The art of the deal

The following is an edited transcript of the webcast What is your advisory business worth held Feb. 23 in New York.

The following is an edited transcript of the webcast What is your advisory business worth? held Feb. 23 in New York. InvestmentNews deputy editor Evan Cooper was the moderator. The panelists were Paul Lally, Steven Levitt, Daniel Seivert and Harman K. “Jet” Wales.
Investmentnews: Jet, give us an idea of the current state of affairs in the advisory business, and the overview from Moss Adams.
Mr. Wales: We’ve been working with registered investment advisers or broker-dealers for over 10 years as consultants, and also in arranging transactions. My particular area is the investment-banking side, with a focus on RIAs and broker-dealers.
The environment at the start of 2010, of course, has been affected by the past 18 to 24 months, and so in this environment, the real question is: “What is the value of my firm?”
In the media, we do a lot of reading and a lot of reporting about the value of a firm and often see it reduced to a single number. Moss Adams has found that getting true value is not only getting a fair price but also achieving a number of other objectives at the same time. Rarely does the owner determine value as meaning just a singular objective of price. Nonetheless, we’re going to try to do our best to zero in on a number here. And I think all of the panelists are going to give you their respective views.
There has been a slowdown in deals, but alternatives do exist right now for the owner thinking about a sale, whether that’s a 100% sale, a gradual buyout, consolidation with strategic partners — all of these are alternatives. The good news is, there are things that you, as advisers or broker-dealers, can do today to increase the value of your firm, whether it’s for a transaction now or two and three years out.
So what is the number? We live in a world where the measure of the market is a multiple of revenue. That’s easy language to use. It’s a metric that gets communicated often. The fact is that we don’t think it’s a great measure, but it does get reported, and that’s what people want to hear. So I will give you a general view from Moss Adams’ perspective about the number. And then as a group, I think you’ll hear each of us tell you why a multiple of revenue is not a reliable way to value your practice.
Here’s Moss Adams’ measure of the market. The all-in deal values today are about two times annual revenue, ranging from 1.5 to 2.5 times revenue. We would say that there’s been little movement in this figure over the past 18 months, so there hasn’t been a material decline in that revenue multiple. A two-times multiple doesn’t mean much without knowing the terms and the structure, however. This is the area where there has been a material shift in the actual deal value. Two years ago, you might have expected 50% of that number to be upfront; now it is more like 20% to 30% of that number upfront, with the remainder being paid out over three years or perhaps longer — all based upon hitting certain benchmarks such as retention and growth in earnings. So the timing of the payments, and whatever contingencies are tied to those payments, really can dramatically swing the value of your firm.
Now that we’ve gotten those numbers out of the way, I want to tell you why we don’t think they’re really the numbers to look at if you want to value your practice, meaning two times revenue, with roughly 30% upfront. And our experience is, most buyers are looking at the future transferrable value of your company. And value means earnings. So if you look at the value of your company, you really want to be thinking about: “What are the earnings that I can transfer to the next buyer?” And remember that that really is a function of the future. A knowledgeable buyer isn’t going to determine the value based on what’s gone on in the past.
This is an area where you can really help yourself and work hard to determine what level of earnings your firm is going to generate for the next owner. There are a lot of techniques that focus on the financials, adjusting today’s earnings, reflecting what’s going to happen in the future. Called “normalizing earnings” — I’m sure we’ll talk more about that later — it’s a way of presenting those financials in a manner that a buyer can look at that and understand: “What are they going to be getting out of this, and what kind of value they can place on that?” Over and above that, you can start to build up a strategic value. There are a number of things that you can bring to a buyer through strategic benefit. There are some value drivers that will continually drive that up.
Investmentnews: Dan, tell us a little bit about Echelon Partners and your approach.
Mr. Seivert: Our firm was found¬ed in 2001. And over my 20-year history of serving the financial services industry, I’ve worked for a number of firms, starting off in mergers-and-acquisitions law at Skadden Arps Slate Meagher & Flom, then working for The Capital Group Cos. as a buy-side portfolio manager and then in strategy, then at Lovell Minnick Partners as a venture capitalist — all of those prior to founding this firm.
