In the past few years, there has been much debate on how to value a financial planning business. In light of recent government proposals set to change the industry from July 2012, it has proven even more difficult as business owners generally have preconceived ideas of business value.
It is common to hear financial planners say that they want 3.5 times recurrent income for their business when in fact the market is paying between 1.5 to three times (Radar Results November 2010). The issue with valuing financial planning on recurring income is that it completely ignores the cost of producing that income. Most financial planning businesses are small enterprises, but they are generally offered for sale as an ongoing concern or as a simple database/revenue source. In this case, the purchaser is going to look at the return they will make by investing money in the business. In simple terms, they will be asking, “What will be my net-profit after I have paid the business expenses and after I have been paid a salary?”. The purchaser will then make a judgment as to whether this is a good investment.
The multiple of recurring income method places a value on the recurring income stream with no regard for the cost of producing it. This is only valid if a business is going to buy the business as a client base and merge it into existing cost structure. (There is a case for ignoring the seller’s cost structure in this scenario). However, the true value of an income stream must account for the cost of producing it and therefore capitalising EBIT (net-profit) provides a valuation of the whole business. (In reality, a purchaser is buying the future earnings of the business and therefore a valuation should be based on capitalisation of future maintainable earnings discounted by a risk factor.)
The problem that most business owners have is that they spend their time looking after clients and have not focused on the business fundamentals because the monthly trails are constant and consistent.
We have identified five issues faced by many financial planning businesses which will impact the sale price.
The most common flaw in financial planning businesses is that they have not addressed service and pricing. This is fundamental to the value of your business because it impacts on the amount and quality of recurrent income.
Step 1 You need to segment your client base according to the income delivered to your business by each client.
Step 2 You need to define the service that you will deliver to each client segment.
Step 3 You need to calculate the cost of delivering the defined service.
Step 4 You can then determine what pricing you should adopt for each client segment.
It is essential that you deliver consistent service to each segment and that this service offer is valued by your clients. This will create quality relationships and strong recurrent income streams.
The value of your business ultimately depends on your ability to transfer client relationships to a new owner. If the maintenance of client relationships is dependent on you, then you have not only placed a limit on the income of the business, you have also increased the risk of not being able to transfer the relationships to a new owner.
You need to ensure that the clients have a relationship with a team of your staff that delivers your service proposition. The client will perceive that they have a relationship with the firm, not an individual. This will make transition to a new owner much easier.
A profitable business is more valuable than a marginal business. It is also a measure of business efficiency. The purpose of running your business is to make a profit and you should show a purchaser that your business achieves its goals. The most common problem, apart from service and pricing, is that they are often over-staffed. The most common response to this observation is that they are positioned for growth and have not defined the roles of key staff in the business.
Keep good financial records. Produce monthly financial statements measuring actual performance against budgets. Monitor key ratios and graph trends so that you can see if you need to take corrective action. Being able to produce good financial and management information for a prospective purchaser makes a big difference in the qualitative view of your business. Make sure that all processes in your business are documented and are reflected in your staff’s KPIs.
Reaching agreement on price is the easy part. The art to a successful transaction lies in negotiating the transition of the business. These transactions normally include a deferred payment that will be adjusted to reduce payment for clients that did not make the transition to the new owner. After all, the purchaser does not want to pay for a client who did not stay. Other issues that you may encounter include:
In summary, there is a host of other matters to be agreed between the parties before the transaction can take place.
The financial planning industry is likely to go through an interesting evolution over the next two years with many financial planning businesses reaching a stage of maturity where their growth has plateaued. Many business owners in our industry are in their late 50s and have built their business from scratch. They are generally good financial planners and marketers but have not closely examined business fundamentals, which they must do in order to take the business to the next level of growth and value. The skills needed to do this are different from the entrepreneurial skills needed to start and nurture the business.
Why are business owners accepting the need for better management? The GFC taught us a painful lesson and has hopefully educated business owners to invest in their businesses now.
You should always manage your business as though it is for sale. Understand the factors that add value to your business and focus on them in your day-to-day management. Adding new clients to your database does not create value in itself. You need to deliver consistent service and value to your clients to create strong relationships with your business. In the long run, a strong business relationship will add value to your bottom line.
At IOOF, we have created the Business Optimisation Program to help advisers understand their business in more detail, to help them grow their business and increase business valuations.
For more information on this topic please contact your Business Development Manager.
Kind regards,
Joshua Parisotto
Head of Practice Management
Viewpoint
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