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Business valuations under the FoFA regime see significant change, write Stephen Prendeville and Steve Murray, but there is every reason for continuing confidence.
| The proposed changes for advice-related licensees can be summarised as follows: • A general ban on commissions paid to licensees.• Volume-based payments to advisers by a licensee are banned.
• Volume-based benefits paid to a licensee are banned. • The adviser must give priority to a client’s interests where a conflict arises. • The adviser is required to act in the best interest of the client – with minimum steps that must be taken. • Commissions on insurance through superannuation banned. • A product provider must not provide conflicted remuneration to a licensee or representative. • A general ban on licensees and representatives receiving soft dollar benefits. • A ban on licensees charging asset-based fees on borrowed amounts. • Licensees will be required to provide annual statements to clients showing fees and services with a biennial requirement for the client to “opt in” to continue with the services. • Advice can be scaled for retail clients. Note: there are exceptions to a number of the changes shown above that are not relevant for the purposes of this article. |
While the debate over the final form and implementation timing of the FoFA regime continues, the political agenda is set. Failure to adjust to the new environment may reduce business competitiveness and lessen current or future value.
There are 10 recommendations that licensees should consider in order to improve and maintain a practice’s value.
Recommendation 1: Banning of commissions One of the key tenets of the legislation is the removal of commissions and the relationship between the manufacturer and the adviser.
The first recommendation for maintaining or improving business value is to move your business to a fee-based model at the earliest opportunity. In almost all cases this has lead to enhanced revenue and client engagement.
Recommendation 2: Volume-based payments The second recommendation is that whether volume-based payments are deemed to be conflicted revenue or not and whether they will be able to be received in the future directly by the practice or not, they must be considered at risk. There is some grandfathering of existing volume payments, however as they are capped they are likely to diminish over time. There is also the question of whether a capped volume payment will continue to be paid if a business or client base is sold to another licensee.
Any practice receiving volume-based payments needs to reduce its dependency on this revenue stream and if clients are not aware of the subsidisation of a service offer because of the existence of the volume override, they need to be. Clients need to understand and accept that if volume-based payments are removed, they may be asked to pay more for the same service.
Recommendation 3: Service proposition This brings into question the perceived value for service that is currently presented to clients and what that value proposition should look like in the future.
Apart from the change from commission-based to fee-based charges, the opt-in requirement will require licensees to firstly think through their approach to providing advice and then look at documenting that in a way that clearly articulates their service offering to the client.
Those licensees that do not have a clearly defined service offering that all clients participate in will receive a lower valuation.
Recommendation 4: Opt-in process The initial suggestions that the cost of satisfying the opt-in requirements would be $11 per client are laughable. Almost all the cost analysis thus far has been generated by product providers, and is of course limited to their products.
Bear in mind that licensees are required to advise clients of the services that they received during the previous 12 months – this may include such things as assistance with any or all of the following: formulating a budget, Centrelink application, chasing lost super, handholding in a market downturn, acting as a sounding board for discussion of general finance issues, submitting an insurance claim, estate planning and legislative changes that might affect clients.
It may also include many other intangible services, but it is the intangible services such as those above which clients tend to value the most.
Unfortunately, details of these services are not recorded in a list; at best they are contained in individual file notes within the client file.
Clearly each licensee will need to develop a process for extracting this information so that clients can be reminded of the range of services provided.
Any business with strong processes, particularly for retaining clients, will be valued more highly.
Recommendation 5: Add value to the service offering High-value practices in the current environment, with little new investment other than cash, are focusing on alternative areas to add value, such as ensuring a current last will and testament and estate planning
Additionally, after the fire and flood disasters experienced across Australia, many licensees are offering full document archiving and, for example, storage of deeds, life insurance policies, investment plans and tax information, plus family photos in secure online electronic storage facilities. An audit against a checklist can be done of what should be stored and what is missing and needs to be addressed and created. Additionally, full reviews are being done with many clients reassessing previous risk profiles and requiring new portfolio adjustment.
We have seen the movement of many practices and dealer groups for greater participation along the value chain – moving from purely advice to administration, portfolio creation and research. This is being enabled by the new technology individually managed accounts (IMAs), managed discretionary accounts (MDAs) and separately managed accounts (SMAs) and the ability to outsource to specialists while still reducing costs to the client and increasing revenue participation.
Recommendation 6: Re-evaluate personal risk business One area that has seen a repricing upwards is personal risk. Risk practices demand a premium of 3.5 times or greater. There are a number of reasons for this – the robust nature of the revenue stream, its immunity to market movement and apparent freedom from legislative risk (with the exception of corporate superannuation).
Recommendation 7: Re-evaluate corporate superannuation Corporate superannuation revenue has collapsed since FoFA announcements and there is little seller or buyer interest. The last offer on a corporate superannuation book received was at 1.5 times and the disappointed vendor felt that the revenue would not continue beyond 18 months and therefore decided to hold it as an annuity stream.
