Financial advisors should think five, ten or even 15 years ahead to plan their exit strategies and build equity in their firms, the president of FP Transitions says.
"Every one of you will transition your business one way or another," said David Grau Sr., president and CEO of FP Transitions, the largest provider of valuations of advisory firms (850 in total) told attendees at TD Ameritrade Institutional's "Momentum Optimized" conference in Washington, D.C.
Grau said an advisory practice is often the most valuable asset a financial advisor owns, but it is also incredibly fragile. This is especially true for one-owner practices, he added.
Grau urged financial advisors to think beyond just paying themselves and about how to add equity value, which can help in negotiations with potential buyers. FP Transitions says there is currently a 50-to-1 buyer-to-seller ratio, and that figure is sometimes greater in more populated areas.
The supply and demand imbalance might explain why Grau has seen the multiple for reoccurring income steadily increase from 2.0 in 2000 to 2.3 in 2010. FP Transitions saw valuations ranging from 0.6 to 3.3 last year.
Based on the 423 valuations the firm has completed for RIA firms, FP Transitions found:
Average firm value: $1,980,000
Average age of owner: 54 years
Average years of experience: 23
Average annual owner compensation: $490,000
Number of firms with two or more owners: 131
Firms set up as a corporation or LLC: 291 (88%)
Five-year average revenue growth rate: 12.1%
"The value of an RIA practice is worth two to three times as much as any other service provider in America (e.g. a dentist practice)," Grau said.
Although financial advisory businesses might be doing well, he added, their exit strategies stink, with 90% not having a written succession plan tied to an actual business value, 96% not having valuations and 97% not having a continuity plan in case of an owner's death or disability.
Improving Your Firm's Value
Market-based valuations represent one method for arriving a firm's value. "It is like selling a house," Grau said. "Look at every home in your area and see what the other homes are selling for." Other factors that are part of all valuation methods are supply and demand, payment terms, business structure, capitalization of the business, client demographics, concentration risk, fees that might not be sustainable, expense drag, multi-generational structure and more.
A Common Mistake To Avoid
Almost every financial advisor works less at the end of his career, and as a result the firm's revenue and selling price drop if a strong succession plan is missing, Grau said. Because they are likely to work less as they get older, advisors who focus on creating higher revenue and enterprise strength will help retain or even increase their firm's value, he added.
Grau believes providing ownership to key staff members is an important way to manage talent. Besides the advisor avoiding ordinary income taxes, it helps keep younger people motivated and working hard. He gave this example of how equity might be distributed:
Tier 1 - founding owner [majority ownership -- age 50+]
Tier 2 - minority owners [less than 50% -- age 36 to 50]
Tier 3 - minority owner [non-voting owners 1% to 5% -- age 25 to 35]
Unfortunately, when it comes to succession planning, Grau says advisors often tell him, "No thanks, I am not ready to sell."
- Mike Byrnes
Mike Byrnes founded Byrnes Consulting to provide consulting services to help advisors become even more successful. His expertise is in business planning, marketing strategy, business development, client service and management effectiveness, along with several other areas. Read more at www.byrnesconsulting.com.