Despite the industry’s challenges, advice books are still the preferred asset in the financial services market and the value of robust practices is set to soar in a few years according to business valuation consultant Tim Lane.
“You’ve got to look to the future, they’re going to be great assets,” Lane says of advice practices. “You can make these businesses fly in three to five years.”
Lane, who is a partner at Centurion Market Makers in Sydney, says there are a couple of factors that position advice firms ahead of other financial services models. The most enduring of these is that advice practices generally get their revenue straight away, he says.
“The real issue that drives value in financial planning practices is that they don’t carry any working capital, which makes them good businesses,” Lane explains. “In accounting I get paid in 90 days, but in financial planning I get my profit within days because of the way the fees work.”
While the industry may feel “beat up” after the royal commission and with a host of regulatory constraints bearing down upon practices, Lane says it’s important for principals to remember they’re still onto a good thing.
A robust advice business that is up for sale will generally be looked at by an acquirer with a valuation multiple of six, he explains, before the price of the business and costs to transition are taken out. An accounting firm, he reveals, would be more likely to start with a valuation of four, which makes end value much harder to create. Law firms are even worse, he says, and only go “dollar for dollar”.
“Accounting firms are a bit better but financial planning practices are the top of the tree, they get six times EBIT if they’re the right size,” he continues. “The point is that whilst we’re getting belted up you still have the preferred asset.”
The other factor set to put wind in the sails of advice practice valuations is that it’s probably already seen the darkest of days.
From a regulatory standpoint, the generational changes have already been announced and in large part incorporated. In terms of public perception, the horrors of the Hayne royal commission may linger but the worst has come and gone. And in terms of professionalism, the education mandate and forthcoming code monitoring body should underpin future conduct.
“After we get all the education stuff out of the way, what can they do to advisers that hasn’t already been done? Lane says. “And from a legislative point of view… what else can they do?”
A further valuation strength, he says, is Australia’s world-beating superannuation system, which makes advice business incredibly attractive to overseas buyers like Swiss-based private banking group EFG International, which recently upped their stake in Shaw and Partners to 75 per cent in a deal that valued the firm at $120 million.
“Even though it’s been beaten up, that’s why I talk about how good the industry will be in three to four years,” Lane says. “I’ve always been bullish about it. That’s why overseas guys say ‘wow, this is like Singapore on steroids’.”
Read the fine print
In its latest 2020 Practice Valuation Guide, Centurion lists further reasons advice businesses will continue to trade at a premium over other professional services firms, including a low level of bad debts and monthly recurring revenue with “limited ups and downs”.
There’s also no stock required for advice practices and low plant and equipment costs, the guide states.
The guide does, however, come with a warning that banks are much less willing to lend now and much more finicky when it comes to the nature of the business being purchased. Further, practices with smaller client books including clients being charged under $3,000 per year may struggle to fetch attractive prices.
“Clients paying less than $3,000 per year probably have negative value,” Lane says. “The basic cost of delivering the advice have gone to a point where you may have a profit margin but it’s not worth the effort.”
Finding a way to service these clients while making a profit will be the key to a whole new market, he says.
“The great opportunity in the industry which isn’t being exploited is how to take these low value clients and make them profitable,” Lane says, adding that industry funds are well placed to make a run at this sector.