financial advisor business valuation

Advisors who are considering retirement and want return on what they’ve built must plan carefully in order to sell their practice when it commands peak value.

Not sure if it’s time to sell your financial advisor practice? Selling as your business nears peak value may allow you to capitalize on the upside.

When it comes to selling your financial advisory practice, timing is crucial. So when is the right time to monetize? Valuations are based on projected future cash flows of you practice, and businesses command the highest purchase price just before they hit their peak. Therefore, advisors who are considering retirement and want return on what they’ve built must plan carefully in order to sell their practice when it commands peak value.

“My revenue is stable, why should I sell?”

Potential buyers much prefer to purchase businesses with rising revenue projections rather than businesses in decline. As clients age, it’s important to remember their client lifetime value decreases. Assets under management for older clientele tend to shrink over time, as they are no longer in the accumulation phase and assets are withdrawn as clients pass away. This means that in order to even maintain the value of your practice, younger clients and new assets must be added on a regular basis. Although it’s tempting to continue running your practice with the same clients and processes you have for years, this can result in decreasing the value of your business when it’s time to sell.

“This sounds great, but I’m not ready to retire yet.”

Many advisors enjoy their job and have spent most of their lifetime building a book of business consisting of clients and friends they truly care about and want to continue to serve. The good news is that selling your practice doesn’t mean you must fully retire. LPL’s Advisor Financial Solutions team can help structure deals that allow you to monetize today and retire later. These are commonly called “sell-and-stay” or “sell-and-service” models, and they’re growing in popularity.

“The sales multiples on revenue are not attractive enough for me to sell now.”

Misconceptions about sales multiples are another factor that leads some advisors to sell their practice past its peak value. Although the average sales multiples are hovering around 2- to 2.5-times recurring revenue and 1- to 1.2-times transactional revenue*, it’s important to note that these multiples are based on gross revenue before expenses and tax, rather than on take-home pay. Once expenses and ordinary income tax are factored into the equation, the sales multiples typically range from 4- to 5-times net income when expressed in terms of take-home pay.

Tax implications on income are another factor to consider**. The income earned from operating each additional year is subject to ordinary income tax, whereas income earned from the sale of your practice is subject to a much lower capital gains tax rate.

Is the value of your practice growing at a rate that outpaces the tax advantages of selling your practice at its current value? Does the estimated terminal value of your practice plus the net cash flows (take-home pay) from working additional years exceed the current market value of your practice? These are important questions to consider when assessing the appropriate time to monetize your business. Operating risk should be monitored and assessed as well. For example, market level risks and individual health status risks should also be considered when determining the marginal value of continued operation.

Next steps if you feel it’s time to sell

Whether you’re eagerly awaiting retirement or aren’t quite ready to pass on your business to the next generation, it’s important to plan your succession responsibly. Early and strategic succession planning is in the best interest of you, your clients, and the legacy of your life’s work. Here are a few best practices to follow in order to monitor and maximize the value and marketability of your practice:

Here are a few next steps to maximize the value and purchase price of your practice:

Tracking # 1-05332022

Exp. 09/2024

Selling Your Business

Learn how LPL’s network of active buyers can help you sell your business and create a succession plan.

Common Deal Structures

The acquisition process can be overwhelming for buyers and sellers alike. Learn about the three most common deal structures for the transition of ownership.

Improving Your Market Value

Better prepare for selling your book of business and improve its potential. Learn the three key factors LPL’s Business Valuations team consider when assessing an advisor’s book.

Disclosures

The views and opinions expressed by LPL Financial Advisor(s) may not be representative of the views of other Financial Advisors and are not indicative of future performance or success. Neither LPL Financial nor the LPL Financial Advisor can be held responsible for any direct or incidental loss incurred by applying any of the information offered.

More From Forbes

What’s the ‘real’ value of a financial advisor’s business.

Headline-making M&A deals in the independent space have many employee advisors wondering what their business could be worth on the open market. Here are 3 valuation scenarios to address that curiosity.

Focus Financial Partners, the largest investor in the independent space, went public in 2018 with a $2B valuation.

United Capital Partners, a $25B RIA, sold to Goldman Sachs GS last year for a whopping $750mm.

And, in June of this year, CAPTRUST, a $47B AUM wealth management/401k consulting firm recently took on a 25% minority investment from private equity firm GTCR at a $1.25B valuation.

Those are some eye-popping numbers. Was there something extra special about these 3 sellers that garnered them such sensational deals? Or are deals like that waiting at the ready for most any independent firm?

The answer is, well, sort of.

To be sure, Focus, United Capital and CAPTRUST have built extraordinary franchises, each hitting on all the right data points and capturing the attention of the most well-capitalized and bullish buyers. And certainly, there are plenty of firms out there that have identified the right combination of exceptional client service, smart recruiting and strategic growth initiatives—making them attractive acquisition targets.

Why The Rock's Social Media Muscle Made Him Hollywood's Highest-Paid Actor

Google pixel watch users report serious and alarming issue, meet michael howells: a visionary in a place to make a difference.

But what of the advisor who is an employee of a traditional brokerage firm? No doubt, deals like these make most any advisor sit up and take notice—raising the question of whether a business’s value can be maximized under a brokerage umbrella.

And that sentiment is especially true now. In the past decade, as the momentum has accelerated in the breakaway movement (that is, advisors leaving the traditional employee-based brokerage world to build their own independent firms), advisors have come to view their business as a “business” and more-than-casually wonder what it could be worth on the open market.

Could they become the next Focus Financial, United Capital or CAPTRUST? Maybe.

But even for those who think that these deals are just too good to be true, let’s consider Paul Pagnato, ex-Merrill advisor who sold PagnatoKarp, the $2.3B firm he built with David Karp, to the $9.5B multi-family office Cresset Wealth Management, for an expected mega-valuation in June of this year.

Or take Mark Sear and David Hou, also ex-Merrill advisors, who grew their California-based RIA firm, Luminous Capital, from $1.7B to $5.5B in assets in just 3 years and then sold it to First Republic Bank in 2012 for $125mm cash (not to mention the fact that the duo left First Republic in 2019, giving themselves the opportunity to build another behemoth firm and sell it again).

