How to value a financial planning practice

If you’re in the market to buy or sell a financial advisory practice, understanding its valuation is key to paying or receiving a fair price. Many well-established methods for valuing a financial advisory practice exist, and they all involve complexity and subjectivity on its worth. While a business valuation conducted by an expert is not necessarily what a buyer would pay or a seller accept, it is a very valuable starting point.

That’s because if you are buying or selling a business, you need to have an objective understanding of what that business is worth. Putting a price on a financial advice business can be challenging – whether you’re the buyer or the owner who’s looking to sell.

Indeed, what a seller thinks a business is worth and what the other party thinks it is worth can often be two very different figures. For a buyer, the worth of a financial advisory business may well hinge on how much profit it can make in the future, balanced by the risks that the business and the industry in which it operates face. Historic cash flow, profitability and asset values are important starting points, but many other factors are relevant too. Intangible factors such as team and business relationships and a business’s goodwill or reputation often add considerable value to a business or can detract from it where a business’s reputation is not particularly good.

Get an expert valuation

An expert business valuer can provide a thoroughly researched and documented value for a business. If you are a financial adviser considering buying an existing financial advice business, it’s important to seek the services of a business valuation specialist to arm yourself with all the knowledge and facts and figures that you need to ensure that you do not pay more than the business is worth.

That’s where expert advice is essential. A valuation expert can develop a thorough understanding of the business to build a detailed picture of its underlying drivers of value. While there are several ways to value an existing business, the methods detailed below are some of the most commonly used business valuation methods, and each comes with their own benefits and downsides.

Asset valuation method

The asset valuation method tells you what the business would be worth if it was closed down and all assets and liabilities were sold today. It is a simple method, and it does not value the intangible assets of the business such as its goodwill or a firm’s future prospects for growth.

That’s a big downside. Goodwill is the difference between the true value of a business and the value of its net assets. Goodwill represents the features of a business that aren’t easily valued, such as its reputation. It’s not always transferred when you buy a business, since it can come from personal factors like the owner’s reputation or his or her relationships with key clients, which are so important to the growth of a financial advice business.

Capitalised future earnings method

The capitalised future earnings method  is one of the most common methods used to value small businesses and it is relevant to valuing financial advisory businesses. When you buy a business, you are buying both its assets and the right to all profits it might generate in the future, which are known as future earnings. The future earnings are ‘capitalised’ or given an expected value in today’s dollars. The capitalisation value gives the expected rate of return on investment (ROI), shown as a percentage or ratio. A higher ROI is a better result for the buyer. This method lets you compare different businesses to work out which would give you the best ROI.[1]

Earnings multiple method

The earnings multiple method helps compare different businesses, where the earnings before interest and tax (EBIT) are multiplied to give a value. The ‘multiple’ can be specific to the financial advice sector or based on business size.

Comparable sales method

The comparable sales method allows you to get a realistic idea of what you may need to pay for a business by checking out the price for which similar businesses have sold. Buyers will need to check the revenue of recent advice businesses that were sold and compare that to the price of the business they are considering buying.

If you’re the seller, be ready to sell

Business owners often fail to consider the gravity and time demands of what is required to sell their business, such as preparing an information memorandum that highlights where the business is strong, where it differs from competitors and what increases the value.

Rod Bertino from Business Health says that the seller may be exceptionally good at financial planning, but managing the process of a business sale can be difficult. Regardless of the reason for selling, he recommends seeking external help to sell the business. Sellers should clearly define what they must have vs what they would like to have when selling a business. “The more must haves you put on a deal limits your pool of buyers and impacts the valuation of your business,” he says.

“Common examples of ‘must haves’ include keeping all of the staff in the business. This can raise significant issues on the buy side as it is likely that the buyer has their own people they know and trust who they already have in their own business. Other stipulations that can significantly impact on negotiations is a requirement that the buyer must remain within the same licence or retain the existing premises or continue to use the same investment platform,” he says.

“It’s impossible to put a dollar figure on what these ‘must haves’ could cost the deal; however, the cost could be enormous because they just might make the deal untenable.”

Jeff Long, HLB Mann Judd Melbourne managing partner, also recommends that business owners should regularly value their businesses so they understand their inherent worth. “It can make good sense to value a business regularly, such as once a year.  Once a valuation has been undertaken the first time, the same bases and assumptions can be used each year.  This creates a benchmark valuation process so that the factors affecting the performance can be highlighted and evaluated on a regular basis by the business owner,” he says.

