As we move into 2009, many independent financial advisors are looking at their business strategies and trying to figure out how to grow this year and in the years ahead. The recent market turmoil has reinvigorated some of them.
But at the same time, advisors overall are getting older, and for other firm owners, this is a good time to consider exiting the stage and leaving the stress behind. Selling the company has often been a good choice-just one among a range of good options that also include merging or consolidating with larger strategic partners.
That naturally leads one to wonder: "In this environment, what's the value of my firm?" and "Are there still active buyers?" Until mid-2008, the elevator was moving up, there was no rush, and many owners planned to ride it out for a few more years before selling. Now the elevator has taken a sudden and jarring drop, and it looks compelling to sell sooner rather than later. Fear has gripped many as their revenue has declined.
So what alternatives are left for an owner of a firm that is suddenly two-thirds the size it was a year ago? And at a time when that firm might not be nearly as fun to manage?
Unfortunately, the old assumptions about a firm's value have to be tossed out, and advisors must deal with new ones. To do this means looking at several trends. The good news is that many of these new realities actually bode well for financial advisory firms' current and future value. Namely:
There is a surging wave of clients that need advice more than ever before.
Many high quality advisory firms are capable of serving these clients.
There's a promising future for the investment advisory industry.
A variety of well-qualified buyers are still looking for opportunities.
For an owner considering the sale of her firm, we provide the following guidance, based on our experience and recent studies.
Be Part Of A Growth Business
In this market, clients are acutely aware of their need for good advice. We have often said, "There is no shortage of clients who need advice; there is only a shortage of people to render it." This is truer now than ever before. So the future is bright for the advisory business. Moreover, the opportunity to grow with the industry is significant, and good firms will show that. The stock market is in the process of resetting itself, and this creates opportunities for agile advisory firms that can adjust and grow from the new starting point. We occasionally see firms where owners focus only on harvesting business from existing clients, and as a result see assets gradually decline, limiting their future opportunities. It's growth that attracts buyers, and today's market condition offers that growth opportunity. Be a participant in it.
Value: A Function Of The Future
We have found that prospective buyers place value on your firm's future transferable earnings, and that the purchase price will not be determined by the earnings of the past. In the lexicon of the M&A world, the "measure of the market" has often been multiples of trailing revenues-values that are easily communicated. These, however, are used mainly by sellers who seek reassurance about the value of their practices. And when it comes to consummating a transaction, Moss Adams has discovered these problems with using revenue multiples as a guide:
They measure the past, not the future.
They are rarely used by knowledgeable buyers.
They do not focus on transferable earnings.
They do not consider the schedule and timing of payments.
They do not differentiate between contractual and contingent payments.
Instead, knowledgeable buyers want to focus on future earnings. You must think like the buyers, and develop within your firm a recurring earnings stream that will readily appeal to them.
Stay Close To Clients
It's true that an advisory firm's size and technology can improve its operations, but the true value of the firm depends on the quality of its client relationships, something that can't be commoditized. The better the relationships, the higher the future value to a buyer. Excellent client service will not only help you retain your existing clients, it will also create gateways to new ones, giving you more opportunities and ultimately more value.
In our experience, buyers start their evaluation of a firm by studying the strength of those client bonds. Where they find quality relationships, the value will rise.
Building Value Takes Time
Don't rely on the timing of a sale to create value. Focus on continually building the enduring great firm. No doubt, the M&A activity in the industry is slow right now. As the market resets, think about how you demonstrate leadership and management to your team and your clients. Keep developing new internal talent that will help you grow. Establish the practices that give your firm a capacity to take on new clients. Building the team takes time.
The most highly valued features of a firm are the ones that take years to develop, and they don't come because you chose the right time to put the firm on the market.
The Importance Of Clear Objectives
When it comes time to sell, owners should have clear personal objectives. They must know what they want their ongoing role at the firm to be. They also want to know how employees will be treated and how their clients will be looked after. And then, of course, they want to know what their specific dollar gain will be from the sale. After these personal objectives are met, the owner should also present clear business objectives-in other words, know what the key resources and capabilities are that the firm needs to grow and succeed. There is often more than one shareholder, and so there can be multiple sets of objectives. A well-crafted deal will create value by finding the best solution for all. Our experience at Moss Adams shows that rarely does the owner have a single objective of "getting the absolute top dollar." Instead, she has other goals in mind as well, and knowing what those are will help her determine the firm's value.
Financial Results Count
What are your revenues? What is your cash flow? We constantly meet owners who believe buyers focus exclusively on these financial metrics. There's no question that they are important, but the full value of a firm comes from other measures of quality we've already described. Nonetheless, metrics are important, and many of the key metrics haven't changed.
Recurring revenues derived from AUM is the starting point. This metric tells a buyer how good the firm is at keeping its clients, and is generally considered transferable revenue. The firm's earnings before the owner's compensation (EBOC) is another important figure. And owners also need to isolate the "normal" compensation they would receive for their skills-in other words, the salary they would agree to take if the firm was sold to a new owner. "Normalized earnings" is the profitability of the firm after the owners receive normal compensation. From the owners' view, this is the return they've earned for the risk of being an owner. From the buyers' view, it is the transferable earnings they are buying if they acquire the firm. The example below demonstrates a two-owner firm with approximately $300 million under management.
Exhibit 1:
Revenues $3,000,000
Expenses
(except owners' comp) $1,250,000
EBOC $1,750,000
Owners' Salary & Bonus
(for labor) $1,000,000
Normalized Earnings $750,000
That Was Then, This Is Now
Most buyers are more focused on normalized earnings and the future sustainability of these earnings. Exhibit 1 probably feels like the profile of a firm from one year ago. After the precipitous drop in the market, the same firm today would be facing 25% less revenues, which offsets the normalized earnings margin of 25%. How will a buyer today view a firm like this? The number of clients remains the same, and the intensity of client service is higher than ever before, yet the same firm could have minimal earnings after the owners are compensated. What earnings should the buyer expect in the future? How should these future earnings be valued? Given the current market environment, realistic projections of future cash flows-figures that both the buyer and seller can believe in-are more critical than ever before. The projections for future earnings will be more readily accepted by the buyer if the firm shows resiliency in the face of adversity and can demonstrate the non-financial quality points cited earlier.