What is your practice actually worth?

Founder of Sapling Financial Consultants outlines how advisors can start to look at their own businesses and assess their value

What is your practice actually worth?

Many advisors already know how difficult it is to value businesses. Serving entrepreneurial clients, advisors often seek certifications to help assess the values of their clients’ businesses. They have to engage in the delicate emotional work of distilling a business — that represents a life’s work — down to a single number. Doing that work for someone else is hard enough, but how can advisors assess what their own businesses are worth as they consider moving on and retiring?

Rob Hong is the co-founder of Sapling Financial Consultants inc. in Toronto. The boutique financial consultancy covers a wide range of services, one of which is valuation modelling of financial services firms. Hong recently spoke with WP about the rules and market forces currently driving the valuations of advisory practices and what advisors need to know as they begin to assess their own businesses’ values.

“At the end of the day, all valuation is more art than science,” Hong says. “I’ve seen people get a valuation report that could be 20 per cent of what the company actually transacts for. The market is always moving and it’s very different from what you’ve learned in school. The only real test of a valuation is when you actually go into a deal.”

Even if the truest test is on the market, Hong outlined some of the methods advisors can use to value their own businesses. The easiest way, he says, is to apply a multiplier. A multiplier could be applied to revenue, EBITDA, or AUM to determine enterprise value. Hong prefers to look at EBITDA as it’s a little higher up the income statement and the underlying variables below EBITDA can be changed more easily.

The multiplier applied, he says, has drifted down from around 2.6x to around 2.1x over the past ten years. That drop, Hong says, can largely be explained by fee and margin pressures from the rise of robo-advisors, as well as a reflection of generational wealth inequality. More wealth is held by older generations, who are approaching retirement and drawing down on that wealth, leaving less to manage overall. Even high earning young people are struggling to save amidst a cost of living crisis, which dampens the future growth prospects for advisory practices.

The multiplier method, Hong says, is quick and gives you a good starting point, but can be a bit too simplistic. Advisors may also consider a discounted cashflow method which is significantly more robust, though it is more complex and time consuming to use.

Outside of the hard numbers, other intangibles in a practice can play a key role in valuations. Hong breaks those into the “tangible intangibles” and the “intangible intangibles.” The latter category includes things like the individual relationship an advisor has with their clients, the happiness of their staff, the reputational value of the practice, and the culture of learning and service that exists on the team. The former category includes questions like client concentration, the proportion of total AUM does the biggest client represents, the average age of the clients, the age of the company, and the employee turnover. All of these factors will play into exactly what multiplier is applied when a valuation is arrived at. 

Market sentiment and other outside macro forces will always play a role in a practice’s valuation, as well. Dealmaking is often cyclical and there can be periods when buyers are few and far between. In those periods dealmaking can prove difficult because there are fewer similar deals to inform valuations. Sellers and buyers may have greater price divergence and coming to an agreement may prove difficult. Interest rates can play a role in deal volumes, too, and the expectation of interest rate cuts coming soon may be positive for practice valuations.

As advisors look to value their practices, Hong suggests financial modelling as a useful tool. These models, which his company is expert in, can include factors like social media marketing and client growth by age into some of the other more concrete and amorphous factors outlined above. While it can’t give the same definite answer that a final deal can, it offers a solid foundation.

One area of risk that Hong believes advisors need to be aware of is what he calls “key person” risk. Many independent advisors, and even those associated with larger firms, market themselves under a personal brand. That established personal brand and the focus on personal relationships can negatively impact the valuation of a practice. If that advisor is the whole face of the practice, and they want to sell, the value of the practice without them is clearly going to be much less. As advisors consider the sale of their practices and work towards strengthening their valuations, Hong believes they can work towards establishing a business brand that will outlast them and make potential buyers more interested.

“Do things to maximize the long-term value,” Hong says. “Make sure fees are at sustainable market rates, that clients are satisfied, and build out succession plans. Staff your team so that the business can run without you there one day. Build a marketing strategy that focuses on building the brand of the business. These are things that are probably going to harm your bottom line in the short-term, but will help you in the long-term when a buyer comes in.”