While these transactions represent just a sample of some of the more high-profile deals in the independent space, they do leave an employee advisor wondering:

Ultimately, the first question can be more easily answered once an advisor has a better understanding of how a valuation is derived. So, I asked our resident expert in M&A at Diamond Consultants , Louis Diamond , and he shared this real world example:

Let’s consider a wirehouse team generating $5mm in annual revenue, managing $600mm in almost all fee-based assets for high net worth clients. This team’s desire for greater freedom and control over economics has made them very interested in going independent. Let’s further assume that, as an independent business, their local expenses (including rent, staff costs, benefits, marketing and the like) would be 30% of annual revenue and that an additional 30% of revenue would be allocated to advisor(s’) compensation.

In simpler terms, that would mean this $5mm business would be left with $2mm in EBITDA that would then be distributed to the owners of the business. If the business in its current state – with zero growth over a 5-year period (a highly unlikely scenario) – were to be sold, it would be valued at $15mm (assuming a 7.5 market rate multiple for a business of this size).

Estimated valuation for RIA with no growth for 5 years.

But, what if we assume that this $5mm team grows at a compound rate (CAGR) of 10% for a 5-year period? How does that impact the value of the enterprise? It almost doubles its EBITDA and enhances the multiple to a conservative 8X instead of 7.5X—thus almost doubling the value of the business overall.

Estimated valuation for RIA firm with organic growth alone.

And, finally, let’s look at how the same compound annual growth rate of 10% for 5 years, plus the acquisition of a $2mm practice in year 5, impacts overall enterprise value. A conservative 9X multiple is now applied to EBITDA because the scale of the business has increased—and that yields a $40mm overall valuation.

Estimated valuation for RIA with organic growth and acquisition activity.

Let’s unpack this a bit:

Most often, independent-minded advisors break away from the traditional brokerage world because they are frustrated by the status quo—hamstrung by limitations and bureaucracy, and burdened by the loss of control. Yet, they are also driven by a desire to accelerate growth (and retain a greater percentage of revenue) and to add inorganic growth to the mix by way of recruiting and M&A .

As figure 3 above illustrates, the operating leverage and margin expansion that is achieved by moderate organic growth plus a $2mm acquisition serves to greatly expand the value of the business overall—by almost 1.5X!

So, the answer to the most frequently asked question, “How can it make sense to go independent where there’s no upfront money, when I can get a 300%+ deal from another major firm or opt-in to my firm’s retiring advisor program?” lies in these illustrations.

For the advisor who is willing to be long-term greedy, there’s tremendous potential to build an extraordinary enterprise in just 5 years’ time—the value of which can dwarf even the most aggressive recruiting or retirement deal. Plus, there are several key benefits that come with the sale of an independent business: First, it is largely done at long-term capital gains vs. the ordinary income tax associated with a recruitment deal or sunset agreement; and, secondly, the business owner now has complete control over who to sell to (whether that be a private equity firm, family office, local RIA firm, or even a bank), how many bidders he will entertain, and even how he wishes to retire.

Ultimately, there are plenty of extraordinary businesses that thrive in the brokerage world. But for those who want to make the leap to business ownership, there’s real potential in building an enterprise in the independent space—where value can grow exponentially, and an advisor can create a business based upon his vision and timeline for retirement.

Partnerships

Marketplace.

We can help you complete a deal. Where are you right now in your process?

Interested in a listing? Complete the buyer profile to be notified first when a new listing is published:

Learn More »

Whether you are a team of 1 or 100, SRG's open market of seller listings is at your fingertips in MyCompass.

Sign up for our free membership to complete a buyer profile and express interest in any listings you want to bid on. If you are a good fit, we will contact you to begin the deal process.

It is that simple.

Recent Articles

Read our blog.

Succession Resource Group is a boutique succession consulting firm based in the Pacific Northwest, serving clients across the country. SRG was founded by David Grau Jr., MBA in 2012 after nearly a decade of helping advisors with valuation and succession planning. SRG's team of experts leverage their industry expertise, combined with best-in-class resources, to help advisors, agents, and accountants manage the equity in their businesses...

10 min read

Selling a book of business for financial advisors.

Jun 29, 2021 11:08:20 AM

There are multiple reasons to believe that the number of mergers and acquisitions in the wealth management space will be high in the next five to ten years. To start with, over 50% of active financial advisors are over age fifty. Many of them will be looking for an exit strategy. Combine that with the fact that very few advisors have a succession plan and the increased deal volume year-over-year recently and it is reasonable to expect more consolidation short and long-term.

Other factors include increased competition, likely higher tax rates, interest rates climbing, more compliance (think Reg BI), increased reliance on technology, and compressed fee structures. These all add up to potential loss of revenue or increased stress (or both), which will drive many advisors to reactively seek firms looking to buy their existing book of business. The combination of deals prompted due to the aforementioned reasons and the normal amount of advisors retiring each year, sellers will be numerous.

Successfully selling your book of business to the right person, and for the right price, is a complicated process that requires multiple steps and considerations. Assessing how much the firm is worth is one of the first to establish reasonable expectations. Finding the right buyer is another critical step. Then the deal terms need to be agreed upon. And do not forget the tax implications. They will have to be dealt with as well.

To assist you in this endeavor, we have compiled some questions and answers to review before and during the selling process. We have also added some tips for after the sale is closed. The relationships with clients will not just end when you sell. There is a transition process.

When is the Right Time to Sell Your Book of Business?

Personal circumstances are rarely in proper alignment with market conditions. Simply “wanting out” does not necessarily mean that it is time to sell your book of business. If your revenue is declining, you just lost your largest client, or made any major internal changes, you may not get the value you are hoping for or expecting.

Retirement is an easier scenario. If you set a target date a few years into the future, you can take the necessary steps to ensure you have maximized the value of your business and positioned yourself to attract the best suitors.

Another priority for those last few years may be prospecting and on-boarding younger clients if you want to create an internal transition plan. Advisors who have worked in the industry long enough to be considering retirement generally have aging clients, specifically clients over the age of 70. While buyers expect an older clientele when buying a business from a retiring advisor, the specific age of clients and the concentration of assets with those older clients can have a detrimental impact if no multi-generational planning is happening.

