Beyond Revenue: 8 Determinants of Valuation for a Financial Advisory Business

by James Bode James Bode | April 18, 2024

If you’re thinking you’d like to sell your practice at some point, you’ll want to know what it’s worth. As a prospective seller, it makes sense to get a valuation from a  third-party professional valuation firm, and to update it periodically. A big chunk of a third-party valuation is based on revenue. Let’s be clear here, revenue is an essential component of the valuation, but there is more to the story than revenue.

As prospective buyers - my business partner, Ben, and I have purchased several practices over the past decade. We have learned that while a professional valuation is helpful, we also like to look more closely at several factors that may or may not be spelled out in the valuation report. 

Here are 8 additional aspects of a practice that we like to investigate. Some of them seem obvious, but don’t underestimate them – it’s easy to overlook these things, so it’s worth paying attention.


8 Questions When Considering Buying or Selling a Financial Advisory Practice


1. Is It Real Growth or Are You Simply Riding Market Trends?

When we look at the practice over the past 3-5 years, a buyer will want to see that you have been growing your practice, as opposed to relying on the markets being up. Say your practice is up 20% - how much of that is attributable to your bringing in new assets, versus simply riding the rising markets? 

Our firm, Beck Bode, is a growth company and as such we want to acquire companies that have historically shown the ability to bring in and grow assets regardless of current market conditions. Stale practices are not exciting or desirable to us. Any practice that is not growing actively, in our book, is a dying practice. If the practice isn’t growing, we are going to lower our overall margin on the acquisition. That’s a problem we don’t want to have.


2. Is Your Client Base Diversified? 

Who your clients are contributes a lot to the value of the practice. Any buyer would want to know the profile of the client base. Even so, this is tricky, because what looks like a solid client base on paper isn’t always so in reality. We like to drill down into specifics. How many high-net-worth clients do you have? What is the age distribution across your entire client base? What portion of your clients are actively accumulating assets, versus how many are drawing down on their accounts? 

While in our industry it’s common to only go after big prospects, some of our largest clients today started out with small IRA or 401(k) rollovers. They might have had no more than $20,000 or $25,000 to begin with. But they've grown with us over time, and they could be our most valuable clients now because they’ve been with us for 20 years and hopefully for another 20, 30 or more.

On the one hand it’s nice to have clients who are close to retirement, because that’s when they are saving the most. But you can’t simply look at a business based on today. Anyone who is at or near retirement age will be looking to access their wealth soon. That means they will want to live off those assets, requiring them to take a distribution. You need fresh money coming in the door. 

A diversified client base – in terms of age and life stage – will affect the value of your practice. 


3. What is the Longevity of Your Client Relationships?

Client longevity indirectly and directly affects how we view the value of a practice. Clients who have been around for a while have shown that they trust your guidance and that they are loyal to the practice. In our experience, longer term clients tend to stay with the firm even post acquisition. This is important, because no buyer wants to buy a practice only to watch clients leave right after the deal closes. 

The savvy buyer will want to have to understand the nature of your relationship with your clients – how will they react when the original owner is no longer in the picture? These are tough questions without hard and fast answers. 

Obviously, the handoff from seller to buyer needs to be good and carefully planned.  In general, practices with higher client tenure will have higher client retention post acquisition.


4. How Are Retirement Distributions Affecting Your AUM?

In an ideal world, buyers look to buy practices that are either roughly equal on distributions versus contributions, or skew higher toward contributions. Both indicators signal that the practice will be a money maker. (Of course, there are many other factors at work.) Money-making firms will be valued higher, naturally. 

A smart buyer will look for tranches of clients in your practice; some of the clients need to be younger, perhaps even starting out, some need to be in their 30’s and 40’s, and some need to be in their 50’s and 60’s and above. The older clients typically provide the wealth you need to build a practice, but the younger clients bring the assets that you need to continue to grow your business. If you don’t grow the younger segment, your practice can become stale because at some point in time you will be sending out more distributions than you are going to be receiving contributions. 

The amount of dollars that are leaving the practice in the form of RMD (Requirement Minimum Distributions) says a lot about the phase of growth that your practice is in. Just as important is how many clients are set up for automatic contributions into their investment accounts. That, too, tells a lot about the value of the practice.  


5. How Consistent is Your Fee Structure?

Every RIA will have a unique fee structure; in my opinion there is no perfect fee or fee structure. However, when assessing the value of a firm, the fee structure does play a role. We have found that sometimes advisors are discounting their fees so much that it devalues their firm in the eyes of a prospective buyer. If you are an advisor who has given into fee compression you run the risk of reaching a fee threshold that’s so low that an acquirer may say your firm is simply not worth the money. Firms that over-discount to attract or retain clients aren’t necessarily doing a good thing for anyone. 

On the other hand, a consistent fee structure helps improve the value of the business. I’d advise that whatever you write in your ADV your fee is, stick to it. Try not to make exceptions to your own rule, don’t discount fees for certain people. If you do find that you have been inconsistent in structuring your fees, it helps to have a clear explanation as to how they are different, and why. 


6. Are The Buyer and The Seller’s Investment Strategies in Alignment? 

If the buyer is looking to absorb your practice into their own, it’s important that the investment strategies of both firms be at least compatible. You may say what does this have to do with the value of my practice? Well, a compatible investment strategy may make your practice more desirable and therefore more valuable to a buyer who is seeking that profile. Ultimately, buyers want to invest in practices with high retention rates and any incompatibility will again impact retention. 


7. How Strong is the Referral Network?

In a perfect world, new clients come by organic referral from your very best clients who refer you because they believe in you and appreciate the service you provide. A buyer will want to see healthy referral activity, not only because that brings in new assets to the firm, but because it says a lot about the overall health of the practice. It says that you have a solid service model, delivered by a trustworthy and competent team, that your clients are loyal to you, that they are willing to share you with their friends, their family and extended network. All these things contribute to increasing the value of your practice.


8. What is the Level of Client Engagement?

Speaking of service, service metrics are a great indicator of the value of a practice. A seasoned buyer will want to know how you are communicating with your clients.  If you have close relationships with your clients, it means that you’re likely communicating with them on a more regular basis, not just doing an annual review. 

When we assess a firm, we will look into their customer relationship management software (CRM) to see how frequently they are engaging with their clients. If you’re not speaking with your clients frequently but suddenly you tell them that you’re selling your practice (this happens more often than not), they could have a lot of concerns. No buyer will want to buy a book of concerned clients.

Alternately, say you talk to your clients three or four or more times a year. You let them know that you won’t be staying with the firm forever, that you must retire at some point, too. Then one day you pick up the phone and say, “Hey, I've sold my practice, and these are great people, and I know you will be in good hands.” It goes a long way toward ensuring a smoother transition, and that contributes to the overall value of your practice. 


Taking A Holistic Approach to Practice Valuation

If you’re looking to buy a practice, I would advise you to look way beyond revenue. The value of the practice cannot rely entirely on dollars and cents. Unfortunately, a successful acquisition is much more complicated than that, and the accuracy of the buyer’s due diligence is only revealed long after the deal is closed. 

If you’re looking to sell your firm, I would advise you to invest time and energy into structuring your practice (or re-structuring your practice) so that you incorporate many of the areas I discussed here - that directly and indirectly impact the value of your business. 

James Bode is Managing Partner at Beck Bode, a deliberately different wealth management firm with a unique view on investing, business and life.

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