Are you a baby-boomer financial planning advisor thinking about succession planning?
Perhaps you want to acquire a financial planning practice as part of your growth strategy?
Or maybe you’re going through a corporate breakup and it’s time to take stock.
Whatever the reason, knowing the value of your firm, where you stand in the marketplace and what to expect from the valuation process is critical to a successful handover, purchase or sale.
When benchmarked against the average family home, a financial planning business is a very valuable asset. In fact, for most practice owners, it is their biggest investment. Yet most practice owners do not prepare well when it is time to sell this valuable asset.
Poor preparation, lack of knowledge and lack of experience in selling a business most often equates to poor results at the time of sale. You may know your business inside and out but this doesn’t mean you’re on top of the numbers in the way that you need to be.
Here’s why expert appraisals matter as well as some suggested steps to help you through the valuation and negotiation process.
Why Expert Valuation is Important
Valuation is often seen as an overly complex, technical or boring concept however, in my view, it is one of the most important financial concepts.
It may not be the sexiest tool in the finance terminology toolbox but the concrete numbers produced as a result of an expert valuation capture the reason you are in business in the first place: to create value for your customers.
An expert market appraisal considers all of the factors that a potential buyer would consider when reviewing an acquisition opportunity. It accounts for your firm’s past, present and future situation that, in turn, indicates its true value to a prospective buyer.
Other than when you’re buying or selling a financial planning practice or client book, there are many other reasons you might need to obtain an expert valuation:
- To use as a business management tool
- In shareholder negotiations
- For succession planning
- For legal or financial reasons (ie, divorce or settlement)
- To use as a basis to grant equity to partners
- For sellers looking to validate a buyer’s offer, or
- Because you’re simply curious!
So even if you’re not planning on selling, valuation can be used as a smart tool to take a holistic look at your business right now.
It can become a powerful driver of how you manage your business, including making strategic decisions that impact your bottom line.
A valuation-based business approach can offer up a chance to review the dynamics of your business and set you apart from the competition so that when you’re actually ready to sell, you’ll be able to demand the highest price.
Whether you obtain an independent, expert valuation is a business decision for you to make however there are many benefits to an expert appraisal, including:
- a professional, accurately estimated market value, and
- the necessary financial and forensic accounting expertise and experience to value businesses across all industries.
Valuation Methods: How it Works
So what is a valuation exactly? Valuation is the process of determining the current worth of an asset or a company.
There are a few different ways to calculate your firm’s value but the more common methods for our industry are the discounted cash flow (DCF), capitalisation of earnings and market multiple methods.
With DCF, you basically forecast future earnings and apply a discount rate to each year to account for the time value of money and cost of capital.
Another approach to valuing your business is called the capitalisation of earnings approach which we take at Centurion Market Makers. The other is the multiple of recurring revenue. We assess businesses and/or client bases against several key items that significantly influence the buyer’s perception of value and risk. We value your firm by looking at:
- Recurring Revenue, and or
- Earnings before Interest and Tax (EBIT).
In either assessment, we take a transaction guideline approach and focus on what would drive the multiple to be applied to either the recurring revenue or EBIT. We also compare the offers made and sale price of businesses that have actually been sold and compare it to a metric in your business, such as revenue or EBIT.
The multiples of earnings (or cash flow) method allows buyers and sellers to account for expenses. With this method, advisors can opt for EBITDA (earnings before interest, taxes, depreciation, and amortization), EBIT (earnings before interest and taxes), or NOI (net operating income).
In 2016, many small practices and client books were sold for between two and three times annual recurring revenue (which was similar to 2015). There were some exceptions: purchases made by large institutions under BOLR (or similar) arrangements, sales of clients from corporate super plans resulting in accrued default account clients (ADAs) and small risk client bases.
But remember: crunching the numbers and looking at multiples or discount rates is not the whole valuation picture.
When we value firms, there are 8 key factors we take into account:
- Client data including numbers on various segments: service, recurrent revenue, FUM (funds under management), demography, location, Opt-in numbers, SMSF numbers, FDS numbers. Also, information on sales history, new revenue and clients per year with sources, new FUM written and recurrent revenue split between existing and new clients.
