Sticker price isn’t everything for M&As
Succession planning is complicated for a multitude of reasons, but it’s also like selling a house.
There are various factors that impact your property’s selling potential — an updated kitchen or an outdated bathroom. While understanding the various components that add or decrease resale value of your house is relatively easy, selling an advisory practice is much less obvious.
The process of selling your advisory firm should start well before you plan to retire by understanding how to improve the value of your practice and pay dividends when it’s time to sell. With myriad considerations to evaluate come plenty of misconceptions. Getting to the bottom of what’s important in the sale of RIA is one of the most important things an advisor, as a business owner, should be thinking about.
Here are four tips to consider — and misconceptions to avoid — when selling your practice:
RIA’s are valued at two times gross revenue
As firms mature into larger entities, the emphasis shifts from top line revenue to bottom line EBITDA. That’s because larger firms incur operating costs associated with servicing additional acquired assets. These costs need to be included in the transaction and therefore must be considered when valuing the future free cash flows generated through the acquisition.
The buyer may also be assuming most of the deal risk, making paying a premium for those assets less attractive. A typical risk is an aging client base that is no longer in the accumulation phase and may lead to a declining value of assets. These assets will soon be inherited by children, who have no relationship with their parents’ advisor or firm.
Firms must also recognize potential challenges of different service models and geographic dispersion of clients. The more labor-intensive or geographically spread out the clients are, the more expensive they may be to service. This consideration should be reflected in the valuation as well.
To accurately value your firm, you’ll need to consider your revenue, cash flow, demographics of your book, technology stack and human collateral to name a few. Also be prepared to start the sale process years before you’re ready to exit the business.
Sticker price isn’t everything
When selling a business, understanding the clear difference between deal value (the sum of the consideration paid for the equity stake plus value of the net debt) and deal structure (ie: sale vs. merger, etc.) is very important:
- Installment payments: Typically, the longer the installment payment time period is, the more the seller is entitled to and vice versa. The buyer paying more, in total, over a longer payment period is a typical notion when it comes to owing money to the seller.
- While the sum of payments will be greater, the buyer’s installment payment will be less in a given year. This means less of the firm’s valuable capital is required each year. In turn, buyers should pay special attention to the acquired businesses’ expected cash flow versus annual payments to the seller. Capital outlay must be strategically planned by the buyer. Expected cash flows will frequently be used as a tool to cover the capital required to pay annual payments to the seller.
- Down payments: Higher overall down payments or guaranteed upfronts — seem to vary anywhere from 20% of the initial deal value all the way up to 40% — benefit the seller and may result in a lower total deal value, since more cash is being guaranteed, and shifting risk to the buyer.
- Interest rates can have a key impact on the total consideration someone receives for their business. The impact of interest is critical to total deal value and should be negotiated carefully.
Ultimately, deal structure is equally as important as deal value. There are a variety of deal structures at firm’s disposable to help make the deal terms work for both parties. From the seller’s perspective, the timing and type of cash flows can have major tax implications. From the buyer’s perspective, offering equity instead of cash to the seller limits capital outlay and can help with their strategic plan. Often, the buyer and seller can discuss their individual situations collectively and a structure that is mutually beneficial can be arranged.
Clients won’t change custodians
It’s an understandable anxiety point for sellers, but one that can be easily overcome. Advisors will overestimate a client’s loyalty to a custodian, specific technologies or branding, when in fact their loyalty is to you, the advisor. Don’t forget that.
As a financial advisor, you have guided these clients through some of the largest decisions they may face in their lifetime. A custodian change should be simple, in comparison. If you communicate the changes clearly, address any pricing differences, and maintain a transparent and confident approach, then your clients are unlikely (always exceptions) to push back too hard on moving from Fidelity to Schwab. What is most important is they understand any changes that may result. If they aren’t caught off guard, then our experience suggests they will trust the advice of their advisor.
You will lose your identity
Many advisors fear they will become a corporate extension through a rebrand their clients will not recognize. Depending on how involved a seller would like to be, often times their services, growth strategies and community footprint can remain in tact. Buyers are looking to retain assets and clients, which means retaining as much as the original practice as possible.
Whichever path an advisor chooses as a succession plan, the most important part is always planning. Thoughtful consideration can benefit all parties involved, in our opinion. Preparation results in potential for higher valuation, a more seamless succession and will allow you to best serve your clients in the years to come.