Accurate figures point the way

Brad Bueerman, executive vice president at FP Transitions, knows advisory practices. In fact, he's looked at thousands of them with the goal of helping owners increase their value. The demand for an accurate valuation of advisory practices has exploded as aging advisers hope to sell their practices to outsiders or younger successors within their firms. Last year, FP Transitions conducted more than 1,000 valuations — about 60% of them registered-representative practices, 30% registered investment advisers and 10% pure insurance practices. This year, Mr. Bueerman expects that his firm will do 1,500. InvestmentNews spoke with Mr. Bueerman about valuing advisory practices. InvestmentNews: Why should advisers get a valuation of their practice? Mr. Bueerman: People used to get a valuation of their firm for one of two reasons: Either they were selling it or they were getting a divorce. But there's been a shift in the market … For the majority of RIAs we do valuations for, their practice is their biggest asset, and you need to manage your biggest asset. That's what a wealth manager would do for any client with an asset that is important. To protect it, you need to know its value, and you need to monitor it. That's why we've seen a big increase in the demand for valuation services. InvestmentNews: How does one conduct an accurate valuation of a firm? Mr. Bueerman: For a long time, the industry was hung up on using simple multiples of recurring revenues and of nonrecurring revenues to get a value for a firm. It's an easy approach, but it assumes all firms are the same. We use multiples ranging from 1.7 to 3.4 for recurring revenues [such as fees], and 0.6 to 1.7 for nonrecurring revenues [commissions]. The purpose is to determine what a practice would sell for in the market. That's different from an appraisal, which typically looks at discounted cash flows, asset values and comparables to public companies. That doesn't make a lot of sense to us. Future projections depend on performance in the market. Advisers usually don't have a lot of hard assets and there aren't a lot of comparisons to be made with public companies. InvestmentNews: What are the problems with using simple multiples of revenue to make valuations? Mr. Bueerman: It's like stock analysis. The average P/E ratio on the S&P 500 index might be a good starting point, but it won't tell you what a stock is worth. Basic multiples assume that all practices and all client books are the same, and they're not. They're all built by entrepreneurs, and they're all different. If you want to use valuation information for managerial purposes, you have to be more precise. InvestmentNews: What are the factors you look at? Mr. Bueerman: We look at three major factors: transition risk, cash flow quality and marketplace. When you buy an advisory firm, you're buying client relationships, and they aren't governed by contracts. We look at the length of client tenure at firms, employee tenure at the firm and whether there are non-compete arrangements in place for key employees. In terms of cash flow quality, we can't predict the market, but we can look at the growth rate on assets, client revenues and the number of clients to start with. We look deeper at the demographics of the client base such as their age, where they are in their investing lives. We also consider how much of a firm's business is concentrated in a few clients. It's a big risk if you lose key clients. We don't focus a lot on expenses or earnings before interest, taxes, depreciation and amortization, because in our market of less than $2 billion in assets, it's the buyer's cost structure that matters, not the seller's. The buyer will just fold the firm into their structure. Lastly, we look at where the firm is located. It's mostly based on the wealth demographics of where a firm is located. If the area is wealthy, the firm is more valuable. A firm based in Naples, Fla., is worth more than one in Baker, Ore. InvestmentNews: What do your clients do with the information you give them? Mr. Bueerman: We do a lot of valuations on a yearly basis as a means of updating the firm's continuity plan. Normally, people aren't selling into the open market but to people already at the firm. We help them increase the value of their practices by benchmarking against other firms. If a client wants to reverse negatives we see, we might suggest they set up non-compete agreements with their employees or make their branding more firm-centric rather than ego-centric. Maybe they need an exit plan for the owner, even if it's 15 or 20 years in the future. If an adviser is always building on the value of his or her practice, it gives them more options down the road.