by Tony Vidler
Given some of the trends in financial services there must be serious questions about how to accurately value a practice of a financial adviser. The short answer to what is an accurate value of any practice will of course always be “whatever a buyer is willing to pay, and which you are willing to accept“. That answer does not however help to establish the initial expectations, or ongoing negotiations. And the smaller the advisory practice the more volatile the valuation range should be if one is to be truly objective about it all…but that is not how the industry generally works historically.
The historical and (stilly fairly typical) method of valuing a financial advisory firm has been on a simple “multiple of renewal income”, which when you think about it is not purchasing a business at all. It is merely an asset strip from a business. There is not really any value placed upon systems, infrastructure, IP, branding, personnel or anything else which might provide genuine ongoing value to a new purchaser. One practice simply sells it’s book of business, or in-force contractual income stream, and then shuts down the rest of the business. It is an asset sale followed by liquidation of the rest of the business. So it does not “value a business” as such; it values an asset of the business.
Importantly, the sustainability of the income stream upon which this valuation method is based is also debatable. There is a dangerous assumption in this valuation method that the existing renewal income – or contractual right to receive an ongoing commission from product providers – is inviolate. That it cannot be changed. Or taken away entirely.
Contracts can be changed….terms of business from product suppliers can be varied. Regulators can intervene in long-standing commercial structures and effectively re-write the remuneration and financial responsibility rules at short notice through regulation or legislation. Indeed, in some parts of the world they have already done so, or are attempting to.
A smart practitioner looking to buy a practice would therefore consider such a method of valuation as being a “snapshot of value”….an indicator, rather than an absolute measure. That same practitioner would consider a number of other methods of valuing the business and then come up with a range of probable values. A really smart practitioner would enlist professional help of course – commercial valuation is a specialist skill (which I do not profess to have!) – and given the numbers involved in a business purchase you would have to consider that expert objective analysis and advice is effectively a form of insurance against getting a deal horribly wrong from the start.
Some of the methods that you should consider might be:
As explained above, this is an indicator of asset value – not full business value. It is not unusual (in this country) for different lines of business to be valued with different multiples (for example; superannuation contracts providing residual income for the adviser might attract quite a different multiple to say life insurance contracts as the anticipated duration of the income streams vary)
An excellent indicator of bottom line value of any business is what it is worth in the event of a “fire sale”. It is a fairly brutal method of valuation, however it does provide a reasonably realistic view of what the market would be prepared to pay when the vendors desire to sell is significantly greater than buyers willingness to purchase.
In it’s simplest form this method assesses Realisable Asset values minus contingent or contractual Liabilities
The key difference between this and the rule of thumb “multiplier” approach is you are considering the earnings of the business on an ongoing basis, taking into account the anticipated expenses in running the business as a going concern. The anticipated Earnings of the business can then be capitalised using discounted cashflow analysis to provide a Present Value of those future anticipated earnings.
There is merit in being able to compare your practice to other similar businesses which have been sold as it gives a strong indication of general market sentiment, and possible demand for your business. This is one of the areas where expert valuation advice adds significant value, as comparative data on private business sales is difficult to obtain, and assess, privately. A key advantage of this method is that it does provide a reasonably strong indication of the premium which might attach to brand value and intangibles
As opposed to considering what the business as a whole can earn for all shareholders, this method focuses primarily upon what an owner can extract from the business in the way of income or lifestyle personally. In addition to the profits of the firm which are available to the owner, there is the income which can be derived by the owner working in or managing the business. There is also usually an element of being able to eliminate personal expenditure by transferring responsibility and cost to a business, such as vehicle leasing, or using the (new) business’ premises instead of maintaining your own office somewhere else.
This list is not exhaustive, and there are a number of areas which can potentially be more valuable to prospective buyers than physical assets or contractual income streams. However, it should be sufficient to highlight that the conventional and simplistic method of agency valuation does (at best!) provide one indicator of value only. A prudent business person would consider a variety of valuation methods in order to determine a “probable range of value”, which then becomes the logical point from which to manage both buyer and seller (and their respective stakeholders) expectations, and from which one can begin to negotiate successfully.