These same advisors are blindly walking around thinking that their practices are worth ‘X’ times revenue, he said. They also feel that there are throngs of advisors lined up to bid up the price under any conditions. That is not the case, he said.
Do Not Rely Only On Multiples To Get A Value
“No business is exactly the same, so you have to look at things that drive cash flow,” Gessert said. For that reason, he does not love the multiple approach to valuations. However, of the 140 closed transactions that LPL has assisted with over the past 36 months, they are averaging 1.6 times trailing 12-month revenue, which includes every revenue mix there is.
Multiples, like price-to-sales and price-to-cash flow, or comparable sales (akin to comparing a home value to other house sales in similar neighborhoods) should really only be used as a starting point.
Gessert gave the example of Facebook and LPL Financial having the same revenue, but Facebook having margins that are five or six times as high. Nobody would expect them to sell for the same value.
Absolute Vvaluation Methods Are Better To Use
Gessert talked about “cost to develop,” where one looks at the comparable cost to develop the same revenue stream. However, he noted that the “discounted cash flow (DCF)” is their method of choice.
Because of the time value of money, the future revenue needs to be discounted to what it is worth today. Gessert suggested asking, “What does each dollar of revenue in the future equal today?”
This approach starts by discounting the treasury yield (2.6 percent), the equity risk premium (6.7 percent) and small business premium (11.6 percent). In other words, the starting discount rate is about 21 percent. Then cash flow quality and transition risks get factored in.
Revenue and cash flow quality are levers that can also play a role in determining the value. For example, recurring revenue is going to sell at a premium. Client demographics also need to be looked at, as older clients will have to be discounted. Gessert said the typical range of clients ages has been between 50 to 70 years old in the deals he sees. Finally, expense structure and historical and projected growth have to be factored in.
Transition risk is also something to be considered. For example, client tenure can matter. Deal structure and terms make a difference, just as if the sale is being done internally or externally. If it is the same broker-dealer or custodian, that can make things easier, although LPL will sometimes provide incentives in the form of a forgivable note to bring on new relationships that can possibly help pay for the entire down payment. Lastly, client concentration risk and post-closing assistance from the seller can help with the valuations.
Other Advice And Observations
Most of the deals LPL has seen are sold as an asset sale (generally a sale of a client list.) The reason they are not sold as a business or entity is because the long-term buyer can be open to liability risk.