What is my practice worth?

In an article titled Consolidation is the dominant theme, published in the June edition of FAnews, it was mentioned that the value of an IFA’s practice depends on a number of factors and is heavily influenced by the negotiation skills of the parties involved and the nature of the acquiring individual or entity.

This article will explore the different perspectives that potential buyers have, viewed through the eyes of a peer Independent Financial Advisory (IFA) business and a product provider, in order to show how these different parties attribute value and what they attribute value to.

Firstly, an understanding of the relationship between price, value and disruption is important.

Price, value, disruption

The typical IFA business lifecycle sees a Cat I advisory business evolve into a Cat II license holder that can earn a Discretionary Fund Management (DFM) fee, and then further evolve into a fully integrated wealth management business that enables revenue earning at four levels:

• Advice fees (upfront and annual recurring);
• Administration platform fees;
• DFM fees; and
• Asset management fees (base and performance).

An acquiring party will typically value an IFA practice on a multiple of annuity revenue or a multiple of net earnings. The multiple paid is influenced by the revenue earning opportunities of the acquiring entity.

A Cat I adviser acquiring another Cat I practice buys advice-fee revenue and continues to earn this sole source of revenue into the future. A fully vertically integrated business acquiring a Cat I practice, buys advice-fee revenue and once the book has been integrated and transitioned onto a proprietary platform and into proprietary investment solutions, revenue is earned at up to four levels, albeit with higher disruption to the client, as illustrated in Table 1.

Table 1

An important point to make is that to extract the additional revenue streams requires the seller making changes to their existing advice process. Typically, the higher the multiple, the
higher the change that is required. This in turn leads to business disruption for the selling IFA business.

Value enhancing and value detracting

There are several pre-sale and post-sale factors that either enhance the imbedded value or detract from the imbedded value of the IFA practice. These are illustrated in table 2.

Table 2

IFA practice buying an IFA practice

When a Cat I IFA practice sells to a peer Cat I IFA practice, the seller will have an expectation that the buyer will pay a multiple of two to three times recurring revenue, or between seven to ten times Profits after Tax (PAT) . Buyers have an expectation that they can acquire a practice for a multiple of one to two and a half times recurring revenue, or between three and a half and eight and a half times PAT.

An alternative methodology is to apply a percentage of Assets under Management (AUM). This methodology is typically used for larger practices with Cat II DFM capability and therefore an extra revenue stream. The rule of thumb suggests a purchase price around 2% of AUM.

The purchase consideration is then typically structured as an upfront payment of anywhere between 30% and 50% of the transaction value, followed by a number of residual payments that are dependent on milestones being achieved. Should these milestones not be met, the residual payments will be reduced accordingly.

The adviser of the target business will usually be required to work in the acquiring business for a two to three year period in order to achieve a successful transition of clients. During this period, the target business adviser will be paid a consulting fee, which is often described as a share in revenue generated by the book he or she has sold.

Product provider buying an IFA practice

The attraction of selling one’s IFA practice to a product provider is that the product provider is able to extract numerous other product related revenue streams in conjunction with revenue generated from advice.

The valuations offered by product providers will therefore be significantly higher and will be driven by the amount of product revenue that can be generated from the target IFA transitioning into the acquiring product provider’s funds, model portfolios and platform.

A large risk for an IFA selling their business to a product provider is that the residual payments will be tied to transitioning clients onto the product provider’s platform and into their funds. Should an IFA not be able to convince their clients to move to a new platform and into new funds, there will be a significant reduction in the total purchase consideration.

The disruption it may cause to the selling business and the fact that it may not be in the interests of the client, are critical aspects the IFA would need to consider when selling their practice to a corporate.

Conclusion

It is clear that the way to maximize the selling price of an IFA practice is to engage with buyers who are fully integrated wealth managers or product providers. These buyers are able to offer premium multiples as they are able to extract revenue streams that a peer Cat I IFA
business can’t.

However, as previously stated, businesses willing to pay higher multiples will cause greater business and client disruption for the seller. This is the constant trade-off to consider when selling an IFA practice.