M&A and Valuations in the Financial Planning Industry
How to Value a Financial Planning Practice
This comprehensive guide will give you an understanding of how financial planning practices are valued.
What to think about when valuing your financial planning practice
Getting a business valuation on your financial planning, or accounting, business should be an educational process, informing you of your current business value and, depending on the purpose, what to do to improve your valuation.
There are many reasons to obtain a valuation on your financial planning business:
- Business improvement
- Shareholders agreements
- Business planning, such as equity sales
- Buy/Sell Insurance
- Planning a sale
- Restructures
- Business disputes; and
- Matrimonial settlements
Whilst a matrimonial or business dispute valuation often hamstrings us in terms of the education process we usually provide, you can still expect to learn about your business value from the process. If you are after a matrimonial valuation you should read our Matrimonial Valuation Guide here. When we prepare the first business valuation for an established business, we often find the business owners can be underwhelmed by the business value. As business owners, you invest your blood, sweat, tears and almost every waking hour to your business – you expect it to be building your wealth. We could tell you a hundred true stories of business valuations and conversations that followed – why it was low, what the business owners could do, the biggest drivers to the valuation. These conversations are of limited value if you’re undertaking a sale at the time. So how can you get started?
Starting the Valuation Process
As Chartered Accountants, we have to start any business valuation engagement with an engagement letter. This letter details our process and fee. To prepare this, we often need to talk to you and obtain a recent set of financial statements. Having this information, means less issues when it comes to scoping the engagement – understanding the structure, complexity or simplicity of the accounts, and any additional information we will need to request.
The engagement letter will list the information specific to your financial planning business valuation, but you can expect to provide:
- Previous 3 years’ financial accounts (including Balance Sheet and Profit & Loss Statements, together with Notes to the Accounts and Depreciation Schedules)
- Current year to date management accounts if applicable (from your accounting software is sufficient)
- Completed Information Memorandum (a document we provide to you, to gain an understanding of your business, including ownership, history, etc.)
- Risk & Value Driver Assessment Worksheet (RAVDA). This survey (provided on engagement) helps us assess the qualitative aspects of your business
- Payroll Summary Report – showing any wages payment, superannuation and other benefits paid to each staff member for the periods above (3 financial years and year to date)
Once we have the signed engagement letter and this information we can proceed with the valuation process.
Our Valuation Process
Once we have the information, we process this into our computer system, analysing the financials, considering adjustments to profit and understanding your business – via the survey and information gathering document. We draft our queries and hold a business valuation interview with you. At this interview, usually conducted via Zoom, we ask you about your business operations, any quirks, and our queries.
Often these queries are based on adjustments we are considering, such as:
- The work done by owners and whether market salaries are paid (and if not market, we ask further questions so we can benchmark)
- Related party transactions, for example an office owned by a related super fund and whether a market rent is paid
- If consulting fees and sub-contractors are continuing
- If salaries are reflective of the current staff
From here, we may ask for further information to be provided. You don’t need to worry in the interview about this, as we will always send an email request.
The Report
Depending on the nature of the engagement, the report will either be a full report or an indicative valuation letter. From our interview, we usually need 7-10 days to provide the report to you. Most of the time, we issue the report as draft to you, so that we can discuss any of your queries and revise our understanding of your business if there are adjustments required. This step provides us with an opportunity to talk to you after the valuation – bridge any valuation gap, further explain any adjustments and also how to use your valuation in a positive manner.
Valuation Methodologies
The methodology we use whilst valuing your financial planning business depends on the purpose of the valuation. In financial services valuations, there are multiple methodologies we could use, these include the capitalisation of future maintainable earnings, discounted cash flows and rule of thumb methodologies such as recurring revenue, or cents in the dollar. Below, we note when we would lean towards each methodology before explaining what these mean.
| Business Improvement / Succession Planning / Shareholders Agreements etc. | Capitalisation of Future Maintainable Earnings |
| Matrimonial Valuation | Capitalisation of Future Maintainable Earnings whilst considering Value in Use |
| ATO Valuations | Highest and Best Use |
Capitalisation of Future Maintainable Earnings
The future maintainable earnings methodology links the likely future profit and a capitalisation rate, a multiple. The multiple of profit is a direct link to the risks facing the business such as industry risk, ability to translate profit into cash, location, and size.
