Maximize your firm's value by leveraging a next-gen adviser

Do you plan on selling your practice and leaving the business within the next five years? If so, do yourself a favor and transition your clients over to a next-generation adviser before you sell.

We’ve all seen the record number of wealth manager transactions. And although some of this M&A involves larger enterprises, a majority are smaller practices (with a few hundred million in AUM). Whether you oversee a large enterprise or you’re a one-person shop, the more completely you can replace yourself prior to the start of negotiations, the better terms you’ll receive.

Let’s look at how most small advisory shops are structured. There’s a founder who was able to identify and attract clients, and hire a support staff of one or two people to assist her, and she’s been able to manage the business for cash flow.

This adviser’s compensation is essentially the difference between the firm's revenue and its expenses.

In a situation like this, what is the value of the business? It’s only valuable if there is some excess profit that would accrue if a replacement adviser would be willing to work for a compensation package that is less than the current adviser takes home.

Consider this example: An adviser has $150 million in assets under advisement and generates $1.3 million in annual revenues. She has two support staff and a small office, and her total expenses are $500,000 per year. She’s been taking home the total profit of $800,000 a year.

So what’s this firm worth? Well, it depends on how much this adviser would have to pay a new adviser to replace her. Let’s assume she would be able to replace herself with a seasoned adviser at $200,000 plus benefits, for an all-in comp plan of $250,000. In this scenario, the firm’s expenses would increase from $500,000 to $750,000, but assuming the founding adviser is no longer working, the firm would be generating an annual profit of $450,000.

With some exceptions, the value of a firm such as this will generally be derived from that annual profit.

The roadblock is that many seasoned advisers who plan on selling their practice in the near term want to maximize profits now, and therefore they don’t want to hire a junior adviser because they want to avoid the increase in expenses.

This is a mistake. To truly maximize the firm’s value, it would be better to bring on a new adviser today, train that person and transition clients over a couple of years.

That means when it comes time to sell the practice, you’ve got a firm that's no longer 100% reliant upon you and you’ve already prepared your clients for this succession. Not only does an acquiring firm place more value on the fact that it won’t have to go through the work of finding a quality replacement adviser, but you also won’t have to stay on for a couple of years under the new regime to ensure a smooth transition.

Acquiring firms will typically pay more for a firm run by a forward-thinking principal like this than one who hasn’t implemented a succession plan.

Scott Hanson is co-founder of Allworth Financial, formerly Hanson McClain Advisors, a fee-based RIA with $15 billion in AUM.