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.