Recently I had an engaging conversation with an advisor who was looking to sell his practice and retire. He was doing roughly $1 million in revenue, taking home $550,000 per year and felt that his practice was worth a little over $2.2 million based on a valuation done by a fairly well known valuation firm. The valuation was based on 2.2 times revenues and 4 times the $550,000 which was his comp. The advisor wanted to be free and clear of the business within 1 year. I asked how each client was serviced, and he responded with, “each client receives a great team; it’s always me and one of my two associates.” I then explained to him that in order for a buyer to expect his clients to stick around after the sale, the clients will demand a replacement that is at least his equal, or he would have to hang around longer than one year, probably 4-5 years while the clients are transitioned to the new structure and relationship. The new advisor hired would demand a market compensation arrangement for their experience level and that would take a very large part of the $550,000 after overhead he had been taking home. This practice is worth far less to a buyer than it is currently to his family….more in the range of $600,000 to $800,000 based on simple analysis. What could he have done over the previous decade to sure up and maximize the value of his practice at the time of sale/retirement? Here are a few simple thoughts:
1) It’s NOT about you
While you may enjoy working with clients and spending time helping them plan their financial lives, having them view you as the primary source of financial advice and guidance detracts from value. Instead, invest in people that can better serve the clients. Specialists in financial planning and investments that spend the majority of the time with the client are the best way to accomplish this. You are then free to bring on more clients and grow the firm. Growth is good! A buyer will be attracted to the fact that the clients do not view you as the primary point of contact and relationship for the clients.
2) Focus on margins and free cash flow….but don’t take it all home
To a buyer, the greatest source of value is the amount of free cash flow a business generates. Therefore, it is critical to focus on running as efficient a business as possible. Also, get in the habit of leaving some of the money in the business as both a safety net and a pool of capital for investment back into the business. Too often advisors are in the habit of harvesting every last dollar from the business every year. As their lifestyle expands to take advantage of this extra money at home, it is very hard to change habits and begin to reserve cash.
3) Invest in the business
Make smart investments in people and technology to keep pace with the ever evolving capabilities in the market. As a greater number of qualified players enter the independent RIA business from the wire houses and other channels, the value delivered to clients in terms of planning, product and experience will continue to expand. Smaller advisors will be squeezed to compete over time. It’s important to stay up to date and keep pace. This may require a reduction in personal cash flow, but a failure to invest in the business may lead to a complete termination of business in time. However, investing in people and processes can lead to a scale-able business with even greater free cash over time.
4) Get your name off the door
This is directly related to #1. If you want to institutionalize your business and have clients rely on the firm and not you specifically, it is wise to remove your name from the door. Also, this conditions your clients to work with the institution that is your business and therefore the institution considering buying your business should be more comfortable that the clients will remain after the sale. Now, this is not always the case – the exception being some very large firms have actually institutionalized the founder’s name. However, I would suggest that is the exception, not the rule. Most firms will not grow to many billions of AUM, thus overwhelming the fact that the founder’s name is still on the door.
5) GROW big and GROW fast!
There are only a handful of large institutional buyers willing to pay a premium for RIA firms. As such, they are seeking deals that are material and worth their time and effort. Therefore, larger RIA firms, that are growing fast, are the primary targets. Currently very few of these firms exist. A multi-billion AUM firm, growing at 20% is going to attract a larger valuation multiple. If you can’t grow your firm to this level quickly, you may be better served to join an existing large firm. This simple re-positioning of your equity solves not only this issue, but all four of the previously stated issues as well. It’s an equity management strategy to increase value.
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