Report: Advisors Have Inflated Views Of Their Businesses’ Values

InsuranceNewsNet

By Cyril Tuohy

Aging personal financial advisors salivating over the sale of their practices may want to step back, pause and take a deep breath: there’s a lucrative future in the sale of their business, but the financial Promised Land isn’t here just yet.

Only 5 percent of advisors say they plan to retire or leave the industry in the next four years, according to research by Cerulli Associates.

The real action will come in five to 10 years when 27 percent of advisors plan to retire, and in 11 to 15 years when 16 percent say they plan to make their final industry exits, according to Cerulli.

“The next few years appear to be the calm before the storm,” Cerulli analysts wrote in the latest issue of the Cerulli Edge Advisor Edition.

For now, though, many financial advisors appear to be jumping the gun with somewhat inflated expectations around the value of their businesses.

Kenton Shirk, an associate director at Cerulli, said that on average advisors believe their practices are worth 2.8 times total revenue. “For those advisors who actually purchased a practice within the past 12 months, the average revenue multiple paid was 2.2 times revenue,” he said.

A retail advisory shop with revenue of $1 million would sell for $2.2 million, for example, even though an advisor might think his or her firm was worth $2.8 million.

Insurance advisors, who perceived the worth of their businesses at 3.2 times total revenue, harbored the most inflated expectation of the value of their business, according to the Cerulli report.

Bank advisors were next with 2.9 times total revenue, followed by registered investment advisors (RIAs) with 2.8 times total revenue, wirehouses and independent broker/dealers with 2.6 times revenue, regional broker/dealers with 2.4 times revenue and, finally, dually registered advisors with 2.4 times revenue, the report said.

Nearly two-thirds of independent advisors said they are interested in buying a practice, the Cerulli report found. Of those, 35 percent said they are not actively searching for buying opportunities, while 31 percent said they were searching for acquisition opportunities.

For every advisor who bought an advisory practice in the past 12 months, nine others wanted to buy one, Shirk said. Traditional laws of economics would thus appear to dictate higher prices for every sale, but Shirk identified “downward pressure on multiples” leading to an average sale price of 2.2 times revenue.

Practices heavily weighted with older clients and with retired clients who have higher demands on asset balances to pay for living expenses are two metrics that sellers will need to pay monitor closely if they want to extract the highest possible price for the business.

With 31 percent of advisors age 55 and older, and with 45 percent of clients of advisors over the age of 60, many advisories may not be as desirable as they would appear since older clients are less attractive as a way to generate future cash flows.

From a seller’s perspective, “future buyers may be reluctant to bid on a practice that does not include a healthy mix of ideal clients, and that fits squarely into the buyer’s long-term strategic vision,” the Cerulli report said.

Advisors looking to sell their practices in the next five to 10 years need to build relationships across more than one generation with the families of clients they already serve. That will plant the seeds for the successful future sale of their advisory as buyers look at the stable of younger clients they can tap.

Waiting four or five years won't hurt either as more sellers enter the market with the retirement of long-time advisors.

Unlike a factory or a piece of real estate, advisories have little or no tangible products or assets. Instead, buyers pay for the future cash flows of the business. This makes valuing an advisory especially challenging.

Revenue multiples were the most commonly used way to value an advisory, with 71 percent of advisors who bought a practice in the past 12 months using this method, the report found. However, using this method runs the risk of ignoring the “quality” or the concentration of the client base.

Other methods included valuation by a third party, assets under management, discounted cash flows based on financial projections, and earnings multiples based on metrics other than revenues.

While discounted cash flow methods are less common in valuing an advisory, discounted cash flows are more technical and offer a more accurate picture of an advisory’s future earnings. But their scarcity in evaluating financial advisory practices “reinforces the casual nature in which many advisors enter deals,” the report said.

Cyril Tuohy is a writer based in Pennsylvania. He has covered the financial services industry for more than 15 years. Cyril may be reached at [email protected].