What’s your advice business worth (to someone else)?

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This is the first in a two part-series of articles that examines the sale of financial advice firms. In this initial article, we consider the various valuation methods that can be used to place a value on your business. Next month we’ll take a look at some of the ways that you can (positively) influence that value.

How to value your business

There are many methods that are used to value businesses, however the most common methods are,

  1. A multiple of recurring income
  2. A multiple of EBITDA

We’ll examine both of these in turn.

 

A multiple of recurring income

This is still the most widely used valuation method, and it is certainly the one used in casual conversations among advisers. This is the basis that is quoted in relation to any “buy back” agreements in place in the market. This basis is popular because of its simplicity, and also because a potential purchaser will be satisfied that they are buying a future income stream. The value of the business is not skewed by a huge uplift in new business sales (and attaching initial commissions) in the year or two before the sale of the business.

Of course the next question is – what’s the multiple! And that’s really where the negotiations start. This will be determined by a whole range of elements including;

  • The business retention strategy in place and the actual retention record of the business. This is a critical factor for would-be purchasers.
  • The compliance profile of the business – are the systems in place robust or is it all a bit lacklustre, with potentially significant hidden problems down the road?
  • The synergy between the seller’s business and that of the purchaser. This includes target markets, systems and the ability to easily integrate the two firms. These factors may make one potential purchase a better prospect than others, as the purchaser may gain more from synergies and be willing to pay a higher price.

 

Multiple of EBITDA  

The simple calculation based on recurring income is not deemed sufficient in all situations. For larger firms, a more refined calculation method is often deemed necessary, and this is where the multiple of EBITDA (Earnings before interest, tax, depreciation and amortisation) comes in, as this takes a much broader view of the business as a whole and looks at the actual profitability of the business.

When this calculation method is used in relation to smaller firms and where the business owner’s salary is the main overhead, EBITDA is often adjusted by removing the owner’s salary from the calculation as this can often significantly skew the EBITDA figure. With the salary excluded from overheads, a prospective purchaser can get a clearer picture of the real profitability of the business.

 

Payment Terms

Usually when an advice business is sold, there is a handover period where the previous owner remains with the business for a year or two to ensure a professional handover of the clients to the buyer, and to assist in the retention of those clients.

As a result, the payment terms usually include some of the purchase price to be deferred – maybe with half paid up front and the remainder paid in tranches over the following two years. There will typically be penalty clauses if the retention turns out to be lower than anticipated. These terms are really important, as they align the interests of both the buyer and seller towards a smooth handover with high retention rates.

 

Make the process easy

Due diligence before a sale is key. Once any confidentiality agreements are in place, it is really important that the required information is easily accessible to a prospective purchaser. If they feel they have to drag the information from you, they will wonder what you are hiding. So make sure you are capable of providing the required information before you start seeking out a buyer.

Equally, be realistic in your price expectations. While of course you may not choose to take the first offer that comes your way, don’t hold out forever for that elusive windfall sale price.

 

These are thoughts solely on the financial side of selling your business. In a follow-up article, I’ll look at steps you can take to actually increase the value (and more importantly the price!) of your business.

What’s the right charging structure for you?

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Trail commission. Is it the silver bullet that enables Financial Brokers to be paid for the value they add, to build value in their businesses and eventually sell the business at a healthy multiple? Or is it a somewhat opaque way for advisers to be paid, sometimes with very tenuous links between the value provided by the adviser and the payment received?

Trail commission is far and away the most popular method of being paid today. First of all it’s relatively easily explained. Clients understand it. And of course trail is very easily collected. Clients don’t have to write another cheque, which is always a potential hurdle. Clients also see a level of alignment of interest – if the portfolio sees strong growth, both the client and the adviser win. Also there is no VAT payable on trail commission, that will apply to retainers and fees if the adviser’s fee based turnover threshold for VAT is exceeded. This is good news for personal clients.