The key is to understand your book of business and the demographic early enough that you can do something about it. Beginning to do more generational planning with clients will not be an overnight success, but with time and focused effort, advisors have the ability to mitigate one of the primary concerns any buyer will have. It is also a good idea to find the technology you need to be able to track and show the age of your clients, which are engaged in multi-generational planning, what assets those clients have, and any potential roll-overs or new money that could come into the practice.

What is Your Book of Business Worth?

The two most common valuation methods for financial service businesses is either a market-based valuation using comparable transaction data, or an income-based valuation that focuses on the business’s ability to generate profits. Neither of these are the correct solution 100% of the time; determining which method is most appropriate is dependent on the circumstances and size of the parties involved. But, the valuation of a financial advisor book of business can be estimated using a revenue multiplier of trailing twelve-month revenue. The industry standard for RIAs or advisors with recurring revenue is generally between 1.6 and 4.4, but when buyers outnumber sellers by a factor of 75:1 in 2020, it is common to see a well-positioned practice that has been prepped for sale, to exceed 3.0x on their recurring revenue.

Another method used for estimating value is an earnings multiplier (e.g., multiple of EBITDA, EBOC, EBIT, SDE, etc.) . Serious buyers will want to conduct an actual valuation as well as take a deep dive into operational costs and profit margins. Even solo advisors have expenses, but the question remains, will you be assuming those expenses? If you will be assuming the seller’s overhead, and it is more reasonable to use a valuation method that focuses on profitability versus a value of the top-line revenue. When using this method, the industry standard for valuation is 4 to 8 times the annual earnings, including reasonable owner’s compensation.

Regardless of the calculation used to determine valuation, buyers will also factor in future cash flow projections, client retention rates, current fee structure, and the estimated valuation of closest competitors. Solid numbers in each of these areas could increase the sale price.

How do you Maximize the Value of a Book of Business?

Multipliers do not tell the entire story. Granted, revenue and profits are the most relevant variables in calculating the value of a book of business , but there are other actions the financial advisor can take to boost (or diminish) the asking price.

A few of the key performance indicators that advisors have the ability to influence and should therefore monitor are as follows:

How do you Build Transitional Value for the Buyer?

Selling the book of business is not complete when the deal is closed. Those clients have relationships with the seller. There needs to be a transition plan in place so that they stay with the new firm. Buyers want assurances that this will happen as a way to mitigate risk, often including a clawback/retention clause in the deal, or wanting the seller to remain involved in some reduced capacity post-sale.

Financial advisors can mitigate perceived buyer risk, and therefore build transitional value, by starting the process early enough they can remain involved post-sale on a part-time basis for a few years, and/or crafting/contemplating the actions needed to create a smooth handoff from seller to buyer, and possibly creating a strategy based on each client segment, whereby you may do more for your biggest/best clients. This often involves a combination of letters, personal phone calls or virtual meetings, client appreciation events, social media posts, and face-to-face meetings (when appropriate). While it is important to create this type of plan prior to closing, it is rare to share or begin any of this with clients until after the deal has closed and the down payment has been funded.

What are the Tax Implications of the Sale?

Timing of payments is another tax-related consideration that more and more selling advisors need to consider since there is bank financing now available for buyers, resulting in many sellers receiving all or most of their purchase price at closing. While a large cash payment upfront is attractive, many sellers are now considering how they can spread the payments out over multiple years to stay at a lower tax rate. However, when payments are made over time, the seller can expect to pay their taxes at whatever the prevailing rate is at that time. So, while he/she may structure the payments to stay at a lower capital gains rate for example, changes in the tax code could/will quickly undo all the creative tax planning done prior to closing.

Obviously, it is important to consult with a tax professional before making any financial moves, particularly one as large as selling an entire book of business. Do this in the exploratory stages to avoid any last-minute surprises when in the midst of negotiating.

How do you Find the Right Buyer?

If you need medical advice, you go to a doctor. When you need tax advice, you go to a CPA (even though you MIGHT be able to figure it out on your own). When planning a sale or acquisition, it is a good idea to seek help from an M&A specialist. Experts in the field can go over the available options, some of which we have covered here, help evaluate and match sellers with buyers, as well as negotiate the sale, provide relevant industry advice, and other critical resources such as due diligence materials and purchase and sale agreements.

A common but far less successful strategy to “get the word out” is to network with other advisory firms and talk to your custodian or broker-dealer. Even worse is simply selling to a colleague without evaluating other potential candidates and/or offers. Selling a book of business is a common topic among financial professionals. It is the way that larger firms achieve rapid growth, so it is possible there may be a buyer that the advisor looking to sell is already connected to. However, connecting with potential buyers is only the tip of the iceberg, and it is the easy part. It is still highly recommended that sellers contact an M&A expert who knows the industry, even if there seems to be an obvious buyer in the picture. Appearing too eager, not having enough suitors, or not knowing what to ask for or how to get the buyers to say “yes” will negatively affect negotiations. Lack of knowledge could jeopardize the deal or could cause the seller to leave money on the table.

Online “matching making” forums are not the right place to search for buyers or to post a financial services practice. These sites often serve as the “clearance bin” of practices for sale that could not find a better solution elsewhere. A serious financial advisor who values client relationships does not shop them around online. Legitimate firms that are looking to buy a book of business do not go there for sellers.

What Happens After the Deal is Closed?

An advisor retiring from a firm where there are partners and associates to manage client relationships can simply sail off into the sunset with little effort. It does not work that way when an outside firm purchases a book of business. There is a transition process that needs attending to, whether the seller plans to remain involved for a short period, or over many years.

In some cases, purchasing a book of business means buying an entire firm. The primary advisor may step away, but there is still an existing infrastructure in place. Even in these cases, people are part of that infrastructure and need direction. What will their role be if the firm is acquired?

Priority number one is taking care of the clients. As an independent financial advisor, the obligations are clear, which means facilitating a smooth transition. Contact each client and let them know how excited you are to have found the perfect successor, and talk about the lengths you went to in an effort to find the right partner. Reassure them that they will be taken care of and ensure they know you will not be suddenly disappearing, but that you will gradually be slowing down gradually over time.