A larger CBD based practice is likely to attract a higher multiple than a regional, sole practitioner business. You will often hear 6 times multiples spruiked in the industry, however it isn’t this simple. The capitalisation rate will vary from business to business, and at different points in the life of the business. For financial planning practices we usually see a range from 5 to slightly above 6. You hear of practices selling for above 6 in the market, but this is almost always due to the synergies the purchaser obtains from buying the business – not that of a true ‘market value’.
For valuations completed under a Capitalisation of Future Maintainable Earnings, you can expect the multiple to fall somewhere between the following ranges.
| Industry | Low Range | High Range |
| Accounting | 3 | 4 |
| Financial Planning | 5 | 6 |
| Mortgage Broking | 3 | 4 |
The factors that influence your capitalisation rate include:
- Systems and Processes – the better systemized your business, the higher the multiple
- Key person risk – the greater diversification in your business and less reliance on principals or key staff, the higher the multiple
- Ability to translate Revenue into Profit and Cash – Work in progress and debtors reduce the multiple, as it takes longer to translate revenue into cash
- Ratios – the more revenue per adviser, or the higher average hourly rate, the higher the multiple
- Regionality – the more regional the practice the less parties likely to bid on a practice for sale, therefore a lower the multiple
Impact of Debt on Your Valuation
We often see debt inside financial services businesses, whether it is buying a client book, or paying out an exiting shareholder. On the most part, debt like this is what we call structural debt. This debt is reduced from the business valuation to determine the equity (or share) value. This is great if this is a conscious decision – e.g. to make the business cheaper for an incoming equity holder to buy into.
An example of this is below:
| ABC Financials (Regional) | $ |
| Recurring Revenue | 300,000 |
| New Business | 20,000 |
| Total Revenue | 320,000 |
| Licensee Costs | 48,000 |
| Staffing Cost | 150,000 |
| Rent | 15,000 |
| Other Costs | 15,000 |
| Total Expenses | 228,000 |
| Profit | 92,000 |
| Regional Practice | |
| Capitalisation 5.2x (Enterprise or Business Value) | 478,400 |
| Less: Debt on Client Base Purchase | 250,000 |
| Equity (Share) Value | $ 228,400 |
Any surplus assets in the business are added to the enterprise or business valuation to determine the share value. This could include items such as motor vehicles, or surplus cash that hasn’t been paid out in distributions.
Discounted Cash Flow (DCF)
DCF is a relatively infrequent method used for smaller businesses, as it relies on long term forecasts of profitability. The truth is, most small business’s simply don’t budget ten years in advance – we’re lucky if it’s 12-18 months.
A DCF model also requires a terminal value, that is, a value that the asset will be worth at the end of time. This is difficult to consider for most small businesses, unless a lifetime is known and quantifiable. As such, we usually use the capitalisation of future maintainable earnings method above.
Rule of Thumb Methodologies
You would likely be aware of recurring revenue (or in accounting cents in the dollar) methods of calculating a business value. These are often branded about when a business is sold “it achieved 3 x recurring revenue”. This method isn’t used as often these days, as buyers are more sophisticated and need to link the price paid for the business, or client base, to the serviceability of the debt.
The risk with rules of thumb is that it can overstate the value of a smaller business, and understate that of a larger business. Take for example, a small financial planning client base.
| ABC Financials (Regional) | $ |
| Recurring Revenue | 300,000 |
| New Business | 20,000 |
| Total Revenue | 320,000 |
| Licensee Costs | 48,000 |
| Staffing Cost | 150,000 |
| Rent | 15,000 |
| Other Costs | 15,000 |
| Total Expenses | 228,000 |
| Profit | 92,000 |
| Regional Practice | |
| Capitalisation 5.2x | 478,400 |
| Recurring Revenue 2.5x | 750,000 |
As you can see from the below payback periods, if the purchase of the business is based on the profitability, the debt is repaid within 9 years. In the situation where the purchaser has paid based on a recurring revenue multiple, and not then cut costs with the base (e.g. kept the adviser employed) you can see that it takes over 16 years to repay the loan – well beyond the usual loan term.
