MIAMI BEACH, Fla. - Exactly how RIAs are valued is a matter of long-standing debate, and the topic is more relevant than ever in the midst of a red-hot market. According to Vic Esclamado, managing director at DeVoe & Company there are three drivers of value RIAs can't afford to ignore: growth, cash flow and risk.
Speaking to an audience of RIA owners at the firm's inaugural M&A conference following the MarketCounsel Summit in Miami Beach, Esclamado stressed the importance of focusing on what's really valuable to buyers, rather than price or assets, when prepping a firm for a sale.
Solutions for growth, especially when measured by revenue, EBIDTA, and net new client assets,"may take the longest to implement but deliver the longest-term benefit," Esclamado said at the company's M&A+ Succession Summit.
RIAs shouldn't be afraid to spend money to hire business development specialists, he said. "It's critical to identify the right people to represent the firm, make calls and get new business," he explained. "The results may take time, but the investment should be well worth it."
Firms should also apply to join referral programs offered by custodians. "RIAs can increase their leads, improve its branding and get in front of more prospects," Esclamado said.
Firms should also create "a comprehensive and integrated marketing approach that will drive sustained growth," DeVoe & Co.'s founder David DeVoe said in an interview with Financial Planning. "It is a growth machine that is important — not a single silver bullet or charisma.
2. CASH FLOW
Carefully measuring expenses and revenue offers RIAs "a rich benchmarking opportunity," Esclamado told advisors in the audience. How owners are compensated is one aspect of cash-flow analysis that is often overlooked by sellers, he added.
For instance, many owners simply "take home a certain amount of cash" and don't separate that amount into a base salary and proceeds from the business, Esclamado said. But that's a mistake, he argued. "Potential buyers want to see a standardized compensation structure," Esclamado said. "Normalizing comp is a big deal."
Buyers also pay close attention to profitability, added DeVoe.
"Running a profitable firm not only creates more income for the owners, it demonstrates you are running a well-managed organization," he explained. "Efficient processes, smart hiring and disciplined decision-making will drive strong profits."
Tackling risk is "the lowest hanging fruit for increasing firm value," Esclamado said.
When hiring advisors, firms should make sure to include non-compete and non-solicit provisions, he told owners. RIAs also need to methodically cultivate relationships with the next generation of clients, DeVoe added.
Every firm should have a succession plan, Esclamado said. "Key-man risk is something every buyer looks at," he noted. "Having a succession plan in place is essential."
An independent board of directors comprised of successful executives from outside the industry is another way RIAs can reduce risk, said Brent Brodeski, chief executive officer of Rockford, Illinois-based Savant Capital Management.
"An independent board with outsiders who can offer truly objective advice is a strategic asset," he said.