The removal of all grandfathered revenue in 2020 has impacted some businesses far more than others. The fundamental mathematics underpinning profit for a practice say that unless revenue has increased profit must fall. If profit falls invariably, the value of the business must fall.
So at a practice level, the following has occurred:
- There has been a severe reduction in the profitability of clients at the lower end of the revenue range. Our work indicates that it is very difficult to be profitable with a client with a fee under $3,000 per annum. Clients much below this level generally detract from the value and have fallen to 1-2 times revenue, below $1,000 would be less than 1 times if they can be sold at all.
- Passive Grandfathered revenue has disappeared further affecting profit for some practices.
- The point of scale for any practice has materially increased. This means that the revenue point where a practice starts to get the benefits of scale has increased. Anecdotally this would be well above $1.5 million in revenue.
- The key acquirers in the market have a detailed understanding of their cost to serve and will price acquisitions accordingly often applying a nil or negative value to small unprofitable clients.
Given those changes, what action should you take?
In summary, the key issue is that a discerning acquirer market has become even more discerning. Perceived risk has an inverse relationship with value. So, the higher the risk, the lower the value. As a result, vendors need to focus on the following:
- Profitable client relationships that demonstrate a solid profit margin above the cost to serve
- Cleansing the client base of unprofitable clients
- Focusing on a “clear client value proposition” so that an acquirer can transfer the client easily
- Those purchasers who can execute a transaction and integrate the clients profitably
- Being able to demonstrate profit history and solid data to underpin their approach to the market.
The Royal Commission has resulted in reduced access to credit for all small businesses as the Banks rework their credit assessment and focus on cash flow and ability to repay. Small financial planning practices have been caught in these outcomes and as such access to credit for “bolt-on transactions” has reduced. Our experience has been that purchasers who are interested in small books have been unable to raise cash flow lending finance and have had to provide “bricks and mortar” security for the lending. This has further exacerbated the lack of demand for small books. Purchasers are looking for higher rewards from acquisitions and will “cherry-pick” the best ones.
In our next blog, we will look at the commonly asked question: “Are businesses selling on a multiple of recurring revenue or EBIT?”
Centurion Market Makers is a wealth management industry expert providing business broking services to owners of financial planning businesses, and specialist business advisory services to large practices and licensees. If you’re planning on selling your firm in 2021, we’d love you to call us at 1300 766 156 for a confidential discussion or continue browsing our website for more tips, tools, and info on the steps to take when buying or selling your financial planning firm.