Early val­u­a­tions and reg­u­lar re­views can help you de­ter­mine whether you can make the tran­si­tion to re­tire­ment at any time. You also can ac­count for changes — both in­ter­nal and ex­ter­nal — that may af­fect the value of your busi­ness

Investment Executive - - FRONT PAGE -

Choos­ing a pro­fes­sional to put a price on your prac­tice.

“Coach’s Fo­rum” is a place in which you can ask your ques­tions, tell your sto­ries or give your opinions on any as­pect of prac­tice man­age­ment. For each col­umn, Ge­orge se­lects the most in­ter­est­ing and rel­e­vant com­ments from read­ers and of­fers his ad­vice. Our ob­jec­tive is to build a com­mu­nity of peo­ple with a com­mon in­ter­est in mak­ing their fi­nan­cial ad­vi­sory prac­tices as ef­fec­tive as pos­si­ble. ad­vi­sor says: a cou­ple of points from your re­cent col­umns on valu­ing an ad­vi­sor’s busi­ness struck home for me. First, that rules of thumb are for “av­er­age” prac­tices and do not take into ac­count what could make one prac­tice or book of busi­ness worth more than another of equal size. Be­cause I be­lieve that my busi­ness is bet­ter in a num­ber of ways (which I won’t go into here) than my com­peti­tors’, I am glad to hear that those dif­fer­ences should be rec­og­nized by com­mand­ing a higher price when I sell my busi­ness down the road.

The sec­ond point is that value is de­ter­mined by fu­ture po­ten­tial — not past per­for­mance. (Where have we heard that be­fore?) Which begs my ques­tion: if I do not in­tend to sell my busi­ness for at least five years, when should I have it pro­fes­sion­ally val­ued? I as­sume any valuation close to my in­tended tran­si­tion date will be most ac­cu­rate. So, should I just use those rules of thumb for now to get a gen­eral sense of value and be more pre­cise later on? coach says: know­ing the cur­rent value of your prac­tice is not cru­cial to a good tran­si­tion plan — pro­vided you are not re­ly­ing on the sale of your busi­ness to fund all or part of your re­tire­ment life­style. If you are in­de­pen­dently wealthy and receiving max­i­mum value for your prac­tice doesn’t re­ally mat­ter to you, feel free to de­lay valuation un­til you are ready to walk out the door per­ma­nently. In fact, if get­ting full value is not es­sen­tial, you even could rely on those rules of thumb to get you close enough.

In my ex­pe­ri­ence, how­ever, most fi­nan­cial ad­vi­sors do not fall into the “in­de­pen­dently wealthy” cat­e­gory. While they have built great prac­tices and en­joyed won­der­ful life­styles due to above-av­er­age in­come, most have not cre­ated sub­stan­tial wealth out­side their busi­ness. Con­se­quently, if most ad­vi­sors want to main­tain sim­i­lar life­styles in re­tire­ment, they need to max­i­mize the value of their busi­ness be­fore they exit.

For me, that is the crux of the ar­gu­ment in favour of early and reg­u­lar prac­tice val­u­a­tions. From a fi­nan­cial per­spec­tive, how will you know when you are able to make the tran­si­tion from your busi­ness to re­tire­ment if you do not have a good idea of the value you can ex­pect to re­ceive at that time?

A num­ber of things can change in five years (cit­ing your ex­am­ple), which will af­fect the value of your prac­tice. Some are in­ter­nal as­pects of your busi­ness, which are within your sphere of in­flu­ence. Some are ex­ter­nal fac­tors, which are not. All other things be­ing equal, be­low are six in­ter­nal fac­tors and four ex­ter­nal fac­tors that can in­flu­ence your valuation: in­ter­nal fac­tors (you con­trol) 1. Net rev­enue. Boost­ing over­all net rev­enue will in­crease the value of your busi­ness. To do that, you have to in­te­grate busi­ness devel­op­ment with your pric­ing pol­icy and ex­pense con­trol.

2. Re­cur­ring rev­enue. Prac­tices with greater cer­tainty re­gard­ing fu­ture in­come are less risky than those with un­pre­dictable rev­enue, such as com­mis­sions. In­creas­ing your per­cent­age of re­cur­ring rev­enue leads to a higher valuation.

3. Busi­ness mix. Opinions vary for this fac­tor. Some buy­ers think a nar­row prod­uct mix presents op­por­tu­ni­ties to ex­pand busi­ness within the ex­ist­ing client base. Oth­ers think that lack of di­ver­si­fi­ca­tion makes a prac­tice too de­pen­dent on one or a few prod­ucts, thereby in­creas­ing risk and re­duc­ing the price a buyer is will­ing to pay.

4. Con­cen­tra­tion. Too large a per­cent­age of your busi­ness be­ing rep­re­sented by one in­di­vid­ual or fam­ily unit in­creases risk and re­duces value.

5. Client de­mo­graph­ics. A prac­tice with an av­er­age client age of 55 is, gen­er­ally, worth more than a prac­tice with an av­er­age age of 70. If noth­ing else changes in your busi­ness, you could see its value de­cline over time as your clients age.

