As many advice businesses reach maturity it is common to consider whether they should “buy to grow”. Should they buy another practice, or more commonly, should just buy a book of business from another practice.
The typical reasons suggested for wanting to grow through acquisition are:
1. Get new clients to “cross-sell” to
2. Increase business turnover
3. Increased cost efficiency
4. Diversify business lines
5. Enhance market position or scale
Generally the majority of transactions in financial services are valued on some form of a multiple of sustainable earnings. This is most often a “rule of thumb” type approach, where a multiple is applied to the passive income stream that the target business promises (which is fair enough). It seems that an “acceptable” multiple continually gets used by purchasers without any genuine consideration being given to either the cost of integration or the inherent value that the other business can actually bring.
Thinking like an investor who is applying capital for the long term, as opposed to someone judging an acquisition simply on its ability to introduce volume of one sort or another (clients; revenue; production; etc), will result in coming up with a valuation multiple which reflects its actual worth to you, rather than a value which the market has universally agreed to “be fair for all business of that type”.
The sort of questions and considerations which should arise in determining what the value of another business is to you would be:
How well matched are the two businesses really?
How easy are they to bring together, and how well do they complement each other?
There are any number of areas to consider, and you might begin with:
The better they are matched, and the easier & better the integration, then higher the potential value should be.
This type of analysis is in reality just a starting point however in understanding how the two businesses may mesh. Having done that one can reasonably begin to assess the cost and the benefits of integrating the businesses. Be aware that the majority of purchasers do seem to optimistically over-estimate the “synergies”, or benefits from the acquisition – and often seriously underestimate (or do not understand) the actual costs in terms of lost productivity impact and additional marketing requirements for a prolonged period.
The single most important thing to my mind though is that relatively few prospective purchasers seem to have formed a clear view or understanding of what stage the target business is at in it’s business lifecycle and as a consequence they seriously misjudge expected gains.
There is nothing at all wrong with purchasing a business that is perhaps heading into decline – provided you understand that decline is the inevitable path unless you have a good strategy for how to re-invigorate it. Buying a business in decline is fine, if there is a good turn-around strategy underpinning the purchase.
Even if the target business looks to have moved into some self-sustaining cash-cow mode and has little organic growth within it, there may still be solid rationale to pay a premium price for it. If the business can seamlessly be added to your own business, with highly complementary systems and data management, and opens up the opportunity for your (superior?) advice proposition to unlock latent value….then it may well be worth a superior valuation.
However, simply valuing a book of clients or an advisory business on an “accepted” industry multiple, without any understanding of how or where superior value from the purchase can be derived makes little sense.