A thriving practice growing at an annual rate of 10 per cent with a profit of $300,000 is definitely worth more than a stagnating or declining business with the same annual profit. Yet historically, both have attracted similar prices and multiples, using the much quoted three-times recurring revenue or 4-6 times earnings before interest and tax.
Fortunately for owners of growing financial advisory firms, the art and science of valuing and selling practices has changed dramatically since the introduction of the Future of Financial Advice (FoFA) reforms.
Growing businesses now command higher prices than declining and stagnant ones.
It’s a revelation for many principals.
Savvy buyers and sellers understand that the slavish application of valuation methods based on EBIT or recurring revenue multiples don’t accurately reflect a practice’s future cashflow, prospects, intellectual property or goodwill. Of themselves, they also don’t reflect the value of synergy benefits or strategic upside for the purchaser compared to other targets. Multiples should be the end result of applying a disciplined approach to valuing the future cashflow of a business, not the other way around.
Discerning business people know that a practice’s true value is tied to future cashflow. They are looking to value a business based on three key areas: free cashflow, synergy benefits and strategic benefits.
Synergy benefits refer to the revenue uplift or cost savings that can be achieved post-acquisition. For example, revenue or cost efficiencies from increased scale in areas such as portfolio management, platform costs or compliance costs are synergy benefits that enhance value.
Strategic benefits refer to any unique attributes derived from acquiring the target which may be access to new markets, products or customer bases. An example might be acquiring a practice with an efficient managed discretionary account service (MDA) or experience dealing with self-managed super fund investors.
Valuations: Everything’s changed
Historically, financial planners have been sheltered from price volatility because buyers weren’t valuing practices in the same way they valued businesses in other industries. They were buying annuity streams that were largely locked in.
Advice practices are now more closely aligned to other industries in how they are valued. Their history of profitability, prospect of future growth, sustainability of the revenue and cost base, and the integrity of the seller in not poaching clients post-sale is now everything.
The FoFA reforms were a major catalyst for change. Broad demographic changes are also driving change.
Under FoFA’s opt-in rules, advisers are required to gain written agreements from their clients every two years in order to charge for ongoing advice.
Advisers will have to ask to be paid for the first time and there’s a high risk many passive clients will say no.
Furthermore, FoFA’s ban on platform rebates means grandfathered arrangements will run off over time. Against this backdrop, compliance costs are rising and a growing number of Australians are retiring and drawing an income from their superannuation and savings.
There were 3.3 million Australians aged 65 and over in 2013 and that figure will double by 2055, according to the 2015 Intergenerational Report. There are serious consequences for financial planners who service an ageing clientele. Their funds under advice (FUA) are falling, alongside revenue, and the value of their business.
Advisers need to win new clients and discover alternative sources of revenue to replenish and exceed what they have garnered so far from the ageing war generation and baby boomers.
Need to get creative
To do that, they’ll need to get creative. They may need to develop a proposition that allows consumers to dial up or dial down the service they receive or come in and out of the process, and charge accordingly. New revenue streams may not have the same stickiness and regularity of the past.
While there’s no available data on how big the advice market is, or the type of advice and service consumers want, it’s clear that many new customers will order their advice services differently with different pricing structures.
The exponential growth of the self-managed super fund (SMSF) market has shown that investors want flexibility, convenience, transparency, control and value for money.
That desire is also driving the popularity of digital advice models around the world.
Thirty six new robo advice providers emerged in the last two years pushing the number to approximately 45, according to the 2015 Automated Investment Advisers Global Market Review.
Some, like Betterment which had 61,650 clients, 72, 757 accounts and over $1.3 billion under management as at January 28, cater to investors with lower account balances. Others like Wealthfront, which had 21,450 accounts and $1.7 billion, target the mass affluent.
The average Wealthfront account held US$79,388 – four times higher than Betterment.
Most traditional holistic advisers shudder at the thought of automated advice, however, robo advice may be an opportunity to capture a new audience. Offshore some advisory firms have white-labelled robo advice engines and set up an alert to inform them when an account reaches a certain size, such as $100,000. An adviser is then prompted to offer the client broader advice.
Managed discretionary accounts are another way top advisory firms are attracting new clients and expanding their durable revenue streams.
A well-executed MDA solution provides investors and advisers with an efficient, lower cost portfolio management and administration service which delivers an improved client experience, enhanced outcomes, access to a broad range of investments, higher productivity levels, and a resilient income stream.
While many self-licensed boutiques, particularly those that specialise in SMSFs, have embraced MDAs and are now reaping the benefits, few traditional aligned practices offer an MDA service.
MDAs often compete head on with the institutionally-owned wrap platforms and managed funds, which can lead to barriers when implementing managed account solutions.
Don’t bank that cheque yet
Product dependency is at the centre of the current debate over whether practices should accept a cheque or other financial benefits to switch from one institutional licensee to another.
On the surface, it appears reasonable for principals who are unhappy with their existing licensee to accept a cheque to move to a new licensee, without giving up equity in the underlying business.
However, principals need to think deeply about what they will be giving up and put a price tag on it.
If, by partnering with a licensee, they’re giving up the freedom to adopt new technology, offer better products and services, and potentially create additional value, then that’s a big price to pay. They’re effectively handing over control of their destiny.
At some point, every practice owner or principal will look to sell and if by locking into any particular product solution or business model they are limiting growth or a buyer’s access to synergy and strategic benefits they may be limiting the valuation on their business or the number of interested buyers.
Although sometimes that can make a practice more attractive to other members of a particular licensee, particularly at the smaller end of the aligned market.
Intra-licensee transactions commonly trade on simple multiples of recurring revenue because the migration of that revenue stream to the other member of the group can be relatively simple.
It’s different for self-licensed advisory firms and independently-minded practices who sell outside their network. Valuations can become more scientific as the buyer and seller work through the standalone valuation, synergy and strategic benefits.
However, thriving businesses with separately identifiable and non-product related revenue sources can appeal to a broader market and can command significantly higher prices.
There’s no doubt that advisers who are staring at a big fat cheque have a life-changing decision to make. Principals faced with this seemingly enticing offer should ask themselves the fundamental question as to what they want to do with their practice going forward. They should carefully weigh up any grab for money now against future value creation if unfettered in their ability to grow a practice their way. Beware any alignment that curbs potential and diminishes value over time. There’s no such thing as a free lunch in any profession.