Payback Period – based on profit
| Playback Period | |||||||||
| Capital | 478,400 | ||||||||
| Interest Rate | 5% | ||||||||
| Year 1 | Year 2 | Year 3 | Year 4 | Year 5 | Year 6 | Year 7 | Year 8 | Year 9 | |
| Opening Balance | 478,400 | 433,320 | 385,986 | 336,285 | 284,100 | 229,305 | 171,769 | 111,356 | 47,922 |
| Profit | 92,000 | 92,000 | 92,000 | 92,000 | 92,000 | 92,001 | 92,002 | 92,003 | 92,004 |
| Tax | 23,000 | 23,000 | 23,000 | 23,000 | 23,000 | 23,000 | 23,001 | 23,001 | 23,001 |
| Interest | 23,920 | 21,666 | 19,299 | 16,814 | 14,205 | 11,465 | 8,588 | 5,568 | 2,396 |
| Closing Balance | 433,320 | 385,986 | 336,285 | 284,100 | 229,305 | 171,769 | 111,356 | 47,922 | -18,685 |
Payback Period – based on recurring revenue
| Playback Period | ||||||||||||||||
| Capital | 750,000 | |||||||||||||||
| Interest Rate | 5% | |||||||||||||||
| Year 1 | Year 2 | Year 3 | Year 4 | Year 5 | Year 6 | Year 7 | Year 8 | Year 9 | Year 10 | Year 10 | Year 12 | Year 13 | Year 14 | Year 15 | Year 16 | |
| Opening Balance | 750,000 | 718,500 | 685,425 | 650,696 | 614,231 | 575,943 | 535,739 | 493,524 | 449,198 | 402,655 | 353,469 | 302,469 | 248,587 | 192,011 | 132,604 | 70,227 |
| Profit | 92,000 | 92,000 | 92,000 | 92,000 | 92,000 | 92,001 | 92,002 | 92,003 | 92,004 | 92,005 | 92,006 | 92,007 | 92,008 | 92,009 | 92,010 | 92,011 |
| Tax | 23,000 | 23,000 | 23,000 | 23,000 | 23,000 | 23,000 | 23,001 | 23,001 | 23,001 | 23,001 | 23,002 | 23,002 | 23,002 | 23,002 | 23,003 | 23,003 |
| Interest | 37,500 | 35,925 | 34,271 | 32,535 | 30,712 | 28,797 | 26,787 | 24,676 | 22,460 | 20,133 | 17,689 | 15,123 | 12,429 | 9,601 | 6,630 | 3,511 |
| Closing Balance | 718,500 | 685,425 | 650,696 | 614,231 | 575,943 | 535,739 | 493,524 | 449,198 | 402,655 | 353,469 | 302,469 | 248,587 | 192,011 | 132,604 | 70,227 | 4,730 |
Unfortunately, as you’ll see below in our examples, we’ve seen a scenario where a long term annual valuation client, purchased a book based on a recurring revenue multiple and then transferred over the 5 staff attached to the client base. The profitability didn’t support the loan payback and it damaged the entire business valuation – so instead of building their value, they actually went backwards. It sure is an important lesson in having another set of eyes over a business purchase.
Why do I hear about Recurring Revenue then?
Recurring revenue multiples are often an item translated into a contract, based on the implied rate from a profit based metric. In a sophisticated transaction, we would see a purchaser make an offer based on the profitability they can deduce from the client base. You then take this overall dollar value and divide it by the recurring revenue to determine a “recurring revenue multiple”. This can then be used for clawbacks in a transaction, as it is too difficult to adjust the profit lost as this is impacted by factors now outside of the vendor’s control.
Why do we use Future Maintainable Earnings vs Recurring Revenue?
