Eric D. Brotman has met plenty of older financial advisers who have decided against selling their firms because they don't think that they will get a good price.
“They can't retire,” said Mr. Brotman, president of Brotman Financial Group Inc. “They know they won't get fair value in a fire sale, so they keep working, and eventually, the value they have built disappears.”
Mr. Brotman was determined to avoid that fate, so he decided to begin planning his exit early. On Jan. 1, just before his 40th birthday, he closed his first related transaction, selling 5% of the equity of his business to a 29-year-old junior partner.
The transaction is the linchpin of his succession planning, and he thinks that it will increase the overall value of his firm.
Bringing on equity partners, especially when they are of a younger generation, is one key to building the value of an independent investment advisory firm, according to investment banks that broker these transactions. But like many of the best practices for improving a firm's value, it takes time.
In fact, the most important step in getting top value for a practice is to start thinking about it years ahead of time, something that all too few advisers do, according to advisers and consultants who help broker sales. But even for the average adviser, who is in his or her 50s, it isn't too late to take steps to build a more valuable practice.
Mr. Brotman began developing his succession plan by getting his practice independently evaluated, a process that investment bank FP Transitions recommends to any advisers who think that they eventually may sell, even if that date is years away. Only about 4% of advisory firms ever bother to do so, according to FP Transitions' data.
“Investment banks are objective; they tell you what you need to hear, and what metrics raise or lower a firm's value,” Mr. Brotman said.
He is using the valuation report as a checklist for building his firm over the years.
TIME TO IMPROVE
Other items on Mr. Brotman's to-do list include building an ensemble practice with equity partners of different ages, a high number of younger clients and a variety of account sizes so that his firm isn't dependent on a few “whales.”
It is a long-term project best started early, he said.
“Advisers have to have sufficient time to improve their firm,” said Mark P. Hurley, president and chief executive of Fiduciary Network LLC, a private-equity firm that makes passive investments in fee-only wealth management firms. “That is why it doesn't get done.”
Mr. Hurley estimates that even a “fast” sale takes about five years from start to finish.
His firm has invested in 12 advisory firms over the past several years, though he has looked “at many, many, many more” that he turned down because they weren't good values, he said.
The first thing that Mr. Hurley looks at when deciding whether to buy is cash flow. He looks mainly for high-quality cash flow driven by recurring fees, as well as a good client base and multiple owners, he said.
He considers commission income “worth zero” to the value of the firm, though not all buyers shun commission-based businesses.
Adviser Brian Heckert has bought four firms in the Midwest over the past 10 years, while selling one business, a third-party-administration firm that served 401(k) sponsors.
Although he follows the industry standard of looking first at recurring-fee revenue when deciding on the price that he is willing to pay, he pays close attention to the quality of the relationships between the adviser and his or her clients, and is willing to take on commission-based business in cases where that bond is strong.
One firm that Mr. Heckert acquired served mainly insurance and variable annuity clients. His first step was to offer those clients fee-based planning services.
Over the first two years, the existing client base has brought an additional $10 million in investible assets under management.
“The people I worked deals with were close to their clients but had narrow product offerings,” Mr. Heckert said.
GETTING VALUE FROM CLIENTS
“That is a big opportunity,” he said. “There was so much more on the table that they weren't involved in with their client's financial life.”
The key is to continue to work with the previous owners, Mr. Heckert said.
“I team up with them in some kind of fashion,” he said.
Mr. Heckert typically structures a buyout over three years, during which time the seller remains active in helping to transition clients.
If he can persuade the seller to stay involved even longer, that adds to the value, he said.
“They can introduce me to new people, even if they have pretty much slowed down,” Mr. Heckert said.
Mr. Brotman thinks he is doing just about everything right to improve the firm's value over time. He continually works to add clients of different ages and to increase his average account size, and will continue to bring on equity partners.
But if Mr. Brotman could go back in time to when he started his practice, there is one thing he would do differently, he said: He wouldn't put his own name on the firm, which he has learned could hurt the firm's value down the road.
“When we first started, I had no idea I would be selling,” Mr. Brotman said.
Now that his firm has become more established, he is finding it difficult to pull the trigger on making a change, though he plans to revisit the issue in about five years after he brings on a second partner.
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