We’ve heard it, you’ve heard it, everybody’s heard it: The valuation metric for RIAs is two times revenue. But here’s something else you should hear about RIA valuations: Two times is too simplistic.
And not just for its imprecision, either. It’s more like…Two times revenue is wrong. It can be too high, in some cases, but for well-run firms it is often too low. Dramatically too low.
But it’s rarely – and we mean rarely – right. And when it is right, it tends to be in the same way that a stopped clock is right two times a day – pure coincidence.
How can a widely-known industry metric be so wrong? Rules of thumb are based on real thumbs, aren’t they?
Well…no. Not in this case. And it feels like high time the industry began to wrap its head around the real drivers of valuation in the wealth management business.
Where Does Two Times Come From, Anyway?
So where does this two times revenue number come from, and how did it get to be industry shorthand?
The answer is that it’s a lazy man’s number – a kind of investment banker-generated construct that tries to paper over a deep lack of information with faux back-of-the-envelope-calculation wallpaper.
Start with the fact that hard data on wealth manager deals is hard to come by, as such transactions are subject to virtually no economic disclosures. You’ll never see the spreadsheet with the last twenty transactions and all the relevant firm metrics and dollar amounts, because it doesn’t exist – certainly not in accurate form.
That paucity of information, augmented occasionally by self-reported survey data that is often more about fueling egos than about revealing industry truths, leaves us with the Shakespearean notion of “a tale told by an idiot, full of sound and fury, signifying nothing.”
It could be that uninformed buyers and sellers get together at around two times revenue because of the mythical rule of thumb, but if that’s all the attention a seller is paying to valuation methodology, two times is all they deserve.