Once the initial contacts have been made, stay available to both the acquiring firm and the clients. It is most common for sellers to remain available for 12-18 months post sale, providing on average 300-500 hours of transition-related support. As a “former” advisor, the role changes to more of a mentor and guide post-sale. But, it is becoming more and more common, for a seller to remain involved in some capacity for 3-5 years. Selling earlier generally results in less attrition and more growth, and as a result, usually a higher sale price.

When Should You Start Building a Succession Plan?

Most advisors think of a succession plan as something you do when you are ready to retire. If you wait that long, you may not get what your business is or could have been worth with just a little bit of advanced planning. Succession involves more than just naming someone to take over. It is about ensuring you have a plan to transition the business and clients you spent decades creating. While a transition can happen in as little as 6-12 months, many find the process more enjoyable when they sell a few years prior to wanting to completely step away from the business, giving themselves and the clients more time to get acclimated.

The time to create a succession plan is right now. Begin with the end in mind. You can never start thinking about succession too early. You may not take active steps when you are in your 40s and 50s, but knowing where you want to end up at the end of your career will help you run a better firm in the meantime and have an exit event that is so gradual almost no one notices. Maybe you want to build your business and have your children or other family members take it over, maybe you want to find the best candidates and sell to the highest bidder as part of your own retirement plan. The key is to have an idea before your clients start asking. Contact Succession Research Group (SRG) today for assistance. Our team has experience with helping advisors increase the net worth of their practice and creating succession and acquisition strategies to guarantee profitability.

Topics: Seller Building Value/Business Valuation building value

Written by David Grau Jr.

Previous post.

Three Traditional Approaches to Valuation Methods

Succession Planning 101: Steps and Processes

Posts by topic.

Succession Resource Group, Inc. is not affiliated with or endorsed by FP Transitions, LLC or Succession Link, LLC

Valuing a Financial Advisor’s Book of Business

The number of financial advisors, investment advisors, and wealth managers seeking to sell a book of business or an entire financial advisory, investment advisory, or wealth management practice is currently in short supply, in comparison to the number of advisors seeking to buy such practices or books of business. Such ratios may fluctuate according to market events, the number of purchasers or sellers in the marketplace, the overall demographics of investors, and myriad other factors.

Due to the numerous elements that are essential to calculating the value of an investment advisory, wealth management, or financial advisor practice or book of business, it is imperative for both sellers and purchasers to acquire a current and accurate valuation. In fact, the valuation will likely be the starting point for any discussions about a potential transaction.

The Valuation Process

Because financial advisor and wealth management practice values depend upon so many different elements and factors, they are constantly in flux, which makes the process of valuation relatively complex. Further, while a practice may receive a particular valuation according to the numbers on paper, a buyer may not always pay that amount, and a seller may not always accept it.

In addition to determining an advisory practice or book of business’s value, the two parties engaging in the transaction must also determine the structure of the transition (e.g., how long the seller will remain involved with the business, etc.). Once the metrics have been run, any agreement for the acquisition of an advisory practice is ultimately determined through negotiation between the purchaser and the seller.

Whether you are on the buying end or the selling end of the deal, there are several components that will help you to make an accurate determination of whether the acquisition is warranted and worth its time from your perspective.

The seller will have to assess the currently-generated revenue that they’re receiving in their advisory practice or through their book of business. As some client attrition is a near-certainty in nearly every such transition, a certain percentage of expected attrition will have to be accounted for, as well.

The financial advisor or investment advisor who is selling will have to determine how they would like the transition to occur and what their level and length of involvement will be during and following the time of the acquisition.

Long-term success is a primary goal for any purchaser. The purchaser should determine what level of profit they’re seeking and the amount of time within which they want to reach those returns. The seller will want an accurate assessment of future profit expectations, as well as a risk assessment of what and how long it may take to recover from an unforeseen downside event in the market or a loss of clients, assets, or revenue.

Once the buyer determines the amount of capital that will be required from them, they will need to determine whether the returns that they can reasonably expect will justify the investment of their time and funds.

In determining potential profits, there are many factors that can drive down those expectations, including an older client base, concentrations of assets or revenue, and clients that may not be a fit for the purchaser.

When financial advisors or investment advisors are willing to spend more time on a transition – both from a purchaser standpoint and a seller standpoint – the business can maximize its potential and thereby its valuation. Longer transition periods give the financial advisory practice or book of business’s clients more time to establish strong relationships with the purchaser while the seller is still active. In those scenarios, the clients feel more attended to, and the relationship-building with the buyer is more fluid.

Other Factors

Likewise, other factors may drive up a valuation. Purchasers may seek to expand their services offered, clientele demographic, or reach by acquiring a book of business with a client base to which they do not currently have access.

If the wealth management practice or financial advisor book of business being acquired offers the purchaser such an opportunity to expand, the purchaser may be willing to pay a premium.

Valuation Methodology

The two most common methods used in practice valuations are multiples methods and income methods. Both such methods assume various market-performance scenarios and various rates of client attrition in multiple models to account for downside risk.

Multiples Method s

Multiples methods compare a business’s statistics with other businesses that have recently sold. Such methods use either revenue or cash-flow multiples. Multiples of revenue averages a business’s numbers over the past year, for example, in order to determine an average. Multiples of cash flow goes a step further and accounts for the business’s expenses by utilizing net operating income (NOI), earnings before income taxes (EBIT), or EBITDA (earnings before income taxes, depreciation and amortization).

If an entire practice is the target of the acquisition, rather than simply an individual financial advisor or investment advisor’s book of business, multiples of cash flow would be the multiples method of choice for that valuation.

While multiples methods involve simpler calculations, they do not provide estimates for future revenue, which is arguably the most important projection to a purchaser. Additionally, information regarding similar sales of practices or books of business can be difficult to procure, as the majority of such acquisitions are executed through private transactions.

Discount Cash Flow (DCF) and Single-Period Capitalization

The other most common methods used in valuating a practice or book of business are income methods – both discounted cash flow (DCF) and single-period capitalization. Where multiples methods fall short, income methods do in fact make projections of future cash flow. DCF accounts for risk and makes projections for a specified period of time. Single-period capitalization is an abbreviated form of the DCF method.

