For anyone trying to sell or buy a financial-advisory business, the marketplace can be a hazy place to navigate.

Because the terms of most deals are hush-hush, trying to slap a price tag on a business sometimes comes down to guesswork and instinct. For sellers, the big concern is getting true value for the business. And for buyers, just finding the right business to bid on can be a sizable hurdle.

"Most practice transitions that have taken place have been behind closed doors," says David K. Goad, CEO of FPtransitions. Goad, however, thinks the market's door has opened at least a crack as a result of data compiled by his company. FPtransitions runs a Web site in which buyers and sellers of financial-advisory businesses can display listings and, they hope, find someone with whom to make a deal.

By compiling data from the listings of about 300 prospective buyers and 100 sellers in 2000, FPtransitions has churned out the "Practice Transitions Report," which tries to get a grip on what it is that creates value in the advisory-practices marketplace.

Among the broad trends highlighted are that fee-based practices in an urban setting-usually in the Northeast, Southeast or Southwest-were valued most by buyers. The report also says practices that have developed a niche specialty, either in clientele or services offered, have a greater chance of finding a buyer. Buyers also expressed a preference for practices with between 50 and 200 clients and a client base with an age demographic of between 41 and 60 years old.

For sellers, the data provides a crucial key for preparing a practice for the market: a profile of what sellers want, says Mark C. Tibergien, principal of Moss Adams LLP, a transaction-consulting business and one of FPtransitions' strategic partners. "If you're a seller, what it tends to validate is that there are certain buyers who are willing to pay a premium in order to build their practices."

The numbers do come with a few disclaimers, particularly those dealing directly with practice value, which are described as guides because they primarily are based on list prices and data from about 35 completed transactions, involving more than $1 billion in assets, in which FPtransitions played a role. This means prices used for the report may be a bit inflated, Tibergien says.

He notes his firm found the typical practice sells for around 1.0 to 1.3 times gross revenues. The report, meanwhile, lists regional asking price-to-revenue ratios that range from 1.55 in the Northcentral United States to 1.86 in the Southwest. "What is not clear from the data is how the terms of the deals may have impacted the net worth," he says.

Goad, however, maintains that the asking price has generally held firm in transactions in which FPtransitions has been involved.

Some of the trends identified in the report could already be changing, Goad says. The downturn in the stock market, for example, has shrunk assets and revenues at many firms-a fact reflected in the lower revenues that were seen in listings in the latter half of last year, he says.

It's highly unlikely that the situation improved in the first three months of 2001. Indications that buyers were becoming more interested in commission businesses were another consequence of the soft market, he says.

Goad also noted that about 75% of listings came from sole practitioners.

Another trend that seems to be sneaking up on the industry is the number of CPAs moving into the business, Goad says. About one-fifth of the non-sole practitioners in the FPtransitions marketplace were CPAs, he says, adding, "CPA activity is picking up." Many CPAs feel the most efficient way to get into the financial-advisory business is through mergers and acquisitions, he says. "Many are coming to the conclusion that it makes sense to merge their client base with a financial-services client base and trade the services off each other," Goad says.

Buyers Look At Bottom Line

Many practices that are up for sale, according to the report, are missing the mark in one of the basic ingredients of value: sufficient revenues.

On one commonly used benchmark, practice revenue as a percentage of assets under management, sellers were most likely to list practices with revenue-to-asset percentages of 0.51% to 0.75%. Twenty-nine percent of seller listings were in this range, while 23% were in the 0.76% to 1.0% range. Seven percent had revenue-to-asset percentages of 0.50% or below.

However, 48% of buyers were looking for practices between a range of 0.76% and 1.0%.

Where did that leave the 36% of sellers who were short of this mark? In many cases, with closing prices tens of thousands of dollars less than they could have been, according to Goad. FPtransitions has found sellers falling short of 0.76% revenues-to-assets usually have to settle for lower price-to-revenue ratios once a final price is agreed upon, he says. "It left them bringing less value for their practice," he says.

The returns sought by buyers isn't surprising, since the typical fee-based advisor charges an annual fee amounting to 1% of assets under management. "The point is that sellers need to prepare their practices for what buyers want," he says. "If you don't have the return that matches with what buyers want today, you need to spend some time retooling your practice."

Buyers Prefer Fees, City Life

If the key to a business is "location, location, location," buyers are placing the greatest value on the areas with large and growing populations. That means practices in urban settings where populations still are rising have an edge in capturing the most value, Goad says. "We know from talking to practitioners that a lot of their increase in business was solely because of geographic population increases," he says.

The study supported that view, showing the nation's more urbanized and high-growth regions yielding the highest value. The Northeast, for example, topped the regional list with sellers listing an average asking price of $673,500 and a median price of $498,200. At the bottom was the Northcentral region, where asking prices averaged $563,800 and had a median of $417,400.

