Determining Enterprise Value: 7 Key Qualitative Drivers for Sellers
We are in the midst of a “seller’s market,” where announcements of mergers and acquisitions continue to dominate the headlines. In the first half of 2019, Fidelity Clearing and Custody Solutions reported 73 M&A transactions; of those, 67 were RIA deals totaling $69.5B in assets, and 6 were IBD transactions weighing in at $391B. Additionally, movement out of the traditional brokerage world has continued to accelerate.
It’s a trend that most industry insiders agree shows no time of weakening in the near term—and for good reason. For most, it’s a win-win scenario, where plenty of sellers and transitioning advisors are looking to solve for scale, succession and monetary goals, and private equity firms, banks, consolidators, regional RIAs and the like are well-poised to capitalize on potential opportunities.
Benefits and opportunities aside, the fact remains that many of these potential sellers often do not have a clear picture of how much their businesses are worth, let alone the upsides they may gain from M&A.
While mergers and acquisitions are typically associated with existing RIAs and independents, the fact of the matter is that anytime an advisor is offered a recruitment package from a brokerage firm, that firm is in essence “buying” a business and conducting its own due diligence process to assess value—so understanding that value is imperative.
Unfortunately, determining enterprise value is a complicated process. Much like what a homeowner goes through when trying to determine the value of a house they wish to sell, there are many qualitative factors that go into the valuation equation. And when there are multiple suitors for a firm, you also have pricing leverage to factor in. To be sure, much of the ultimate valuation for a business comes down to the subjective rather than the objective. That is, the value of a seller’s business is ultimately driven by what a buyer is willing to pay.
Unwrapping the 7 drivers of enterprise value
Whether an advisor is the owner of his own firm or an employee at a major brokerage firm, these 7 factors serve as key markers that drive enterprise value.
A wealth management organization is built upon people; that is, the clients and the advisors who serve them. With that in mind, it comes as no surprise that firms which boast a deep and multi-generational bench of advisors are well-positioned to capture higher multiples. While many transactions are succession-oriented, acquirers look for sustainable firms with business development spread out amongst multiple advisors and which can transition across multiple generations.
As the business of investment advice has become largely commoditized, sophisticated buyers and major brokerage firms covet organizations that provide holistic financial advice, such as financial planning, estate planning, portfolio management, etc. Additionally, providing a consistent and scalable client experience is key to retention and continual organic growth.
The value of a firm is the summation of future cash flows, so ensuring long-lasting client relationships is critical. A diversified client base – one that spans multiple age brackets and a well-distributed AUM base – dictates an important portion of valuation. Additionally, firms that cater to a particular niche market (such as doctors, athletes, business owners, divorcees) are of particular interest to some buyers as they can leverage their own scale and resources to further penetrate these markets.
Independent firms that are professionally managed and laser focused on growth while boasting strong technology platforms and a robust infrastructure make the most attractive merger/acquisition partners. Note that if an acquisition means entering a new geographic market, the acquiring firm will need efficient and scalable operations with strong local leadership.
It should come as no surprise that a spotty compliance record is an immediate red flag for an acquirer or hiring firm, representing a riskier transaction. Keep this in mind, as it can create negative value even when all other areas of the business are considered ideal.
While there is no perfect time to sell or transition from a firm – especially since advisors look to capture as much of their upside as possible – buyers do pay premiums for firms that still have some growth left in the tank. As soon as a business shows signs of stagnation or detraction, the multiple is impacted. Strong organic growth (absent market appreciation) is also key: If a firm has grown purely by acquisition and it hasn’t grown by its own client additions, this may signal deeper internal problems.
While the above qualitative factors drive value, deals are based on financial metrics—most notably earnings, revenue/production and AUM. The most aggressive multiples are reserved for firms with strong operating margins and that have the scale to operate on their own. As EBITDA (in the RIA and independent space) and production (in the traditional space) are often market benchmarks, maintaining an efficient business model is what translates to maximum operating leverage for an acquirer and thus greater combined value.
Valuation, while an important consideration for any business owner looking to monetize their life’s work, should only be a small factor in an acquisition. Vocalizing how a merger/acquisition/transition will allow you to better service clients, grow the business and live a more fulfilling business life should retain the most weight in a decision. If selling or transitioning appears on the horizon, then take a long hard look at your business from the buyer’s perspective and ask yourself, “What can I do enhance the value of my practice?”
At the end of the day, your life’s work is on the line. Be sure that you have recognized its “true worth” and are not short-selling yourself, your clients or your future.