans in your documentation that demonstrate how your advice processes have evolved and improved, including ongoing work to address concerns about advice risk. Again, all of this can be provided at the start of the process to give the buyer a 360-degree view of your exposure and risk.

5. Insure your DBT risk with professional indemnity cover

While it may be possible to sell a financial advice business with DBT exposure without professional indemnity (PI) cover, it is inadvisable to try. Insurers who had previously avoided DBT risk are showing signs of coming back into the market. It is well worth trying again to see if you can indemnify your risk. In addition, undertaking the steps detailed above regarding the mitigation of your DBT exposure may provide further comfort to potential insurers.

Showing that you understand the risks on your books and have committed to derisking them not only provides comfort to a buyer, but also demonstrates that you understand the risks in your own business and have taken appropriate steps to indemnify the company in a worst-case scenario.

Check your current PI policy is watertight in this respect and have the details to hand as you enter the market.

Next steps for selling your business with DBT exposure

Your first port of call should be an external review of your DBT exposure. This should be conducted in line with FCA DBAAT standards and by a reputable company using a thorough, defendable process. Yes, it will cost money to have this done properly, but it will put you in better stead to sell your business with DBT exposure than a comparable firm that has not got ahead of the risk before going to market.

Read our 9-step guide to selling your financial advice business

Once you are comfortable with the findings, you can begin the process of cross-checking your paperwork, carrying out post-advice interviews, updating records and preparing for the inevitable DBT questions a buyer will ask.

Talk through the current market trends with Louise – book a meeting here.