Brett Davidson explains why some adviser firms reach a higher sale value than others.

    The financial planning firms we work with want to make themselves into better businesses and are absolutely committed to quality in everything they do. This should translate into a higher sale value placed on the business when they go to sell it, right? I’m not so sure.

    The valuation metrics

    An industry colleague who’s recently been doing the rounds of the corporate finance and venture capital groups, suggests that they value a financial planning business along normal business valuation lines; that is 3-4 times profit for small firms and up to eight times profit for a very mature, well organised, larger firm. That’s a lot less than the value most advisers place on their firms.

    Many advisers still think their business is worth three, four, or more times recurring income, but that’s inconsistent with what the people with the money are saying. There are (supposedly) deals out there where some fund manager or network buyers will pay a huge number for recurring revenue.

    However I’m always a little sceptical that to get the number, you may have to accede to a multitude of conditions that don’t really fit you or your clients. Also, most of these deals are done under very strict confidentiality provisions and so if someone has been screwed by the dealmaker, it never makes the industry press.

    The paradox

    It seems illogical that businesses trying to do it better might actually fetch less than those that don’t seem so concerned, but this is the risk. All those years of work focused on doing the best job for your clients and improving quality, may not translate into an acceptable sale value. In fact, even if you could overcome the moral hurdle at sale time, you may have made yourself unattractive to buyers of these more ordinary businesses, so why bother?

    I think there are a few reasons:

    Moral

    Most firms I know can’t get over the moral issue. Having built a client-focused business they will struggle to knowingly sell to a buyer that doesn’t share their client care ethic, especially if it means a huge shift away from some of their strong beliefs (a particular investment philosophy or cashflow modelling, for example).

    Profit

    While buyers with deep pockets might not be queuing at your door, if you do run a business that makes good profit margins (after owner’s incomes are taken into account), then you’ll still achieve a nice sale price in line with your expectations. You may need to be more creative in identifying buyers and structuring the corporate finance, but this is all achievable.

    Consider the following businesses:

    Business 1: In good shape but still owner dependent
    Turnover £1,000,000
    Recurring income £700,000
    Net profit (after owner takes market salary) £150,000 (15% margin)
    Valuation (using multiple of recurring income) £2,100,000 (using 3x multiple)
    Valuation (using multiple of profit) £600,000 (using 4x multiple)

    Business 2: Not only larger but a genuinely well structured business
    Turnover £3,000,000
    Recurring income £2,500,000
    Net profit (after owner takes market salary) £900,000 (30% margin)
    Valuation (using multiple of recurring income) £7,500,000 (using 3x multiple)
    Valuation (using multiple of profit) £7,200,000 (using 8x multiple)

    The second business can achieve a sale price more in line with its owners expectations, only because it has profit margins that are far higher than the first business (30% as opposed to 15%) and because it has a sustainable business structure that is not largely dependent on the founder.

    Fulfilment

    Creating a genuine business that’s not owner dependent and is truly client focused is not only financially rewarding, but is more fulfilling. To be able to sign off and think “I’ve created that” means more than just earning a living for 25 years.

    To be able to change the lives of your clients (regularly and systematically) also creates a greater sense of fulfilment. I’m not saying this can’t be done by small and beautiful financial planners (it can), but to do it on a larger basis simply touches more lives.

    I don’t want to dissuade anyone from pursuing what feels right for them – “follow your bliss” is still great advice for a happy and fulfilling life. However, for the financial planners out there who are thinking about their exit and sale options, a focus on building structure and genuine profitability has got to be part of your thinking.

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