Unlocking the value of your business

If you have operated a financial services firm for more than 15 years, you have seen significant change.

If you have operated a financial services firm for more than 15 years, you have seen significant change. Due to the great bull markets of the last decade, the average client is far wealthier than he or she was previously. Over that period, the typical client-adviser interaction morphed from a sales transaction into a relationship that endures and requires far more contact than in the past.

Likewise, this era created major changes in firm valuation. Firms once had little or no practice value except for a few years of retirement trail income. Today, many advisers have established true business value that can run into the millions of dollars.

Let’s recap the ways advisers have extracted business value from their practices and how this process is changing.

• Wave One was the establishment of the first platforms to buy or sell a practice, which gave sellers a way to connect with potential buyers. Market participants thought that advisers would agree to a match with an unknown outsider to sell their practice.

About five years ago, however, the industry’s changing dynamics began to alter exit strategies.

First, advisers reaching retirement age created a supply of practices for sale. Second, since client relationships had become more important, selling a practice became problematic, as clients began to feel like chattel being bought and sold. Third, methods for extracting business value, over and above the external sale model, began to take shape.

• Wave Two is the increasing use of internal succession models by advisers planning their exit strategies. The seamless nature of transitioning ownership internally rather than externally addresses the concerns clients have with transition plans.

Although consolidators and acquisition firms have existed for a long time, how they acquire firms has changed. They seek to buy all or most of the ownership of adviser firms in exchange for a combination of cash and stock in the acquiring firm.

The independent-broker-dealer community also has begun to show strong support both for the internal succession and acquisition models.

“Increasingly, over the last few years, our representatives have asked that we respond to their need for internal succession strategies and certain acquisition models that don’t interrupt our adviser relationships,” said Matthew Gaude, regional manager for FSC Securities Corp. of Atlanta. “We see very few traditional external sales among our advisers.”

• Wave Three is where we are today. Changes are under way that will increase choices for monetizing the value of a business.

Private-equity firms are showing up in a different way. These “micro-private-equity groups” are smaller, and don’t want ownership in your firm. Instead, they seek to acquire a percentage of net profits.

For example, a firm with $400,000 in earnings before interest, tax and amortization, might receive an offer to monetize half the business, or $200,000, at a multiple of four to five times, resulting in $800,000 to $1 million of value.

There are several unusual features of this monetization model.

Interested parties pay all cash, either upfront or over a period of two to four years.

By purchasing a percentage of a firm’s profits, rather than actual ownership, far less capital is involved.

Since micro-private-equity groups don’t need to spend money developing operational platforms, as many traditional acquirers do, they can compete more aggressively for the profit streams of any firm, regardless of size.

The adviser benefits in two ways. First, if a firm has consistent growth, its owners can monetize half their current net profit stream now, increase profits over the next few years and monetize again while still maintaining full ownership.

Advisers also have the option of buying back profit streams in the future for a predetermined multiple. Alternatively, when the firm’s ownership is eventually sold, the investor group can sell their profit stream at the same time as the owners.

It sounds exciting, but like previous waves in the history of adviser business value, this one will take time to develop. For example, investor groups need to work out the problem of how to protect their financial interest, because they aren’t legal owners of the business.

Still, don’t be surprised if one of these groups comes knocking on your door.

David Goad is president of Succession Planning Consultants LLC of Newport Beach, Calif. He can be reached at [email protected].

For archived columns, go to investmentnews.com/practicemanagement.