In terms of the average ratio of asking price to annual gross revenue, the Southwest headed the list with a ratio of 1.86%, followed by the Northeast at 1.82% and the Southeast at 1.74%. Then came the West, 1.68%; the Midwest, 1.58%; and the Northcentral, 1.55%.

Goad notes these are broad generalizations of how regions impact value. A more localized view, he says, would show areas throughout all regions of the country where businesses can thrive. "If you're in Sun Valley, Idaho, your practice may be much higher than average because of the desirability of living in the area and the growing population of high-income people," he says.

Buyers also preferred practices in which 70% or more of the revenue came through fees, according to the report. Eighty-six percent of buyer listings, for example, expressed interest in fee-based businesses, compared with 73% for commission businesses (some listings expressed an interest in both). The report also found that fee-only and fee-based businesses surpass commission-only businesses in asking price-to-revenue ratio. The ratio for fee-only businesses was 2.10%, followed by fee-based businesses at 1.71% and commission-only businesses at 1.10%. The thinking here, Tibergien says, is that buying a commission business is riskier and may result in greater client attrition than buying a fee-based business. "With commissions, what you are selling is a book of business, not a business," he says.

The value placed on location, revenue and fee services has been evident in transactions in which FPtransitions has been involved, Goad says.

In one case, a fee-based practice in Southern California, with annual gross revenues of $360,000, sold for $625,000-a price-to-revenue ratio of 1.73%. The practice, with $36 million in assets under management, also had the 1% revenue-to-assets that sellers look for, he says.

By comparison, a commission-based practice in a small town in Iowa with annual revenues of $100,000 sold for $125,000-producing a price-to-revenue ratio of 1.25%. In this case, Goad says, value was hurt by a revenue-to-assets percentage of 0.24%.

Illustrating the point further, a fee-based practice in Washington, D.C., was recently listed at a price of $466,000-twice its annual revenues of $233,000. The listing got 12 inquiries the first afternoon it was up, says David Grau, FPtransition's chief operations officer. "If we get just 10 inquiries, we usually can get the deal done," he says.

There is evidence, however, that commission businesses are coming back into favor, says Goad. In the last half of 2000, he says, FPtransitions began to see buyers express more interest in businesses that were a mix of commissions and fees. A possible explanation, he says, is that the down market is making financial-advisory clients more likely to consider commission-based planners. Clients who saw their portfolios nosedive last year may be more concerned about losing another 1% from fees, and they may tend to favor commission-based practices as long as the bear market continues. "Towards the end of last year, commission-based books of business became more attractive," Goad says.

A Client Threshold

Because FPtransitions' marketplace is made up of mostly small practices, 88% of businesses for sale had between 50 and 200 clients. This seemed to fit with what buyers were hunting for, Goad says. The sweet spot for buyers, he says, was between 100 and 200 clients. "Those practices that had larger client bases for sale are more difficult to sell, but not because of profitability," Goad says. "It has to do with fewer buyers who can acclimate that number into their business."

The average age of a practice's client base also has a significant impact on value, he says. Fifty-eight percent of buyers were looking for clients during their prime preretirement years, between the ages of 41 and 60 years old. That was also the age range of 50% of the practices up for sale.

Women Underrepresented

The number of women buying and selling practices was low compared with the number of women in the business, according to the report. While studies show women own about 26% of small financial-advisory practices, they accounted for only 18% of the practices for sale and represented only 5% of buyers, Goad says.

This might be explained by the fact that women have only recently started to make inroads in the profession. "Because they are still fairly new, on average, they're not ready to sell," Goad says. "We think over the next decade, we will see sales increase significantly."

Cashing In

In what may be an example of advisors getting out of the business while the getting was good, the report found that 47% of sellers were in business for 10 years or less. Typically, Goad says, practices are sold after 16 to 20 years in business. The rash of advisors looking for an early cash-out may have been a short-lived outgrowth of the recent bull market, he says. Even with the slowdown in latter 2000, the report found that advisor practices averaged 32% revenue growth in 2000 and 25% growth in 1999. "It (the bull market) allowed a lot of practitioners to make more money than they ever dreamed," he says.

Now that it seems a bear market has taken hold, advisors may see the flip side to this: lower revenues and later retirements. "We think that the practitioner who has been in the industry shorter term will see their income decrease and potentially the value of their practice decrease," he says.

Tibergien agrees, saying the market downturn may lead to a slowdown in mergers and acquisitions of practices. "I think that there are quite a number of people who are scared," he says. "Either they are going to try to sell and take their chips off the table or hang on for dear life because the market has impacted their ability to retire."

The shaky economy could force potential buyers to take a more sober view of practices on the market, he says. One common pitfall is for buyers to become overly optimistic about a practice's potential earnings growth. "They should be looking not at its historical performance, but its ability to generate capital on a sustained basis going forward," Tibergien says, adding some client attrition always follows the sale of a practice. "Some buyers fall into a trap where they look at how a book has grown in revenue the past five years and just extrapolate that going forward."