• Equity grows from year-to-year in most cases, certainly over a span of time if the business is growing. As such, the gradual sale of equity through an incremental transition plan (versus a change-of-control transaction that happens all at once) has the ability to provide an additional regular income stream to the founder or founders of an independent financial advisory practice with proper planning.
• A frequent mistake is to equate cash flow with equity or practice value (or to link the two with a multiple of something other than 1.0 x T12). To this end, doubling the amount of cash flow in an ordinarily incorrectly structured practice model often results in little to no change or improvement in the value of the practice. In other words, if value is created and retained by individual advisors, it makes little difference whether you surround yourself with two, three or ten advisor/producers – More money may be made in the short term as cash flow, but no long-term business value will be built. And when you stop working, by fate or by design, the cash flow stops too, and with no enduring or transferable business value, the practice dies.
• By the same token, equity valuation is not based solely on a multiple of revenue, which would be like measuring the sufficiency of your cash flow by what’s left in your checking account at the end of the month.
Validation of the efficacy of equity as a compensation structure can be found in whether buyers of independent practices actually pay the values sought by sellers who have put in place durable and clearly measurable equity structures: Based on current totals in the FP Transitions’ Comprehensive Valuation Report, there is a 50 to 1 buyer-to-seller ratio today. Moreover, the financial consideration for transactions that are completed are within a 4% range of the original valuation, demonstrating the strong probability that an accurately valued practice will go for something very close to, or even above, the asking price.
Once valued correctly, equity becomes the best possible compensation vehicle for building a long-term business of enduring value: One unified firm with all relevant professionals pulling forward in the same direction. It is what separates a one generational job or practice from a firm that stands the test of time.
David Grau Sr., JD, is the president and founder of FP Transitions (www.fptransitions.com), which partners with independent advisors to build businesses of enduring and transferable value. The above is adapted and excerpted from his first book, Succession Planning for Financial Advisors: Building an Enduring Business, which will be published in June by John Wiley & Sons.