6. Busi­ness model. In­creas­ing re­liance on tech­nol­ogy is chang­ing how ad­vi­sors op­er­ate. Up-to-date tech­nol­ogy will be a plus; out­dated sys­tems will be a drag on value. ex­ter­nal fac­tors Fees within the in­vest­ment in­dus­try. Over­all, fees for prod­ucts and ad­vice are de­clin­ing. To­day, the in­dus­try’s av­er­age re­turn on as­sets (a.k.a. turn rate) to ad­vi­sors is hov­er­ing around 1%. How­ever, many pun­dits (in­clud­ing me) be­lieve this met­ric is headed much lower. That will re­duce both rev­enue and prac­tice valuation.

2. In­creas­ing costs. No one will ar­gue that the costs of manag­ing your prac­tice have not gone up over the past five years. And they are likely to in­crease by as much — or more — in the next five years for things such as com­pli­ance, sys­tems, tech­nol­ogy and staffing. Lower profit leads to a lower valuation.

3. Supply and de­mand. Cur­rently, the de­mand for good-qual­ity prac­tices to buy far out­strips the num­ber of good prac­tices for sale, thus cre­at­ing a “seller’s mar­ket” and higher prices. As se­nior ad­vi­sors in our in­dus­try age by another five years, ex­pect the supply of prac­tices com­ing onto the mar­ket to in­crease. That, cou­pled with a much more dili­gent ap­proach to an­a­lyz­ing prac­tices for sale, will shift us to­ward a “buyer’s mar­ket,” in which prices typ­i­cally de­cline for all but the best busi­nesses.

4. Com­pe­ti­tion. I fore­see prac­tices in­creas­ing in size — through amal­ga­ma­tion, ac­qui­si­tions, part­ner­ships and cor­po­rate ag­gre­ga­tion. Larger prac­tices are less risky to buy than smaller ones, so they at­tract higher mul­ti­ples. What once seemed like a large book of busi­ness could be com­par­a­tively small in a few years and, there­fore, at­tract of­fers from only “fi­nan­cial buy­ers” look­ing merely to ab­sorb more clients.

The op­por­tu­nity to find “strate­gic buy­ers,” who typ­i­cally are will­ing to pay more for a syn­er­gis­tic fit be­tween your busi­ness and theirs, will di­min­ish.

Look­ing at the lists above, there is hope that a cur­rent valuation of your prac­tice will serve more than your suc­ces­sion or tran­si­tion plan. A cur­rent valuation also can high­light ar­eas of your busi­ness in which op- por­tu­nity ex­ists to max­i­mize your prac­tice’s value. By un­der­stand­ing what con­trib­utes to a pre­mium or a dis­counted value, you can take steps to im­prove the chances your re­tire­ment life­style will be as you hoped. Pe­ri­odic re­views ev­ery year or two will help you keep track of your progress. who should doy­our eval­u­a­tion Be­cause I de­liver a num­ber of val­u­a­tions each year, I de­clare my ob­vi­ous bias. How­ever, here is my take on who could cal­cu­late your prac­tice’s valuation, ranked from least ap­pro­pri­ate to most:

You. Your view is tainted by the sac­ri­fices and ef­fort you made in build­ing your busi­ness. Buy­ers don’t care about these fac­tors. All they want to know is “What’s in it for me?” Typ­i­cal cost: $0 (plus the value of your time). Re­view cost: Same.

Your accountant. The role of your accountant is to min­i­mize the value of your busi­ness so you pay the least amount of taxes. When you are sell­ing, you want to demon­strate the great­est value in or­der to max­i­mize your pay­out. Typ­i­cal cost: Accountant’s hourly rate, times hours spent. Re­view cost: Same.

A char­tered busi­ness val­u­a­tor (CBV). CBVs are well trained in valu­ing things such as in­ven­tory, cus­tomer con­tracts, ac­counts re­ceiv­able and work­ing cap­i­tal — most of which don’t ap­ply to an ad­vi­sory prac­tice. Typ­i­cal cost: $10,000-$15,000. Re­view cost: ne­go­tiable, de­pend­ing on the in­ter­val.

Fi­nan­cial ad­vi­sory prac­tice valuation spe­cial­ist. These pro­fes­sion­als un­der­stand the nu­ances of what con­trib­utes to the value of a fi­nan­cial ad­vi­sory prac­tice. In ad­di­tion, some­one reg­u­larly ac­tive in this field knows the cur­rent state of the mar­ket and may be able to as­sist in both find­ing the right buyer and ne­go­ti­at­ing a deal. Typ­i­cal cost: $3,500-$7,500. Re­view cost: ne­go­tiable, de­pend­ing on in­ter­val.

The typ­i­cal cost of find­ing a buyer and ne­go­ti­at­ing a deal is 3%-5% of sale price.

Re­gard­less of whom you choose to do your valuation, my part­ing ad­vice is summed up in my “man­age­ment mantra”: “Man­age your busi­ness to­day as if you in­tend to run it for­ever. But al­ways be pre­pared to sell it — at any time, to the most qual­i­fied buyer, for the high­est price.” Ge­orge Hart­man is CEO of Mar­ket Log­ics Inc. in Toronto. Send ques­tions and com­ments re­gard­ing this col­umn to ge­orge@ m a rk et l o g i c s . c a . Ge o r g e’s p ra ct i c e - man­age­ment videos can be viewed on­vest­mentex­ec­u­


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