Apart from an impending sale, another trigger for valuing a business is when the owner is ready to retire.  But it’s not always possible to plan ahead, and other unexpected reasons, such as death, illness, divorce or bankruptcy, can also trigger the sale of the business. “It is therefore worthwhile to have a business ready for sale at all times. This includes ensuring sustainable profit from one year to the next is optimised, as that is what prospective buyers would be seeking, as well as having reliable financial accounts, systems and processes, and understanding the business and the trading environment,” says Mr Long.

Any financial advisory firm owner who plans to sell their business within the next 10 years should be taking action now to implement measures that will maximise the value of the business and profitability, and should be sticking to any business plan.

The process of selling the business can sometimes be a distraction for business owners, which can cause sales and profit to decline or the business owner takes their foot off the accelerator, causing the business to slow down. The best way to prevent this is to have a strategic plan for the business – this ensures that focus remains on the core business operations. Also, engaging a transaction adviser to help manage the sale of the advisory practice can help to keep focus on business operations.

It is also important to note that business valuations are often required to support the submissions made to the Australian Taxation Office (ATO) relating to the sale or purchase of business assets.  While a valuation is an estimate of an asset’s value, the valuation must be based on the most relevant and reliable information that is known or could reasonably be foreseen, at the valuation date. Having an ATO-compliant business valuation is therefore important, according to Mr Long.

For buyers, Mr Bertino advises buyers to be very clear on why they are looking to buy a financial advisory business. “What does a successful acquisition look like in three to five years’ time?” He also stressed that there is ”no substitute for quality data in the due diligence process.”

Buyers should obtain detailed client information, past compliance reviews, explanation as to abnormal figures in revenue and expenditure, client satisfaction survey data, if any exists, and any marketplace benchmarking that has been conducted.

“Buyers should ask how does this firm stack up against competitors?”

According to Mr Bertino, it is also extremely important to understand the internal culture of the business and its operating platform. “An incompatible fit will destroy even the best deal. Also know your own “go” and “no go” points, and don’t compromise. If it doesn’t tick all your boxes, then walk away from it. If you are working too hard to make it work, it probably won’t work,” he says.

If you’re the buyer, examine the client base

A strong client base is important in a financial advisory practice to ensure stable, predictable income streams and the future profitability of the firm. A steady income stream can be an important buffer during an economic downturn, and it can help the practice survive and thrive in the years to come.

Evaluating client loyalty and retention is also important here. Buyers need to consider client retention rates, with high client retention rates likely indicating high levels of client satisfaction and loyalty, which will, in turn, help to nurture a dependable revenue stream over time.

Factors which are relevant to examining an existing business’s client base include the average duration of client relationships, which illustrates the firm’s ability to build and retain clients. Understanding client demographics is also very important. This requires an investigation of who makes up that client base and understanding their needs now and in the future for financial advice.

The demographic factors include the age and wealth levels of existing clients. The age spread of clients is important because it can indicate future opportunities for growth or the potential risk of losing clients, especially as they near retirement age when they are less likely to need financial advice. Wealth levels and accumulation potential are also very relevant to the value of a financial advice business. A potential buyer of an advice firm should also examine existing clients’ wealth levels and their capacity for wealth accumulation, which can help to illustrate the firm’s potential future growth.

Additional considerations for valuation

A financial advisory firm’s reputation is another important asset to consider. A brand that’s well-respected and recognised will be worth more than one that isn’t, so that is something to consider for any potential purchaser. Do you want to buy a financial advisory practice with a well-established brand or buy a lesser-known firm that will need building up? It can mean a smoother transition and a stronger starting point for the buyer to buy a business that already has a firm reputation.

As a buyer, you should weigh how these intellectual assets can bolster your competitive edge in the market. They represent not just value in terms of innovation and uniqueness but also potential for future growth and diversification under your leadership.

Finally, the regulatory environment and compliance status of a practice cannot be ignored by a potential buyer. A practice that consistently meets industry regulations minimises its risk of future adverse action from the regulator. Its compliance record is a critical factor in an industry which is heavily regulated. These additional factors round out the full picture of a practice’s worth and offer a comprehensive view of its value.

[1] https://www.commbank.com.au/articles/business/how-to-value-a-business.html