Business valuation is a topic that’s definitely gone by the wayside in recent months for a lot of advisors. At the height of the last boom — and even as late as summer 2008 — succession planning was a relatively hot topic in advisory circles. Firms were actively creating and managing transition programs and many advisors had retirement on their minds.
Firms might still be managing those programs, but thoughts of retirement have evaporated incredibly quickly for some advisors, as book values plummeted in tandem with client portfolios.
The pessimism is warranted, but hopefully real information will put things into perspective.
Maclean’s magazine [which, like Advisor.ca is owned by Rogers Communications] reported on Warren Buffett’s recent three hour interview with CNBC. In this interview, Buffett reportedly points out that “people are scared, and fear is very contagious. They’re also confused,” he says. “If you’re fearful and confused, you don’t start to get over being fearful until you aren’t confused.”
While Buffett was discussing the stock markets, the sentiment applies to business transition. Valuation is a confusing subject and people are definitely afraid — although a better word might be depressed — that falling portfolio and client book values have impaired their own retirement plans.
When it comes to general business valuation, PriceWaterhouseCoopers experts admit that current markets conditions, bank financing and credit conditions are having an impact, producing analysis that doesn’t always make sense, even to them.
“Things are moving in different directions,” says Ken Goodwin, partner in the dispute analysis and valuations group at PwC, in the firm’s podcast entitled How will the recession affect the value of my business? “It requires you to get below the numbers and dig a lot deeper.”
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The practice of putting a value on good-will based businesses like an advisory practice is even less clear — at a glance anyway.
Although it is a task that can stump some business valuators, Darren Miles, chartered business valuator, president and founder of Fair Market Value Inc., actually specializes in valuing personal service (read: goodwill dependent) businesses. He says it’s true that company valuations in general are coming in on the low side right now — that the asset producing base most advisors rely on has eroded, reducing revenues — but he also says there are still more buyers than sellers in the market to buy advisory practices.
Moreover, he says the current situation is a good opportunity for most advisors to step back and look at their own plans overall. “It’ll allow them to address some key issues that might not have been addressed by those who were, perhaps racing towards retirement a little too quickly,” he says. “They should look at some of the softer sides of their practice; at what makes a practice attractive or unattractive, and address those issues.
If you were planning on retiring within a year, it probably means that you’re going to be looking at pushing that off for a few years. It doesn’t mean you should put the brakes on and your head in the sand and ignore the process that needs to occur to get you the maximum value.”
As with any business, cash flow, profitability, sustainability and predictability of cash flow and future cash flow prospects are the biggest points of focus when it comes to valuation.
Once a business valuator has “normalized” cash flow numbers (cash flow with personal expenses, etc., removed) a capitalization rate, or multiplier derived by considering business and risk factors, is applied.
According to Miles, the capitalization rate, which takes into consideration the risk a person is exposed to when making this business investment, is based on criteria that falls into 10 categories:
1. Current risk free rates of return — the rate of return you might get from government bonds or other “risk free” investments
2. The practice’s recurring to non recurring revenue ratio
3. Product mix
4. Average client age
5. Fee vs. transaction based business
6. Number of clients
7. Continuity of business — how long could you be out of the office and still have your business run smoothly? Could you leave for a month without being contacted? “If you can’t be out for one day, you’ve got big problems,” says Miles.
8. Number and tenure of employees
9. “Institutionalization” of the business
10. Earnings growth and stability.
The institutionalization concept, he says, is the same for any personal services business that relies in any large way on goodwill. Personal goodwill, where clients stay with the firm because of their personal relationship with the advisor, is not transferable. “That business really isn’t worth much.”
If, however, clients are trained to come to a larger team, not the key person in charge, the business is worth more to valuators and prospective buyers.
“This is something that people have a hard time grasping,” says Miles. “It’s kind of counter-intuitive. When you’re building your practice, you really want to have them rely on you in a major way. Once you get past the first five years though, as long as you’re not screwing up in a very major way, you should be able to service them without having to bear hug everyone. Then going forward, you should be able to offload certain responsibilities into your group.”
Practice valuation and retirement planning advice (for advisors):
1. Have a counter-reciprocal agreement with another advisor to safeguard business value for your estate.
2. Focus on moving to predictable, recurring revenue streams.
3. Know your charge-out rate per hour — if you know your time is worth $350 an hour, you’re less likely to spend too much time on unprofitable accounts.
4. Focus on A-list clients.
5. Train clients to accept service from your team. (This is a process that can sometimes take a few years.)
Next: Advisor retirement case studies, by Darren Miles, Fair Market Value, Inc.
(04/01/09)