- Revenue Profile Your practice will likely have several different types of revenue: Adviser Service Fees, trail commission, Risk renewal commissions, Upfront Risk commissions.
- A clear advice offer and fee for service proposition that is documented for clients and staff and is incorporated into the client communications.
- Transferable clients: If your clients are happy to deal with other advisers and staff when you’re not there, this means they are more easily transferable to a new business owner.
- Staff retention: Advisers on fair and reasonable commercial contracts with restraint of trade terms are more likely to stay on in under new management. If they move on, there is more protection against competition.
- Profit / EBIT: Most practices that are buyers will use bank funding and require profit/cashflow to cover loan servicing costs and banks look for the ability to service up to 2 times the loan service costs. Institutional buyers usually look to optimize revenue and profit across advice, platform and investment management so the higher profit/EBIT the better!
- Referral sources that will continue post-sale: Buyers are buying future revenue and profit. They look at the past to identify where the business revenue and profits have been and they’re banking on the future being at least the same or better.
- Ability to control risk: Buyers will want to introduce transaction terms that help them mitigate perceived risk and assist a smooth integration.
- Integration Risk: How well set up is your business to be integrated into another business? Are your client files paper or technology based? If your business is large, does have it have workflow and technology-enabled standard operating procedures? Is your key person reliance across the business?
What Valuations Cost
As noted in Inc Magazine, beware of a ‘low-cost, low-wisdom’ appraisal as the financial life of your business may depend on it! Shopping for the lowest priced vendor may risk your financial fortune if they don’t have the necessary skill and expertise to assess the real value of your financial planning practice.
So what will it set me back, you ask? Well, the cost of a comprehensive market valuation from a qualified appraisal expert ranges from a few thousand dollars to $20,000 or more.
As identified by American Business Appraiser, Steven Schroeder, the greatest single driver of appraisal cost is the ‘purpose to which the client desires to put the appraisal result’. So if you’re using it as an informal price guide for a seller or buyer, it will cost less than an appraisal used in complex litigation matters.
For many practice owners, arranging a valuation before commencing the sale process is a very small investment relative to the value of a practice and the amount of sale value that may be at risk if you get it wrong.
What You’ll Need to Have Ready
Preparing your practice information is one of the most important steps of the valuation process. Here’s what you may need to have ready for your expert market appraisal:
- General business information such as your overall business profile, procedures and plans including information on market conditions, competitors, sales forecasts, business history, business procedure documents and your business plan
- Financial statements such as types of revenue streams, annual turnover, profit and loss statements, pricing, cash flow statements, debt information
- Product data (which may include platform margin, investment management margins, life risk margin and debt product margin)
- Client and supplier information: Number of FDS, opt-in and non-FDS clients, client demographics (Age, RR, FUA), Annual Premium In-force (or similar) or business model segmentation
- Employment details such as pay rates and salaries, job descriptions and KPIs, skills, experience. work histories and any compensation or employee claims
- Details of assets including physical assets like machinery, buildings, equipment, and stock and any other intangible assets (ie goodwill, intellectual property)
- Legal documents such as leases, contracts and insurance policies, risk assessment information
- Registration papers such as business name certificates, Australian Business Number (ABN) registration papers, licenses, permits, and any other papers that demonstrate you comply with government requirements
What you need to prepare is also influenced by the purpose of the appraisal and the size of your business. Being well-prepared for the valuation process is likely to produce a much more accurate result.
Not knowing fair market value of your financial planning practice and indulging in guesswork can prove costly. You may sell your firm for far less than it’s worth so the cost of an expert market appraisal is an excellent investment in the future of your business.
Want to learn more about how to value your practice? DOWNLOAD OUR FREE 2017 PRACTICE VALUATION GUIDE HERE:
Chris Wrightson. Founder and CEO at Centurion Market Makers, the industry experts in the sale, acquisition and management of financial planning firms. If you’re planning on selling your firm in 2017, we’d love you to call us 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.
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