In most valuations, we are valuing the business as it currently sits. If the business is going to continue being operated, it is only reasonable to value it on a profitability basis, the return to the shareholders. Incoming and Outgoing shareholders should transact on the return they receive, just like you would when buying publicly listed shares. An appropriate rate of return is derived from the capitalisation rate, e.g. a 6 times multiple implies a 16% return. Similarly, in a matrimonial or business dispute, the profit is materially expected to continue in its current form, versus the client base being sold.
Recurring revenue is reserved these days for run-off trail books which have limited costs to maintain, which are few and far between. It does however need to be considered in an ATO valuation of highest and best use, for capital gains tax, but is less relevant these days as businesses purchasing client bases now focus on the profitability.
Examples in the Real World
1. Plenty of Capacity
We valued a client base with revenue of approximately $700,000. The business had 2 advisers and 4 support staff, from the outset we knew it wouldn’t achieve the value the client expected it to. It simply didn’t have any material profit. At a multiple of almost 5.5, the value of the business was no more than $550,000. The client base value, in their mind, was $1,800,000. The issue is, the owner wanted all his staff taken care of in his retirement, as in, provided with the same level of employment, at the same terms. The end result? They’re not selling, but now growing the business to bring the value of the business up before retirement. We’ve talked to them and counselled them enough that they have a clear plan of how to grow the business and when to touch base for check-ins.
2. Sole Adviser
We spoke to an adviser recently who manages a portfolio of $850,000 with 2 support staff. He generates a 50% profit margin after a normal ‘market’ salary. The adviser as developed a book that is almost ‘too good’. He’s looking for options as he is at the end of his capacity. Developing a new adviser, e.g., via a professional year takes time he just doesn’t have, and its now a very expensive asset to merge in to another business. It has reached a 6 times multiple, however now it’s being detracted from due to the capacity restrictions and key person risk.
3. Acquiring Practices
We have a client who we did annual valuations for, purely for internal share transactions. They were well versed in acquiring smaller financial planning client bases, bolting them in at three times the recurring revenue and translating significant incremental profit into their valuation at the 6 times profit. One year, they acquired a financial planning business instead of a pure client base. This business came with 5 staff, and an office to hold for a few years before a transition to the CBD location occurred. The recurring revenue multiple stung them, and meant that like our example above, the payback period was significantly more than 10 years, the normal length of a loan. They didn’t understand this until we spoke through the transaction and the impact on their valuation. It didn’t increase their valuation as expected, but actually the debt on the practice took their overall valuation backwards.
4. Shareholders Agreement Methodology
We assisted a multi owner firm agree a shareholders agreement valuation clause. Tired of seeing the basic clause used in client’s shareholders agreements regarding asking an industry body about who should value their business, they reached out to us for assistance.
In their agreement they now have paragraphs explaining their methodology and why, it even includes a snapshot of their most recent valuation before sign off. This way, any adviser picking up their shareholders agreement in a shareholder dispute, can work through the agreed methodology – updating the capitalisation rates in line with market. This is particularly important where shareholders are nearing retirement, and existing and new shareholders need to agree how the transaction should occur.
What these examples show me is by engaging on a business valuation early, you understand your business and can make informed decisions on staffing, acquisitions and capacity. Each major decision, e.g., around mergers or acquisitions, should be discussed with an advisor – even if you’ve done it before. While advisers have a vested interest in work like this, we actually just want to see you succeed – whether that be from a free 15 minute phone call or a paid piece of advisory work. We much prefer setting you up for success than unwinding DIY projects.
How do I get started?
Please contact FinConnect Advisory Group (a venture of Accru Hobart) to get the business valuation process underway for your financial planning practice. Ideally, we would have a set of recent financial statements provided before we have a phone call with you to discuss how we can help, but it can often be phone call first. Email us at info@accruhobart.com.au or call 03 6244 5044.
Authors
Fiona Ettles, Hobart
Fiona enjoys working with clients to understand their problems, consider solutions and implement plans to better their lives. If you need clarity in understanding your situation or tax obligations, Fiona will work with you until you truly do, so you feel confident in moving forward.
Courtney Telega
Courtney’s expertise and professional network ensures her clients get the most out of the valuations process, particularly those needing a valuation for due diligence, family law, performance enhancement, succession planning or insurance purposes.
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