In the latest part of his series examining exit strategies, Phil Billingham reports on the classic exit strategy – the straight sale.
This week we are going to look at the classic exit strategy; a straight sale to an outside firm. We will look at why the business can be worth less than you think, and how to increase that value.
So let’s start with the bit everyone is interested in – how much is it worth? An easy question, but without easy answers. One could say that its worth what someone will pay, but that is less than helpful!
A business should be worth a factor of the profit it generates. That is what businesses quoted on the stock exchange are worth. This figure can vary between 6 and 20 times current profits, giving yields of between 17 per cent and 5 per cent.
Most IFA businesses are not valued that way. The simple reason why is that the source of these profits is the principals of the business, and they are leaving / retiring. So what are they selling?
“Most firms have no real physical assets, just a few secondhand PC’s and a desk or two.”
The calculation of ‘profit’ is also an issue. Many small firms count ‘profit’ as the figure they have left to live on, where it actually should be the figure that is left after they have paid themselves a fair salary.
The flaws with small firm’s profit calculation leads to the calculation of value as being based on the assets. Again, most firms have no real physical assets, just a few secondhand PC’s and a desk or two.
What they do have is a client base, and an income stream derived from that. This leads to the X times income calculation, so beloved of advisers at networking events! “What’s the current rate Phil?”, even outstrips questions about rugby at these events, and that is sad!
The bad news is that this crude calculation, I believe, undervalues the potential for a decent adviser firm. The good news is that values are creeping up, as buyers realise there are future gains to be made.
Current valuations seem to be between 2 ½ and 3 ½ times underlying income. So that includes trail, retainer and ongoing fees. I have seen some deals at closer to 4 times, but that requires an exceptionally good match of seller and buyer.
To put these figures in context, many adviser firms now operate with around 60 per cent of turnover as ‘underlying Income’, and these multiples basically mean they are valued at around 1½ years turnover. Which is similar to an accountants practice, as it happens!
If we accept we would like to see these figures increase – and as sellers, clearly the answer is yes – what can we do about it?
Well, the answers are the usual suspects, I’m afraid.
- have your client data on a proper ‘Back Office’ system, not just on paper files or Excel spreadsheets
- are all your clients, clients of the firm rather than seeing themselves as attached to an Adviser? Look at your branding and client contact to reinforce this. This single factor can make a massive difference to the sale price, so it is worth spending time and effort on
- what are your relationships with introducers like? Is there a proper agreement in place? Again, this can be valuable so do some work on this
- do your RI’s have a proper contract that restricts their access to – and dealing with - clients if they leave? Have you checked this with a solicitor?
- are you getting some income on ALL your client’s investments?
- are you agents for all your clients investments, even where not ‘Under Influence’?
- have you segmented you client base? Does the service proposition work? Do you have records to prove this?
If you have more ‘no’ or ‘not yet’ answers than ‘yes’, then your values will be reflected by that. If that is the case, you probably need some help, and you are probably two or three years away from selling. Start now!
The very good news is that, with help, you can start to affect the value (and income) of the firm almost immediately.
One way is to look at the discretionary route. This is not for everyone, but it will work for perhaps 10 per cent or 15 per cent of the firms out there. There are only about 2 per cent of firms in this category at present, so lots of room to go. We have certainly had more enquiries in this area recently than in the last year or so, so the message is getting through.
That brings us on to the issue of what are you selling, and the regulatory issues surrounding that.
In most cases, you will sell the business, not the shares. That means you have to shut down the firm at some point, and will need to work with the FSA on this point. From experience, you need good advice for this bit. I’m going to leave it there for now, sorry, but space does really not permit further analysis of this!
If you are a sole trader, or a partnership (Why? Have you not been listening!?), then you need both good advice, and a long chat with your PI broker about ‘Run Off’ cover. There are ways of dealing with this, but please do not be without cover for past business if you can possible help it! You remain liable, and the FSCS can come after you.
After a few years of dabbling with both succession and an abortive merger as an exit plan, Julian decided that a sale was the way forward. Fortunately, he had a good client base, very loyal, and pretty used to reviews and doing business on a regular basis.
Through a third party, he met a younger IFA who offered him close to 3 ½ times underlying income, over a 2 ½ year earn out. A very good deal for both parties, as there was room to grow both the business and the underlying income.
Julian almost blew it. He procrastinated, and spent his time ‘tidying up the client records’, and carrying out routine client reviews, which was a complete waste of his time.
The deal did go ahead, but some goodwill was lost, and his staff and clients experienced a period of unnecessary ‘limbo’. The opportunity was almost lost.
The bottom line here is that IFAs find it really hard to sell their staff and clients and walk away. This is to be admired. But instead of addressing this issue, delays were put in place that could have disadvantaged everyone.
It’s hard to sell your baby. We all believe that no-one can look after your clients and staff like we can. But you have to do the best deal you can for everyone, and then ….walk away – for everyone’s sake!