Our firm has conducted over 450 valuations and evaluated more than 2,000 acquisition targets and author¬ed 22 reports specifically on the subjects dealing with the wealth and investment management industry.
So with that as a prologue, I thought I would cover five key questions related to the key theme of: “What’s your advisory business worth?” The first one is, what is value when it comes to wealth management firms? It’s important to consider that value isn’t always the same in different situations. So the first situation is what your practice can be sold for. A key example of how value differs is when you sell a practice to a third party through an auction process, versus selling your practice to internal partners or a lieutenant in your organization. One would sell for a competitive market price. The other might sell for a discounted price. We often see a discount of 20% to 60% for internal sales.
Another thing you should keep in mind is: “What is value as it relates to others’ coming into your business or leaving?” If a partner is added or if a partner departs, one needs to keep in mind whether it is a minority position or a majority position. There are different valuations in those two different situations.
Also consider what your team or division might be worth to other teams or producers inside an independent broker-dealer. Oftentimes you have a fixed market and a currency, or a valuation, by which the overall firm has set for transacting values, and you can’t really affect that. In those situations, value is more of a dictated level. That goes for the wirehouses as well, when a broker leaves.
Finally, consider what your shares would be worth as your company transitioned from private status to public status.
The second question is: “Why is this subject important?” It’s important because this is your retirement. This is your potential liquidity event. Knowledge on the subject is power, and it can mean wealth creation. Also, a proactive approach or early intervention with relation to this subject can create significant value.
The third question is: “When are valuations conducted?” Here’s our list: mergers, acquisitions, sales, partners’ coming or going, the divorce of a partner, litigation, financing — it could be debt or equity — strategic planning, buying and selling agreements, and continuity planning or succession planning. There’s a host of applications for which valuation is important.
The fourth question is, “How does one calculate value?” We have a seven-step process.
The first step is to evaluate the type of firm being valued. Is it a commission-based practice or fee-based? Is it large or small? Does it deal with alternatives? Are fees hourly or fixed? There’s a host of different business models out there. Some are asset managers only; some are asset managers and wealth managers.
The second step is choosing the appropriate method for the valuation. For the sake of simplicity in this example, I’m going to use a multiple of [earnings before interest, taxes, depreciation and amortization] or of cash flow.
The third step is to calculate your pro-forma Ebitda. And this involves adjusting your revenues so that you take out non-recurring items and also adjusting your expenses for occasional personal expenses that are run through the business or any non-recurring or non-operating expenses, and to develop a pro-forma Ebitda.
The fourth step is to determine the appropriate valuation multiple, and this is where the magic is. We specifically have a 10-factor valuation multiple score card for which we go through the different aspects of the business, and we score it so that we come up with the appropriate valuation multiple. Some folks do a multiple of cash flow; some folks do a multiple of revenue. But the hardest task within valuation is figuring out what the appropriate valuation multiple is. With respect to a multiple of Ebitda, it could range anywhere from three to 15.
The fifth step is to calculate the preliminary value, multiplying the Ebitda by the Ebitda multiple. So let’s say you had $1 million in Ebitda, a seven-times multiple, the firm would have a preliminary value of $7 million.
The sixth step is to make adjustments. So is it a minority position? What buyer is involved? How do synergies play on this? For instance, if two firms are coming together, two plus two equals not four but six; how does the additional two in value get split between the buyer and the seller? That needs to be factored in.
And the seventh and final step is to calculate the adjusted value.
The last question is: “How are advisers doing with respect to equity management?” We find that there’s been a lot of difficulty for advisers calculating an accurate value for themselves, and they’ve fallen into the trap of just using some of the rules of thumb rather than going for the appropriate valuation. I think also many often start the value management process too late and have little ability to control their fate in the process. Many fail to execute a professional sales process. We believe that advisers often leave hundreds of thousands of dollars on the table when it comes to these liquidity events.
Listen to the complete webcast at InvestmentNews.com/valuing.