While income methods can provide some predictions, market unpredictability will inherently diminish those methods’ reliability.

Ready to Sell Your Financial Advisor Book of Business?

During any transition, it’s crucial to ensure that the logistics or issues involved do not take precedence over the needs of and attention to current clients. Sellers must ensure that they select a purchaser who will care for their clients with a minimum of the amount of care and attention to which the clients are accustomed.

Purchasers must do their best to familiarize themselves with the clients, their needs, their goals, and their expectations, in order to remain attentive and effective at helping those clients to achieve their objectives.

AdvisorLaw is a one-stop solution with experienced attorneys who understand business law, securities law, and how to complete seamless transactions. If you’re interested in acquiring a financial advisor book of business, or if you’re ready to sell your wealth management firm, we are actively sourcing buyers and sellers with different types of advisory practices in your market.

Learn more about our Practice Purchase Network (PPN) , or contact us using the form below for a complimentary consultation.

Advancing Knowledge in Financial Planning

CE numbers not found!

CE numbers are required for Kitces to report your credits. Would you like to add your CE numbers now?

Please contact your Firm's Group Admin

IAR CE is only available if your organization contracts with Kitces.com for the credit. Please contact your firm's group administrator to enable this feature. If you do not know who your group administrator is you may contact [email protected]

LAST CHANCE

Purchase your early bird pass and receive a kitces-blue goodies mystery box.

Kitces Marketing Summit Thursday, April 27 | 12:00 – 4:00 PM ET

Purchase Early Bird

Early Bird Deadline is March 3

FP Transitions And The Kelley Blue Book Valuation Of An Advisory Firm

February 20, 2017 07:00 am 6 Comments CATEGORY: Practice Management

Executive Summary

An independent financial advisory firm can have significant value, even if the business doesn’t have any physical or intellectual property to yield profits. Because the reality is that with annually recurring revenue and 95%+ client retention rates, there really is income-producing value in an advisory firm, even if it’s mostly based on the “goodwill” of clients to stick around year after year.

However, valuing a business whose primary assets is intangible goodwill can be challenging, especially given that the overwhelming majority of independent advisory firms are small/solo practices that generate little net profit beyond the healthy income paid to the advisor-owner to operate the business. As a result, the traditional Discounted Cash Flow (DCF) approach to valuing most businesses tends to break down (and undervalue) a “small” advisory firm (e.g., those with <$1M of revenue).

For such hard-to-value assets, an alternative approach to valuation is simply to look at the prices being set by buyers and sellers in the actual marketplace, and to simply value the business relative to its marketplace comparables. In fact, sometimes digging further into the piecemeal value of the business isn’t even relevant, just as no one values a car by disassembling it to value and then add up all the component parts; instead, for nearly 100 years, they’ve just looked up the going market value in the Kelley Blue Book instead.

In the context of advisory firms, the leading “Kelley Blue Book” solution for valuation is FP Transitions and its “Comprehensive Valuation Report” (CVR), which uses their comparables database of more than 1,500 advisory firms bought and sold in the past 20 years to estimate the value, after making reasonable adjustments for transition risk, cash flow quality, market demand, and the payment terms of the transaction itself.

Unfortunately, the FP Transitions CVR valuation estimate isn’t quite as cheap and accessible as buying the Kelley Blue Book – due to the harder-to-value aspects like transition risk and cash flow quality that must still be considered – but nonetheless, at $1,200, it makes getting a reasonable valuation accessible for the vast majority of independent advisory firms. In fact, a growing number of firms get regular valuation updates every year or two, just to understand how the value of their firm is changing, and whether/how they should make changes to further enhance the value.

Ultimately, the largest advisory firms that have greater complexity may still want to rely on custom valuations using the DCF approach, and a growing number of online valuation tools for advisory firms are starting to crop up to compete as well. Nonetheless, it’s hard to argue with going right to the source, and getting a valuation from FP Transitions using their actual (albeit proprietary) database of over 1,500 completed advisory firm transactions.

Author: Michael Kitces

Michael Kitces is Head of Planning Strategy at Buckingham Strategic Wealth , which provides an evidence-based approach to private wealth management for near- and current retirees, and Buckingham Strategic Partners , a turnkey wealth management services provider supporting thousands of independent financial advisors through the scaling phase of growth.

In addition, he is a co-founder of the XY Planning Network , AdvicePay , fpPathfinder , and New Planner Recruiting , the former Practitioner Editor of the Journal of Financial Planning, the host of the Financial Advisor Success podcast, and the publisher of the popular financial planning industry blog Nerd’s Eye View through his website Kitces.com , dedicated to advancing knowledge in financial planning. In 2010, Michael was recognized with one of the FPA’s “Heart of Financial Planning” awards for his dedication and work in advancing the profession.

The Challenge In Valuing A Financial Advisory Firm

A financial advisory firm can be incredibly valuable, even though unlike most “traditional” businesses, it has no equipment or other physical income-producing assets, nor any intellectual property that can be licensed. Nonetheless, advisory firms have a client base, that pays regular annually recurring revenue, and has an astonishing lifetime client value given 95%+ retention rates for those clients year after year. Which means if a buyer can step in, and merely continue to service those existing relationships, there’s a profitable cash flow ready and waiting.

And as a result, advisory firms can be sold for substantial sums, even though the overwhelming majority of the sale price is based on nothing more than the “goodwill” of the clients to stick around.

Except the question arises: how much, exactly, should a buyer pay for an advisory firm whose primary value is just the goodwill of clients? Especially if there’s a risk that goodwill may be overly attached to the advisor who is about to walk out the door, as an estimated 95% of advisory “firms” are really just a book of business or a small practice served solely by an advisor and perhaps a handful of support staff (who may or may not be loyal to a new owner/buyer).

Valuation Methodologies For Financial Advice Businesses

The classic measure for income-producing businesses that don’t have physical assets able to be sold/liquidated is to just value the income stream itself, either by capitalizing the cash flows at an risk-appropriate cap rate, or for smaller and potentially-more-rapidly-growing businesses, to calculate the discounted present value of future cash flows (more simply known as the “ Discounted Cash Flow ” [DCF] methodology).

