Key Metrics To Help You Value Your Practice

Michael David is a Toronto-based financial writer and has more than 20 years’ experience consulting with large financial brands. Michael began his career as a Financial Advisor managing his own book of business with one of Canada’s largest private wealth management firms.

They say cash is king. When it comes to valuing your advisory practice, cash flow is certainly important. So is the nature and sustainability of that cash flow. In this article, we will look at some of the metrics that can help you establish an attractive valuation for your book of business.

When determining the value of a company, there are generally two parts to the analysis: the numbers and the narrative.

The numbers help you quantify things like assets and liabilities, cash flow and earnings. The narrative helps you put the numbers into context by accounting for factors like leadership quality, competitive advantages and industry dynamics. Investment decisions are generally made based on a synthesis of both the numbers and the narrative.

If you are thinking of selling your practice, it pays to work on both aspects of your valuation. The sooner you begin this process, the greater the odds of it paying off at the right time. One approach is to develop a Practice Snapshot at least once a year so you can monitor the trends that can drive your valuation – just like a rising stock.

First, revenue

You want to maximize both the amount of revenue from your practice and the quality of that revenue. Here are some of the numbers a potential buyer will look at, and how you might think about them:

Recurring revenue.

This refers to ongoing revenue that you earn virtually automatically. For example, ongoing trailer fees. If a buyer can confidently predict how much revenue will come in over the next several years, they can pay you that amount today, knowing that they will ultimately get their money back.

Transactional revenue.

This refers to one-time revenue that may not be repeated. For example, lump sum sales commissions. Transactional revenue is less desirable than recurring revenue, as it may not be replicated in the future – at least not without incurring new client acquisition costs. A buyer will likely pay a lower multiple on this type of revenue, because it is less certain that they will make their money back.

Assets under management (AUM).

For investment advisors, this figure is often the quickest way to understand the size of a practice. It’s not as important as revenue, but it’s closely related, and it’s desirable to show growth over time.

How to make the most of your revenue picture? One strategy is to check in with every client on a regular basis. There’s a good chance you will uncover opportunities to increase your AUM. And, as long as it is consistent with the client’s goals, you might be able to recommend solutions that move more assets from the transactional side of your revenue to the recurring side.

A buyer will also want to know what it costs to maintain your book of business. Certain expenses may not be transferred to a buyer, such as your office space or Internet service. On the other hand, some expenses may be desirable or even essential for the buyer, such as hiring your support staff.

Second, practice dynamics

The underlying dynamics of your practice help you build a narrative around why it earns the money that it does. It allows a buyer to build a mental picture of what they’re really getting when they make you an offer. Here are some of the key data points to consider tracking:

  • Total clients / households
  • Number of private versus corporate or institutional clients
  • Net new clients added per year
  • Average tenure of clients
  • Top clients by assets and revenue
  • Total clients or assets in fee-based / recurring revenue products

You may have additional statistics that are unique to your practice. For example, if you are active on social media, you could list your number of followers. If you run client satisfaction surveys, you could brag about the results. If you receive a lot of referrals, you could quantify that too.

The goal is to show the breadth and depth of your practice, and to demonstrate that it is a robust asset that is likely to generate solid, sustainable income into the future.

Finally, client demographics

Many buyers will favour clients closer to retirement age, as they generally have the most assets and the most pressing need for financial advice. However, younger advisors may be more willing to grow with younger clients. Your Practice Snapshot should note the number of households in key age categories.

There might be other demographic insights that you can identify, such as the percentage of your client base that is working versus retired, their geographic locations, or the proportion that come from specific niches that you have targeted, such as doctors or business owners. Again, the goal is to build a story around the vitality and sustainability of your practice.

Ideally, your Practice Snapshot should be no more than a page or two covering your assets, revenue, essential expenses, a summary of your practice dynamics, and a picture of your client demographics.

It may sound like a lot of work, but your Practice Snapshot can generate a strong return on investment. First, because of the opportunities it helps you uncover, and ultimately, because it combines the numbers and the narrative to justify a higher valuation for your practice.

All comments presented here represent the views of the writer and are not necessarily those of Home Trust Company. Tools mentioned and examples provided are for information only and do not constitute an endorsement or recommendation. This post does not constitute legal or financial advice.

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