For the adviser, trail makes a lot of sense. It’s the most used factor in advice firm value calculations and trail tends to naturally increase each year in line with portfolio growth, and as new contributions are paid into investments and pension policies. Very importantly too, it doesn’t tend to dominate review meeting conversations. Many advisers have moved to Modular AUM-based Pricing, which is where prices are linked to AUM, but then varied based on the level of service. This has become very popular in Ireland, as the focus of the conversation shifts from the price paid to the value added.

But trail is not perfect. As we see asset management fees fall dramatically in some markets, trail levels will come under a lot more scrutiny. In any case, some advisers (and/or their clients) already baulk at the idea of their remuneration being based on the client’s asset levels rather than the value provided. This might be where fees come in.

 

How do you structure a fee?

I am often asked this question by advisers who have decided to go down the fees route, usually just for a segment of their clients, but on occasion for their business as a whole.

There are of course many different ways of structuring fees – below are listed some of the most common structures used in Ireland and/or in other markets. Of course each of them has their merits and drawbacks, but hopefully this list will help you identify one or more structures that suit you and your business. First of all, the most common structures are,

  • A fixed rate for each service (plan preparation, annual review service etc.). These rates can differ for different levels of complexity associated with different clients.
  • The “McDonalds Menu” approach of bundling services together into service packages, and then charging different fixed fee levels for different service packages.
  • A monthly retainer

Some advisers are now combining one or more of these, including combining them with trail commission. The most often used combination is a fixed fee for preparation of a financial plan alongside modular based trail commission or a retainer for ongoing services.

Other less often used structures include,

  • Hourly charging – rates are quoted by lots of advisers here, but few actually end up using this basis…
  • A model used by advisers in some markets aimed at millennials and others with low asset levels but often high incomes, is advice fees linked to the client’s income and net worth, instead of to AUM.
  • A subscription model based on client preference and personality. A client who is a “delegator” pays more than a client who is simply looking for validation of their own decisions, who in turn pays more than a DIY client who simply wants help with product execution.

As you can see, there are many different bases that can be used, and often the preferred structure is a combination of different structures. The challenge for you is to identify the model that fits best with your own client proposition and that reflects the value that you are adding.

 

What’s the right niche for your business?

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As someone who runs a niche business myself, concentrating solely on the financial advice sector, I’m a real believer in the potential to run a niche financial advice business. I’m also aware of lots of financial advice businesses that are pursuing niche strategies.

I’ve written before about how niche strategies can make your life so easy. When you build expertise in a specific target market, you can then market your services to this group with a laser like focus. You have the opportunity to stand apart from the crowd by establishing your credentials as the specialist within that target market. And having that deep knowledge of a client sector and constantly talking directly to that sector enables you to build a deep and valuable connection with them.

One of the biggest challenges that advisers have when going down this route is to identify the best niche for themselves. I personally don’t consider a focus on business owners as a niche strategy as the group is simply too broad to be considered niche.

So how do you identify the best niche for you?

 

Who do you enjoy working with?

This is as good a place to start as any! Working with people you like will result in greater effort from you and it makes your working life so much more enjoyable and rewarding. When I established StepChange, I knew I wanted to work with the financial adviser community. I was fully aware of the value you add to your clients and I wanted to be part of that journey. I can only imagine how difficult it must be to wake up every day and dread conversations with clients that you have no time for….

Of course you need to be confident that the niche you would like to work with is big enough, the chosen target market must be capable of supporting your business at the level you want it to. This requires research and groundwork before you commit to specialising within your chosen sector.

 

Can you add increased value?

Once you know who you want to work with… now how can you stand apart from the crowd? This is typically going to be through deeper and more specialised knowledge of your chosen sector. As an example, let’s assume you have a real passion for the entertainment industry and decide to target freelancers who work within it. To stand apart from other advisers, you need to understand the nuances of this sector better than other advisers – how people in the sector are paid, the nature of contracts, their working environment and unique challenges and what are their specific pain points. When you understand their lives better than other advisers, now you have an opportunity to stand apart from the crowd and become the go-to person for that sector.