The problem, however, is that the DCF methodology doesn’t align very well to solo-owner independent advisory firms . After all, the DCF method is generally predicated on calculating the free cash flow of the acquired business, after replacing the key employees. Except in a solo advisory firm, almost all of the “profits” of the business are simply the compensation OF that owner-advisor. And so, to a third-party buyer, the present value of the free cash flows would be relatively modest.

Buying, Selling, and Valuing Financial Practices

In January 2000, we listed our first practice for sale, a fee-based sole proprietorship. We used a multiple of about 1.4 × TTMR (trailing 12 months revenue), an opinion extrapolated from the results of the discounted cash flow analyses that many at the time insisted held the right answer. In other words, the DCF model seemed to have priced the business far too low – in what appears to have been a combination of both a sheer understatement of the value of a solo advisory firm based on the DCF methodology, and also the fact that, in the early days, appraisals were typically tied to all-cash transactions, despite the fact that virtually all advisory firm acquisitions today use some kind of shared-risk shared-reward structure (which ultimately allows for higher valuations, at least if/when the client base transitions successfully).

Click To Tweet

But if the DCF model doesn’t work for smaller advisory firms, how should you determine the appropriate price for a buyer and seller (and not let it become a major point of dispute and contention)?

Valuing An Advisory Firm From Direct Market Data Comparables

One of the most straightforward ways to value a hard-to-value asset is simply to look at what other similar assets are selling for in the marketplace, and just make adjustments along the way for known-to-be-relevant features of the particular asset.

In point of fact, automobiles are commonly priced this way, a practice first established by Les Kelley when he created the Kelley Blue Book , that “simply” estimated the value of a car by looking at the market prices of other cars being bought and sold in the marketplace (with reasonable adjustments for everything from wear-and-tear condition, to upgraded features).

Of course, the challenge in the advisory firm context is that pricing an advisory firm based on comparables requires a large database of comparables in the first place! Though this was a challenge in the past – FP Transitions , which has been facilitating advisory firm Mergers & Acquisitions for nearly 20 years – actually does have a database now, of more than 1,500 completed transactions!

The FP Transitions Comprehensive Valuation Report (CVR)

The FP Transitions Comprehensive Valuation Report (CVR) aims to provide a “most probable selling price” estimate of value by looking at comparable market data from its proprietary database, and then adjusting the valuation based on relevant market factors.

In the context of advisory firms, the three primary adjustment factors used to estimate a price in the CVR are: Transition Risk, Cash Flow Quality, and Market Demand.

Transition Risk

Transition risk is arguably the biggest and most material issue to consider. After all, if the clients don’t transition to the new owner-advisor, and their recurring revenue doesn’t stick around, the entire value proposition collapses.

And notably, there are a lot of issues to consider when assessing transition risk, including how long the clients have been involved with the firm in the first place (and therefore how likely they are to remain ‘loyal’ and stick around), the availability and willingness of the departing advisor to stick around after closing to help with the transition, whether clients will continue at the same broker-dealer/custodian or have to be transitioned to a new platform (as a requirement to re-paper accounts isn’t fatal, but at least increases the risk that fewer will transition), and whether there’s already any established relationship between the buyer and the clients (for instance, an internal transition or intra-family transaction usually has lower transition risk than a third-party buyer).

Of course, it will never be perfect – FP Transitions notes that even in a typical well-executed acquisition, only 90% to 95% of clients stick around after a year. But obviously, it could be better, or could be far worse… which matters, a lot, to the value of the advisory firm.

Cash Flow Quality

In addition to the transition risk of clients, it’s also important to recognize the “quality” of the cash flows that the clients are paying – in other words, what are the risks and underlying trends of the cash flows themselves.

For instance, the demographics of the clients who are paying the advisory fees is a big deal when it comes to cash flow quality of the business. After all, there’s a huge difference between generating $500k/year of revenue from a bunch of 75-year-old clients who are spending/withdrawing, versus a group of 50-year-olds who are still accumulating and mostly past the stage of paying for college (where there should be a lot of substantial ongoing contributions).

In situations where there actually are multiple advisors, the “cash flow quality” also involves the question of how likely it is for those other advisors who support the clients (and their cash flows) to stick around, or whether they may break away, and take clients with them , potentially severely undermining the cash flows for the buyer.

Market Demand

Last but not least, there’s the sheer market demand itself, which is driven by the size of the firm and the structure of the practice (for instance, sellers on a large custodial platform may have more demand than those currently at a small broker-dealer), its location (as the buyer may or may not want to expand to clients in that location), and whether the practice has a niche or other unique characteristics that would add strategic value.

Payment Terms

Of course, it’s also important to note that Payment Terms matter, too. Because how the payments are classified and structured can impact the taxation of the transaction for the seller, and also the buyer. Which matters, because whether a buyer can deduct or amortize the purchase price has a real impact on what he/she may be willing to pay in the first place .

In addition, the reality is that the more risk-sharing there is in the terms of the deal, the easier it is for the buyer to pay more (at least if the deal works out well, because the buyer is protected if the transition goes poorly).

How Risk Sharing In Deal Structure Can Impact Advisory Firm Valuations

In practice, Grau notes that deals typically include some cash at closing – e.g., 30% – because the seller usually won’t tolerate “nothing down” (although pure revenue-sharing transitions do occur sometimes within broker-dealers), but the buyer won’t accept the risk of an all-cash deal that might not turn out well. And Grau advocates for a performance-based promissory note that reduces the remaining amount owed after a year or two if there’s been a substantial “miss” on anticipated retention.

The Importance Of Getting A (Regular, Independent) Valuation

One of the reasons that the Kelley Blue Book (KBB) became so popular as a means to figure out the price to buy or sell a used car was because it was so simple and easy to use. It made reasonable pricing information easily accessible, and potential buyers or sellers could simply look up the car in question, make a few reasonable adjustments, and get a good estimate of the appropriate price (from an independent source they could mutually agree upon). Of course, an especially unique car with specialized features might require a more formal appraisal process. But for the overwhelming majority of transactions, the KBB got the job done efficiently.

