The selling advisor always thinks their practice is worth a lot more than it is and valuation companies seem to agree.

Practice acquisition (acquiring a retiring advisor's practice) is an incredibly lucrative way to grow your business exponentially, and as advisors age, there will be ample opportunity for younger advisors to acquire practices. In the next 10-15 years, there's going to be a glut of “for sale by owner” practices, but the simple fact is that they are not going to be worth the multiples that are being thrown around now.  

As an advisor coach, I have worked with financial advisors for a number of years on practice transitions  -- selling and acquiring practices and getting in and out of the business. The number one thing that we find in working with advisors who are buying practices is that the selling advisor thinks their practice is worth a lot more than it actually is. 

There are many factors that go into how to evaluate a practice, but I believe some key items are being overlooked by those who value practices. Here are five things to ask the selling advisor and the appraiser before you buy a practice:

1. What is the demographic of the client base What is the average age of each of the clients?  How does that affect the value? If the majority of the clients are very old, it is not worth as much.

2. How much income is being taken from these accounts each year?

Have you accounted for that? If you have to replace 20% of the book every year just to break even due to income and/or distributions, it's not worth as much.

3. How much money is locked up in permanent insurance or variable annuities, and how was that paid?  When are the surrender dates?  How does that factor in to the valuation?

If you cannot get paid for three, five or seven years on a client, it is not worth as much.

4. What other commissionable products have been sold to these clients that lock things up?

Did you take into account real estate investment trusts, master limited partnerships? If so what multiple are you paying on those “assets”? Again, if it is locked up and commissions were all taken up front, it is not worth as much.

5. How often is the advisor meeting with these clients?

How much of this book are you calculating will not move to you as their advisor? If the advisor is meeting with their clients less than annually, it's not worth as much.

When you're looking at purchasing a practice, you need to have the next layer of investigation done for these five areas. There are many other ways that they selling advisor is getting paid on their book that could truly affect the value and what you should be paying for the practice. Be careful and ask more questions about the numbers. These guidelines should help ensure you pay a fair price for a practice.

Matthew Halloran is the president of Top Advisor Coaching. He is a certified coach, an author and keynote speaker. More information available at www.topadvisorcoaching.com.