How much is your advisory practice worth? Thousands of financial advisers — many of them solo practitioners — are asking themselves that question as they approach retirement. It's an emotional question, given the blood, sweat and tears that they have invested in their practices. And many advisers will be disappointed by the answers they get.
“Most potential sellers [of advisory practices] have no clue of reality,” said Mark Hurley, chief executive of Fiduciary Network LLC of Dallas, which takes minority stakes in advisory firms. “They hear what they want to hear, and hold on to the hope that some businessman will show up and write them a big check for their business.”
Mr. Hurley typically works on a dozen potential deals at any time, and as a professional investor, he has a blunt view of the situation. Of the roughly 19,000 advisory firms in the country, fewer than 1,000 are big enough and have the sustainable business models in which he is interested.
“Most advisory practices are barber shops,” Mr. Hurley said. “They are jobs for the advisers who run them. They're not businesses.”
GO BEYOND
If advisers want to sell their practices to an outside party or to associates within the firm, they have to plan for the continuity of the business beyond themselves.
A first step in that direction is getting a formal valuation of the practice. According to a recent succession planning study by IN Adviser Solutions, a division of InvestmentNews, 45% of those firms that have executed or are ready to execute a succession plan have retained a third party to value their practice.
Nearly half of those “succession-ready” firms have used two or more valuation methods in their efforts.
Formal valuations can cost thousands of dollars, so it's not surprising that advisers tend to wait until they are ready to leave before they fork out money for an analysis. Brad Bueerman, a partner at consulting firm FP Transitions of Portland, Ore., however, sees growing demand for his firm's valuation services.
“We started out in support of succession planning, and that need is still there, but there's a new group of customers who want to establish a value for their practice in order to grow it over time,” said Mr. Bueerman, who charges $1,000 for a firm valuation. He has close to 1,500 clients. “They use an annual valuation as a tracking tool. Advisers understand that their own retirement can depend on growing the value of the asset.”
While mergers-and-acquisitions advisers and investment bankers are a more expensive option, they can offer more information on sales of other practices in the market and dive deeper into client demographics, employee resources and quantitative analytics, said David Selig, president of Advice Dynamics Partners LLC of Mill Valley, Calif., a mergers-and-acquisitions adviser focused on wealth management firms. “It's important to know what the market is likely to pay for your business before you start dealing with potential buyers,” Mr. Selig said.
A typical valuation by Mr. Selig's firm costs $7,000 to $10,000, although more-complex situations can run to more than $20,000.
There are essentially three ways to value a business: look at the book value of the assets, the prices that comparable firms are being sold for in the market or discount the cash flows generated by the business.
Asset-based approaches don't work in the financial advisory industry, because firms have few hard assets, with the value of the business largely tied to the adviser's skills and relationships with clients. The IN study found that 44% of the respondents who had gotten a third-party valuation of their firm used data on sales of comparable firms in their analyses.
APPLYING MULTIPLES
The most common method of valuation employed by respondents in the study was applying a multiple to recurring revenue; 68% of respondents used that method. Mr. Bueerman said that among the more than 3,500 valuations that FP Transitions has performed, valuations have ranged broadly between 1.8 and 3.5 times revenue, with the bulk of firms falling between 2.1 and 2.7 times revenue.
Revenue multiples, however, are a fairly crude valuation tool. A multiple of earnings before interest, taxes, depreciation and amortization, and/or discounted cash flow analysis, can provide a deeper picture of a firm's value and profit potential.
Thirty-three percent of the IN study respondents used EBITDA multiples in their valuations, and 38% employed DCF analysis. Mr. Selig uses several methods when doing valuations for clients.
Whatever method is used, each advisory firm is unique, and the characteristics that make them so are the biggest determinants of their value. How loyal are your clients? Are they spending more assets than they're accumulating now? Does the firm have the people and resources to generate new business and retain important clients? These are the factors that determine the risks of an advisory business, and the multiples and discount rates that apply in a meaningful valuation of it.
What's more, no valuation can be divorced from context. The discount rate for a sale of shares to a junior partner, for example, has to be greater than for an outsider looking to buy the whole firm. A firm with low profit margins could be far more valuable to another advisory firm that can roll it into its business, than to a buyer from outside the industry.
The valuation of a firm is only a starting point, said Kim Dellarocca, director of practice management at Pershing LLC.
“When clients ask us about valuation of their firms, we don't immediately suggest numbers,” she said. “We try to reframe the issue around growth planning.”
A Pershing study found that it takes about 11 years before bench players at an average advisory practice are ready to assume leadership responsibilities. If an adviser waits too long before dealing with continuity and succession issues, he or she risks hurting the value of the firm to both insiders and outsiders.
“If clients and associates aren't sure about the future, it sets the adviser up for a lot of risk. You want options, and growth planning maximizes your options,” Ms. Dellarocca said. “The potential check will be a lot bigger if you've done all the things that make the business valuable.”
aosterland@investmentnews.com Twitter: @aoreport