And arguably, the same may be true for what FP Transitions has created with its CVR valuation solution. As while there are advisory firm valuation experts who can assist in applying the DCF model to large and complex advisory firms, the reality is that for most practices, simply looking at comparable market data, and making reasonable adjustments for known-to-be-relevant factors (e.g., transition risk, cash flow quality, etc.) are more than sufficient to get a good estimate of a reasonable price for a buyer and seller. In some cases, more detail doesn’t even help, just as disassembling an entire car and valuing each component from the bottom up won’t actually give a better valuation than just looking at what price buyers and sellers are valuing the car in the actual marketplace.

Especially since for “smaller” practices as opposed to businesses (e.g., most of those under $1M of revenue), it’s not even clear that the more granular DCF methodology is effective to value the firm, as it appears to under-rate the value for buyers who aren’t just looking to invest capital for profits, but want to “buy a job” that will pay them well to service the clients, too.

The relevance of this for the individual financial advisor is that it tools like the FP Transitions CVR make “regular” valuations of an advisory firm more feasible because the straightforward market data approach brings the cost down substantially. While “complex” firm valuations can run $6,000 to $16,000, advisors can get a CVR from FP Transitions for just $1,200/year. (Michael’s Note: Nerd's Eye View readers interested in purchasing an FP Transitions CVR can receive a $200 discount through March 31, 2017, when using the KITCES200 discount code.)

Notably, that’s still significantly more expensive than the automobile equivalent of just buying the Kelley Blue Book – ostensibly because it’s still a more manual (and somewhat subjective) process to “score” or index an advisory firm’s transition risk and cash flow quality and assess market demand. Nonetheless, the price point is low enough that even solo advisory firms could get “regular” valuations every year or few.

This can be especially important for those who are considering a sale in the coming years – even if not imminent – because it provides clear feedback on what the firm is really worth, and indicators of what can be changed or improved to enhance the value by the time it’s really time to sell. In other words, it gives you (the advisor-owner) an understanding of the levers you can move that materially maximize value.

And of course, getting an (independent) valuation is also important for those who really are getting ready to sell their advisory firms, especially if they’re “smaller” advisors. Because the reality is that even a “small” advisory firm still has real value to a buyer. In fact, Grau emphasizes in his book that just getting indications of interest from the “closed market” platform of an advisor’s existing custodian or broker-dealer may substantially undervalue the business – a fact that the custodian or B/D itself may not disclose or emphasize, since it’s in their interests to see the assets retain on their platform, not to necessarily maximize the value for the selling advisor. And an advisor who doesn’t get an independent valuation may never realize what he/she missed.

Of course, it’s worth noting that FP Transitions is not the only company offering valuations for financial advisory firms. Other ‘competitors’ include Echelon Partners and DeVoe & Company for very large advisory firms, along with Succession Resource Group , and Advisor Growth Strategies . Another player is Gladstone Associates , which initially developed and then separately spun out an online eAnalytics platform called Truelytics to facilitate and ease the (annually recurring) valuation process, along with more recent newcomer 3X Equity (at an even lower price point). And firms like Succession Link and RIA Match are trying to operate as competing marketplaces to FP Transitions.

Nonetheless, FP Transitions appears to be unique in having real-world market data of more than 1,500 transactions that they’ve facilitated over the past 15+ years, giving them unique insight into the factors that are actually driving the valuation process, and what buyers and sellers are actually agreeing to (as opposed to just what a DCF model would predict).

For the truly large and complex advisory firms (e.g., $500M+ and especially $1B+), it may still be appealing to get an even more customized valuation using the DCF model. But for the overwhelming majority of practices, where the owners (and the DCF model) seem to actually underestimate the value of the practice, the FP Transitions Comprehensive Valuation Report appears to be a good fit to fill the void.

So what do you think? Would you pay for a Kelley Blue Book valuation of your firm? Have you used the FP Transitions Comprehensive Valuation Report? Do you think all firms should get regular valuation updates? Please share your thoughts in the comments below!

(Michael’s Note: Nerd's Eye View readers interested in purchasing an FP Transitions CVR can receive a $200 discount through March 31, 2017, when using the KITCES200 discount code.)

Showcase YOUR Expertise

Submit Podcast Guest Submit Guest Webinar Submit Guest Post Submit Summit Guest Presentation

Stay In Touch

General Inquiries: [email protected]

Members Assistance: [email protected]

All Other Questions, Or Reach Michael Directly:

This browser is no longer supported by Microsoft and may have performance, security, or missing functionality issues. For the best experience using Kitces.com we recommend using one of the following browsers.

Username or Email Address

Remember Me

Forgot my password

To complete this Course purchase, you must log in to your Kitces.com account, or create a Reader account if you don't already have one.

Don't have an account?

Set up a free Reader Account to save articles and purchase courses.

Friend's Email Address

Your Email Address

Whether you’re making internal equity decisions, or selling your investment practice, understanding the methodology for valuing a financial planning business is critical to make the right next step.

What impacts the value of an RIA firm?

While the final sale price of an RIA firm can only be determined by negotiations between buyer and seller, and depends heavily on how the transaction is structured, the value of any business comes down to three main factors:

How these factors are assessed is unique to each transaction, but the following are a few key considerations that are widely used during the valuation process:

Valuation Methodology

Multiple of revenue.

One of the simplest methods to value a wealth management firm relies on a multiple of revenue. This multiple is most often applied to Trailing 12-month (TTM) revenue, but may be applied using 3-year average revenue, quarterly annualized revenue, and projected 12-month revenue.

The actual multiple applied to determine the value of the practice depends on how the revenue is generated. In general, a higher multiple is placed on recurring revenue (fee-based), and a lower multiple is placed on the portion of revenue that is transaction-based. The resulting values are added together to determine the total value of the advisory firm.

One problem with a revenue multiple is that it fails to consider other aspects of the wealth management firm that make it unique when compared to its peers. Consider the following example:

Since both RIAs have the same revenue so if we relied solely on a revenue multiple, we would value each advisory practice the same. But a quick look under the hood would reveal very different expense structures, resulting in very different profitabilities.

