Relying only on recurring revenue to value business is flawed, particularly when it comes to succession planning, according to a business coach.
Professional Planner reported last week that succession planning would outdo other practice sale strategies.
Slipstream Group chief executive Sharon McClafferty tells Professional Planner it’s impossible to control the valuation methodology that will happen in the future.
“The idea you’re going to focus on recurring revenue being the valuation model you’re going to sell under is very flawed. You don’t control the market or your potential buyer.”
She says she asks clients to analyse two different types of valuation methodologies – EBIT with a multiple of six and a recurring revenue model – and then find the gap between valuations.
Multiple EBIT also takes into consideration several discount factors related to location, key person dependency, paper files and low-value clients.
The recurring revenue model analyses client advice fees whether it’s over $3,000 (3x recurring revenue), $2,000-$3,000 (2.2x), under $2,000 (1.5x), as well as insurance trails (2x).
“Regardless of the methodology, when you exit your responsibility is to reduce the gap between those methodologies,” McClafferty says. “If you can get your multiple of EBIT being the same thing as recurring revenue, then you’re in control.”
‘Flavour of the month’
McClafferty says the fastest succession outcomes have been scenarios where firms are looking to retain talent through equity sharing.
“Sharing equity with the team is the flavour of the month but only for firms that aren’t reducing their profit. They’re in a place of paying more dividends and they are planning ahead for the 10 years ahead.”
The mistake often made is only thinking about whether it’s an internal or external sale, “there’s a range of options” McClafferty says.
“The old school in financial planning is build the revenue and who cares about profit. It’s just hustle and build revenue. Those days are gone.”
All at the top
The biggest issue for succession planning, McClafferty says, is eliminating key person dependence. A sole leader with concentrating responsibilities often prevents the business from being able to expand.
“It’s not an easy fix; there’s no silver bullet on that. That’s by far the largest issue.”
The other issue is profitability, particularly when company leaders don’t allocate their salaries to revenue.
McClafferty says she would instead make a valuation on owner salaries in a similar fashion the banks would if they were to give the business a loan.