Deciding on a price can be challenging, says Danny Sarch, president of Leitner Sarch Consultants in White Plains, New York, because the adviser must balance his own needs—selling the firm is likely a big part of his own retirement plan, after all—with those of his clients. “You are selling your access to relationships and that is worth something, but there’s no certainty that it will convert into revenue for the buyer,” he tells PLANADVISER. The plain fact is, the practice may be worth more to the current owner than to potential buyers. “That disconnect is the issue,” Sarch says.
“With many buyers in the market, advisers’ expectations regarding the value of their practices are high,” Kenton Shirk, associate director at Cerulli, explains in “The Cerulli Edge – Advisor Edition,” which examines adviser succession and practice acquisitions, and the opportunity for rapid growth.
The rule of thumb for valuation—twice the fee-based revenue plus the transactional fee, according to Sarch—is seen as a starting point, but a practice’s structure also plays a part. Perhaps an advisory firm is very heavily staffed in order to service clients and is not that profitable, Sarch theorizes. “Or someone isn’t staffed enough, and the (client) relationships aren’t as solid,” he says. “Some practices have thousands of relationships. But you cannot be everyone’s trusted adviser.”
“On average, advisers believe their practices are worth 2.8 times their total revenue,” Shirk says. According to Cerulli’s data, for advisers who actually purchased a practice in the past 12 months, the average revenue multiple paid was about 2.2 times revenue.
John Furey, principal and founder of Advisor Growth Strategies in Phoenix, Arizona, and a founding member of aRIA, the Alliance for Registered Investment Advisors, agrees that the vast majority overvalue their practices. It’s understandable, he says. “They own the practice, and it’s been reinforced by that rule of thumb,” he tells PLANADVISER. “You read about some transaction and that price, and you extrapolate to your own situation.”
Beyond the Formula
However, advisers should consider being proactive in managing their own assessment, Furey advises. A range of tools—high cost, low cost and free—are available to help run the numbers, and some practices might turn to outside firms for an objective, unbiased opinion of what the practice would bring on the open market.
A firm’s size may mean that a straightforward calculation based on multiples of cash flow is not the best yardstick, Furey says, recommending more advanced appraisals for larger firms. “Some smaller practices may be able to look at it in a more formulaic way, such as a multiple of cash flow, but as firms get larger a greater amount of precision is going to be called for,” he says. “If your practice is worth $10 million and you’re 1% off, that’s really big money.”
Sarch agrees that all the dynamics and intangibles of transitioning a practice to a new owner mean the formula is likely way off in many cases. “If someone has 50 solid relationships, there is still no guarantee the value will transfer over,” he says. “All the businesses are as different as different people, making it very challenging.”
Factors to examine include the age of the adviser selling the practice, and the average age of the adviser’s clients. The current older adviser generation tends to have older clients. “Will the new adviser be able to maintain those relationships?” Sarch asks.
If the adviser is the brand, and he disappears, perhaps there is nothing left, Sarch suggests. “The business model is very important,” he says, comparing a registered investment adviser (RIA) to a restaurant. “Maybe people love that great restaurant on the corner,” he says, “but without the chef, what do you have?”
The Price Is Right
Transparency about client demographics is one key to a successful valuation and eventual sale, Sarch says, adding that many of the most successful transitions are the ones in which the new adviser is brought in for a period of time. Smaller medical practices frequently do this, he says, and it can be applicable to an advisory. “It’s a more natural transition,” he says, “and can help avoid something like an abrupt name change that could be disconcerting for clients.”
Depending on the work flow, Sarch recommends a year or longer. “It shouldn’t cut into the sale price. If it is done correctly, it makes everybody feel it’s going to be successful. And if the transition is no longer in question, it makes the negotiation easier.”
Valuation is not a last-minute, end-of-career event, Furey says, and advisers should be strategic about managing their equity. “You might be 20 years away, but you should still think about your business value and what drives your business equity,” he says. “It should be more a fluid, continuous process, working on your business and in your business.”
Cerulli notes the current imbalance of buyers to sellers in the market as one reason for price optimism. “For every adviser who actually acquired a practice, there are nine who wanted to buy one,” Shirk says. However, this state is unlikely to continue as advisers begin retiring in greater numbers, and Sarch anticipates that in 10 years the supply and demand will be turned on its head. “There will be many more sellers than buyers,” Sarch predicts, “and prices will come down.”
“The Cerulli Edge - Advisor Edition, 4Q 2014 Issue” is available by subscription through Cerulli’s website.