Multiple of EBITDA

EBITDA stands for Earnings Before Interest, Taxes Depreciation & Amortization. It is a measure of earnings that eliminates financing costs (interest), non-cash expenses (depreciation & amortization), and taxes. It is often used in the valuation of a financial firm’s operational performance because it removes the impact of the management decisions mentioned above. Many of the earnings-based multiples you see for RIAs are based on EBITDA.

While an earnings-based multiple is often more accurate than a revenue multiple, it still fails to accurately assess all of the unique aspects of a wealth management firm. Consider the following example:

Once we move beyond profits and explore other aspects of the financial practices, we can see that the growth of the two firms has been quite different over the past few years. RIA 1 could also have a very high percentage of revenue generated from its top 5 clients leading to higher risk. These are just a couple of examples related to growth and risk, but many of the factors listed above could impact an investment advisory firm's value.

The advantage of using multiples, including revenue, EBITDA, and others, when valuing an RIA is simplicity. One can get a quick “ball-park” valuation of the practice by doing elementary math. But when it comes to making important decisions multiples fall short of assessing the unique aspects of each financial planning firm.

Discounted Cash Flow

Another method often used to value financial advisory firms is the Discounted Cash Flow method, which uses historical performance, discussions with management, and a thorough understanding of the specific business model to project future financial performance over a defined period. One then calculates a terminal value and discounts all resulting cash flows to present value utilizing a discount rate that reflects the perceived level of risk present to that specific company. The final value is the terminal value plus the discounted cash flows.

While this method does rely on some assumptions and predictions, it allows a valuation expert to more thoroughly assess the business as a whole. The specifics of a good Discounted Cash Flow valuation can be quite complex and will involve many relevant factors specific to valuing wealth management firms, which is why it’s often best to utilize a valuation expert.

Third-Party Valuations

Third-party valuations are utilized as a gauge of the firm’s enterprise value for several M&A participants and are often a starting point for negotiations. While this valuation reflects what one might expect using an “average” deal structure, it rarely reflects the final sale price.

A significant majority of banks and other lenders require a third-party advisor valuation service for assisting their underwriting team. Banks are very judicious in selecting valuation firms consequently, it is important to retain an RIA valuation from a recognized firm with expertise in the RIA industry. Please contact our Credit Team at [email protected] to receive a list of approved valuation firms.

Does SkyView perform RIA valuations?

SkyView does not provide third party RIA valuations. Our network of bank partners requires a third-party RIA valuation for each wealth management loan. SkyView has partnered with a number of the leading RIA valuation firms across the nation and can help financial advisors choose an advisor valuation partner that is best suited for their RIA loan.

In general, what is an advisory practice worth?

Often, advisory practices with a larger portion of their revenue generated from recurring advisory fees attract higher valuations than revenue from non-recurring resources. RIA valuations and multiples vary based on a number of factors.

What are a few of the key factors that these valuation firms use in valuing financial advisory firms?

Here is a list of some of the key factors that drive valuations:

What is the most accurate method of valuing a financial advisory firm?

SkyView relies on the expertise of our third-party RIA valuation experts to determine the value of each RIA practice. Each RIA valuation firm utilizes a proprietary valuation methodology, but commonly use a multiplier on revenue or EBIDTA.

Ready for the next chapter in your career?

Valuation Tool

Resources & articles, exit strategy, for sellers, goal setting, succession planning.

ADVISORS ARE LOOKING TO TAKE CHIPS OFF THE TABLE, NOT EXIT ENTIRELY

EXIT PLANNING 101:FINANCIAL ADVISORS EXCLUSIVE

LOOK FOR THESE SIX (6) THINGS BEFORE SELLING YOUR PRACTICES

SIX TIPS FOR EFFECTIVE SUCCESSION PLANNING

Get in touch.

1303 Main Street, port Jefferson NY 11777

Sign Up For Our Newsletter

IMAGES

Financial Advisor Business Work Stock Photos
Business Plan For Financial Advisor Pdf
Financial Advisor Business Plan
A Financial Advisor Business Plan Template You'll Want to Use
Business Valuation Spreadsheet Excel pertaining to Business Valuation Spreadsheet Template And
Business Financial Plan

VIDEO

What does a financial advisor do? #shorts
Business Valuation
Business Finance
The value of an expert financial advisor
Financial Management and Investment Options under the Current Economic Conditions
Financial Management (Valuation of securities Part 2)

COMMENTS

Valuing a Financial Advisor Practice
The revenue multiple method is the most basic means of obtaining a valuation for your financial advisory firm. Here's how it works. Multiply the
Valuation Multiples for a Financial Advisory
For instance, if a financial advisory firm generates $400,000 in revenue and transacts at a 2.54x multiple, then the business value is worth
Valuing an Advisory Practice: Fundamentals to Consider
For buyers, getting a more granular understanding of the book of business is critical for generating strong financial returns, but it also enables them to focus
How to Know It's Time to Sell Your Financial Practice
Valuations are based on projected future cash flows of you practice, and businesses command the highest purchase price just before they hit
What's The 'Real' Value Of A Financial Advisor's Business?
Headline-making M&A deals in the independent space have many employee advisors wondering what their business could be worth on the open
Selling a Book of Business for Financial Advisors
The two most common valuation methods for financial service businesses is either a market-based valuation using comparable transaction data, or
Valuing a Financial Advisor's Book of Business
Revenue. The seller will have to assess the currently-generated revenue that they're receiving in their advisory practice or through their book of business.
Reviewing The FP Transitions Comprehensive Valuation Report
An independent financial advisory firm can have significant value, even if the business doesn't have any physical or intellectual property
What impacts the value of an RIA firm?
Another method often used to value financial advisory firms is the Discounted Cash Flow method, which uses historical performance, discussions with management
Valuation Tool
ADVISORS ARE LOOKING TO TAKE CHIPS OFF THE TABLE, NOT EXIT ENTIRELY · EXIT PLANNING 101:FINANCIAL ADVISORS EXCLUSIVE · LOOK FOR THESE SIX (6) THINGS BEFORE