How to Make an RIA At­trac­tive to Buy­ers

There are savvy ways to po­si­tion a firm for a fu­ture sale be­yond fo­cus­ing on rev­enue or AUM, ex­perts at Sch­wab Im­pact told ad­vi­sors.

Financial Planning - - SPECIAL REPORT: M&A OUTLOOK - Charles Paik­ert is a se­nior ed­i­tor of Fi­nan­cial Plan­ning. Fol­low him on Twit­ter at @paik­ert.

By Charles Paik­ert

Two ad­vi­sory firms can have nearly iden­ti­cal rev­enue and as­sets un­der man­age­ment. Yet if one firm struc­tures its busi­ness in spe­cific strate­gic ways, it can com­mand more than twice the val­u­a­tion of a life­style-ori­ented prac­tice — even if the other firm is larger.

“Char­ac­ter­is­tics drive value, not size,” said John Furey, prin­ci­pal of Ad­vi­sor Growth Strate­gies, at the an­nual Sch­wab Im­pact con­fer­ence in Novem­ber.

Furey, who spoke to ad­vi­sors about how RIAS are val­ued, to­gether with Todd Thom­son, chair­man of Dy­nasty Fi­nan­cial Part­ners, stressed the im­por­tance of ad­vi­sory prin­ci­pals run­ning their busi­ness as if they were try­ing to sell it.

Firms that fo­cus on ar­eas they can con­trol, such as in­vest­ment prac­tices, client re­la­tions and tech­nol­ogy, can po­ten­tially achieve a mul­ti­ple of nine to 11 times free cash flow, Furey and Thom­son main­tained.

WHY NET MAR­GIN MAT­TERS

Net mar­gin and earn­ings growth are two of the most im­por­tant char­ac­ter­is­tics that po­ten­tial buy­ers will eval­u­ate, the men said.

Even if firms have sim­i­lar earn­ings, a larger net mar­gin can have “a sig­nif­i­cant im­pact on val­u­a­tion,” Thom­son said. “It’s a mul­ti­plier ef­fect.” Earn­ings ex­pan­sion is also crit­i­cal, he pointed out.

“Buy­ers want free cash flow to be sus­tain­able,” he said. “They are go­ing to ask sell­ers, ‘How are you grow­ing, ex­actly?’ ”

THE LIFE­STYLE FIRMS

Life­style prac­tices tend to have clients tied di­rectly to the firm’s prin­ci­pal, Thom­son said, while pro­fes­sion­al­ized firms in­sti­tu­tion­al­ize client re­la­tions.

The for­mer will re­sult in a dis­counted val­u­a­tion, ac­cord­ing to Thom­son. “If more clients are di­rectly tied to the prin­ci­pal, the buyer is only go­ing to pay the owner when the clients ac­tu­ally tran­si­tion over,” he said. “In­sti­tu­tion­al­ized firms don’t have to worry about that.”

Life­style firms also have to worry about hav­ing too many older clients and ad­vi­sors. “Buy­ers want younger clients and ad­vi­sors,” Furey said. “If they’re older, it’s con­sid­ered a de­clin­ing as­set and buy­ers pay a lot less.”

AS­SET MAN­AGE­MENT MOD­ELS

Firms that in­sti­tu­tion­al­ize as­set man­age­ment with stan­dard­ized in­vest­ment mod­els that are scal­able tend to be more highly val­ued than firms that spend more time and money on cus­tom­ized in­vest­ment so­lu­tions, Thom­son as­serted.

“Buy­ers want less risk,” Furey said, “and a scal­able model is con­sid­ered more sus­tain­able.”

WHAT BUY­ERS LOOK FOR

Val­u­a­tions are highly de­pen­dent on what buy­ers are look­ing for. Furey and Thom­son noted that buy­ers can of­ten be char­ac­ter­ized as fi­nan­cial, strate­gic or peer-to-peer.

Fi­nan­cial buy­ers, for ex­am­ple, are look­ing for growth and are un­likely to buy a prac­tice from a prin­ci­pal who is re­tir­ing. Strate­gic ac­quir­ers may be more in­ter­ested in larger firms, while an RIA who is a peer-to-peer buyer may be less con­cerned about an

“BUY­ERS WANT FREE CASH FLOW TO BE SUS­TAIN­ABLE. THEY ARE GO­ING TO ASK SELL­ERS, ‘HOW ARE YOU GROW­ING, EX­ACTLY?’ ” — TODD THOM­SON, CHAIR­MAN, DY­NASTY FI­NAN­CIAL PART­NERS

owner re­tir­ing if the seller is a lo­cal firm that is a good cul­tural fit.

Furey warned sell­ers that they should not to read too much into news sto­ries about firms sell­ing for a high price or mul­ti­ple.

“The main im­ped­i­ment to the sale of RIAS,“Thom­son added, “is un­re­al­is­tic ex­pec­ta­tions on the part of the seller.”

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