Some of the revenue your firm generates may not be worth much in an acquisition. Certain revenue, in fact, may actually reduce your valuation. If you’re thinking about selling or merging at any point in the future, you need to be sure you’re generating the “right” kind of revenue and you may even want to rethink the business lines that create the “wrong” kind.
It’s all about risk. The M&A market loves revenues that are both recurring and stable because the risk of those revenues continuing (or not) is easy to measure. At the same time, the market severely discounts non-recurring revenues because of the unpredictability of the future cash flows. And the market clearly despises revenue from sources that shade client trust and fiduciary relationships due to regulatory and litigation risks.
Here’s a short guide to “good”, “bad”, and “ugly” revenues in the wealth management business:
Good Revenue
The “Fee-Only” model – in which advisors are compensated directly and exclusively by their clients – continues to produce the gold standard in wealth management revenues. And, advisory fees tied to the level of assets under management command the highest valuations in the M&A market. Why? The fees are recurring, they automatically increase as the market goes up or clients deposit more assets and history has shown that Fee-Only firms with this type of billing arrangement have almost stunningly low rates of client departure.
In fact, whenever you hear a story of a buyer paying an extremely high multiple of cash flow for a wealth manager, rest assured that the seller was “Fee-Only” and had lots of AUM-based fees.
Other revenues that are likewise recurring and somewhat stable but not quite as attractive include:
• Retainer Fees – Single negotiated fees for a full range of services (investment management, financial planning, tax, etc.).
• Family Office Services Fees – In addition to AUM-based investment management fees, some firms also charge for services like bill payment, property management, various concierge services, etc.
Bad Revenue
1. Trading or Product-Based Commissions – Some firms call themselves "fee-based" to describe (or euphemize) a hybrid of trading and sales commissions with AUM fees. It’s a model most often used by brokers or advisers who are affiliated with a B-D.
Commissions are the economic equivalent of a “sugar high” for wealth managers in that the near term cash flow may generate an immediate rush of pleasure but the long-term negative impact on valuation is likely to leave you feeling irritable. From an acquirer’s perspective, commissions are pretty close to worthless, in part because they are non-recurring and in part because they create a structural conflict of interest between advisor and client that jeopardizes the future stability of client relationships.