However, there has been significant work done in this area and specialist practices have moved from commission to fee-for-service on a member basis, and in most cases have experienced enhanced revenue streams. It is felt confidence will return to this part of the market once legislation is clarified.
The positive is that now members are being serviced, relationships are being built through service delivery, the competitive pressure of industry funds addressed and the revenue stream is not only not at risk, but promises cross-selling opportunities.
Practices that have not addressed their corporate superannuation remuneration model need to do so immediately. As a result, a practice is likely to experience a 100-per- cent increase in valuations on this revenue stream by moving to a fee for service model. However, there needs to be delivery of service, and this requires in many cases product change and in some cases additional resourcing.
Recommendation 8: Service and client segmentation This value relationship is normally evident when service segmentation is in place, where multi-service packages are offered and are clearly defined by offer and pricing.
While industry practice has seen most fees as a percentage of FUM or FUA, seeking to improve business value requires setting fees that attract a higher valuation. The reason being that if fees are not held hostage to economic, market or product performance, but solely on service delivery, the revenue is more secure and a known profitability or margin-per-client service segmentation is evident and ongoing.
The more knowledge licensees have of client demographics, the better their ability to drill down or cut and dice electronic client management systems (CMSs).
Any investment in this area will normally bring greater dividends. CMSs should not only be able to provide licensees with all contact dates and diary notes, but also to supply birth dates, location, type of employment, remuneration, marital status, age of kids, professional relationships (accountant, lawyer), hobbies, sport preferences, club affiliations etc. It is with this level of transparency that a database becomes valuable. Any prospective purchaser can immediately see the quality of clients, and also carry out specific marketing and communication activities rather than general ones.
Enhanced management tools (cash-flow management and projection, business and marketing plans and the ability to segment FUM by product, platform, superannuation, investment, risk, allocated pension, and so on) will also be more specific. This information will be critical in any assessment by a prospective buyer and will also assist management until the time for realisation.
Recommendation 9: Focus on profitability Profitable businesses are being awarded higher multiples of recurring revenue and, if or when volume overrides are removed, we may see greater use of valuations based on earnings before interest and tax (EBIT) than ever before.
There needs to be a focus on profitability and in order to maintain current recurring revenue valuations in businesses, licensees need to be operating at above 35 per cent EBIT to gross revenue to achieve pricing convergence (three times recurring revenue equals six times adjusted EBIT).
Consider this example: A business with gross revenue of $500k, recurring revenue of $400k and an adjusted EBIT of $200k (40 per cent of gross revenue) on a recurring revenue multiple of three, the value is $1.2 million. On an EBIT multiple of six times, a licensee can achieve $1.2, and price convergence.
The issue with this example is the difficulty in achieving a 40-per-cent-adjusted EBIT without compromises in service delivery. The adjustments to EBIT are the acceptance of a principle’s salary in capital cities of $120,000 and therefore, if drawings have been $200,000, then $80,000 is added to EBIT. Additionally, any expenses or personal expenditure – such as travel, car leases and insurance – is also added back. The assumption is that if the principle is not there, then a senior adviser would need to be employed and that cost structure determined.
Recommendation 10: Generate new business Premiums are being paid for practices that are generating new business. Such practices are a minority in the current environment, but some are actually growing against significant head winds. Those that are growing are doing so because their value proposition gains clients and referral acceptances, especially from new accounting relationships.
The reasons for greater acceptance from accountants are the limitations imposed on service offers, acceptance of risk regarding product failure and impact to client relationships, the fundamental acceptance and alignment with fee-for-service and the need for financial planning advice in the self-managed super fund arena, and the acknowledgement of cross-over referral relationships. Practice principles need to recall how they grew their businesses in the early days and get back to business development activities.
And finally… Compliance has and will always be the core of any business assessment and constant vigilance must be maintained. Good compliance is just good business as no one wants to buy your problems. Annual audits are essential and any recommendations made need to be enacted. Principles want good, clean businesses – as do dealers, clients and potential purchasers.
Compliance has also moved into product selection, with a focus on closed or failed investments that could potentially lead to future claims. The more generic or mainstream the advice and managers selected, the greater the comfort level of purchasers.
All licensees have to review their business models and look especially at improving client engagement. By doing so, they will improve business value. This introspection may have been prompted by FoFA proposals but if changes are made, valuations will reflect this positively.
The result is better serviced and engaged clients, better business models and better managed and compliant businesses. With increased barriers to entry, there is every reason to be confident of value maintenance and improvement under the FoFA regime.
Stephen Prendeville is managing director of Forte Asset Solutions.
Steve Murray is managing director of Catalyst Compliance.
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