Announcements of mergers and acquisitions continue to dominate the headlines as private equity firms, banks, consolidators, regional RIAs and the like capitalize on the significant headwinds facing standalone independent firms and RIAs.
The reality is that we are in the midst of a “seller’s market”, and as such, there are plenty of firms that would benefit from M&A. Even a wirehouse “sunset program” – where a retiring advisor can monetize his business via an internal transition – can essentially be considered an opportunity for the right buyer. Benefits and opportunities aside, the fact remains that many of these potential sellers don’t really have a clear picture of how much their businesses are worth, let alone the benefits they may gain from M&A.
Unfortunately, determining enterprise value is a complicated process. Much like what a homeowner goes through when trying to determine the value of the home they wish to sell, there are many qualitative factors that go into the valuation equation. And when there are multiple suitors for a firm, you also have pricing leverage to factor in. To be sure, much of the ultimate valuation for a business comes down to the subjective rather than the objective; that is, the value of a seller’s business is as much as a buyer is willing to pay for it.
The 7 drivers of enterprise Value
Whether an advisor is the owner of his own firm or an employee at a major brokerage firm, these 7 areas provide key markers that drive enterprise value.
A wealth management organization is built upon people; that is, the clients and the advisors who serve them. With that in mind, it comes as no surprise that firms who boast a deep and multi-generational bench of advisors are positioned to capture higher multiples. While many transactions are succession-oriented, acquirers look for sustainable firms with business development spread out amongst multiple advisors and which can transition across multiple generations.
As the business of investment advice has become largely commoditized, sophisticated buyers and major brokerage firms covet organizations that provide holistic financial advice, which encompasses financial planning, estate planning, portfolio management, etc. In addition, the litmus test of “does this firm provide a really good client experience?” – one which is repeatable and systematic – drives enterprise value.
A diversified client base – one that spans multiple age brackets – dictates a key portion of valuation. The value of a firm is the summation of future cash flows, so ensuring long-lasting client relationships is critical. Additionally, firms who cater to a particular market niche (doctors, athletes, business owners, etc.) are of particular interest to buyers as they can leverage their own scale and resources to further penetrate these markets.
RIAs and independent firms that are professionally managed and laser focused on growth, while boasting strong technology and a robust infrastructure, make the most attractive merger/acquisition partners. Especially if an acquisition means entering a new geographic market, the acquiring firm will need efficient and scalable operations with strong local leadership. Even large wirehouse teams with a dedicated COO or strong support staff can appear more attractive to the market.
It comes as no surprise that a spotty compliance record is an immediate red flag for an acquirer/recruiting organization and represents a riskier transaction. So keep this in mind, as it can create negative value even when all other areas of the business are considered prime.
While there is no perfect time to sell or transition firms, advisors always look to capture as much of their upside as possible, as buyers pay premiums for firms that still have some growth in the tank. As soon as a business shows signs of negative growth, the multiple is immediately impacted. Strong organic growth is also key. If a firm has grown purely by acquisition and it hasn’t grown by its own client additions, this may signal deeper internal problems.
While the above qualitative factors drive value, deals are based on financial metrics—most notably earnings, revenue/production and AUM. The most aggressive multiples are reserved for firms with strong operating margins and have the scale to operate on their own. While EBITDA (in the RIA and indy space) and production (in the traditional space) are often market benchmarks, maintaining an efficient business model translates to maximum operating leverage for an acquirer and thus greater combined value.
Valuation, while an important consideration for any business owner looking to monetize their life’s work, should only be a small factor in an acquisition. Vocalizing how a merger/acquisition will allow you to better service clients, grow the business and live a more fulfilling business life should retain the most weight in a decision. If selling or transitioning appears on the horizon, then take a long hard look at your business from the buyer’s perspective and ask yourself, “What can I do enhance the value of my practice?” At the end of the day, the house you built is what’s on the line. Be sure that you have recognized its “true worth” and are not short-selling yourself, your clients or your future.