 

How can you demonstrate that value?

It’s all well and good knowing who you want to work with and building the expertise in the sector, one of the biggest challenges is establishing your presence as the best adviser for your chosen sector. This is where the hard work really starts, as there is no single silver bullet to demonstrating that value. Instead it’s going to come from many small activities executed well and delivered consistently over time.

Testimonials from existing clients within your chosen target market, case studies of work you completed that demonstrate your specialist knowledge of the sector and an online presence that speaks directly to your target market. These then need to be supported with a regular stream of fresh content that speaks to your target market about their specific challenges – maybe in the form of blogs, videos, podcasts or webinars etc.

 

What’s your route to your target market?

Then you need to build your presence within your target market. Of course, this will include working from the “bottom up”, one client at a time. However, you also should be looking at getting out in front at an industry level too – this might be through partnerships with other sector specific professional firms (accountants who specialise in the sector, agencies etc.), industry bodies, trade associations, sector publications and any centre of influences within the sector. Building links with them takes time, effort and patience, but if done well it will deliver strong dividends over time.

 

Does a niche strategy rule out other clients?

The bottom line is, no it doesn’t. A niche strategy enables you to narrow your focus in terms of the clients that you are going after, but it doesn’t prevent other clients from outside your niche approaching you about your services. From my own experience, people from outside the financial adviser community have approached me over the years to determine if I’d be willing to work with them. You are then in the fortunate position of deciding who you want to work with.

 

I’m a fan of niche businesses. Do you know who you want to work with?

 

Different people deserve different things.

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How many clients have you? 200, 500 or 2,000? Often as your client base grows, it results in your number of staff growing. But the chances are that even with your increased staff numbers, you are unable (and unwilling) to provide a top-drawer service to every one of these clients…

Really the question is – why should you? After all, you derive hugely varying levels of income from each of those clients so surely the clients that are driving very high levels of income to your business deserve a higher level of service?

Of course this is not at all a novel concept! Every time you step on a long haul flight, it’s immediately obvious. Turn right for the cheap seats in Economy or turn left to be pampered in Business Class or 1st Class. And then when you book a hotel, you can pay less for a standard room or pay more for a suite with all of the bells and whistles that come with that.

Now let’s take this concept into the financial advice space where for many of you, your remuneration model is built around trail commission. If I’m fortunate enough as an investor to come to you with €1 million to invest, your trail commission might be €5,000 p.a. (assuming you charge 0.5% of assets). That’s fine if your proposition stacks up.

But what happens if I decide to place just €200,000 of my money with you? Now your trail commission falls to €1,000 p.a. Still very attractive, but obviously not as nice. However the question that’s in my head is, “What extra am I getting from you by placing the full amount with you, that’s giving you the benefit of an additional €4,000 p.a. of my money?”

If there is no difference between the services offered in each of these situations, I suggest you’ve got a challenge on your hands… Simply adding trail commission to policies without thinking through your client proposition is fraught with danger.

Not completing a robust segmentation of your clients is also very dangerous. Even without doing a segmentation exercise, I’ve no doubt that a small number of your high value clients get your best service at all times. But inevitably what happens is that there are other high value clients that slip off your radar. Either you don’t realise that they are high value or they just aren’t demanding. This is aside from some low value clients who are constantly on the phone end up getting a huge amount of attention. That’s hardly fair, is it?

So what do you do?

 

Segment your clients

For starters, do a proper segmentation exercise. Know who is valuable to your business and who is not. Don’t be put off from doing this work with the excuse of “it doesn’t capture the full picture”. Yes, there will always be exceptions within your segmentation – for example a client with very little business with you, but who constantly refers other clients to you is actually a high value client to you and should be treated as such. But don’t start with the exceptions; work out how to deal with them later on a case-by-case basis.

I’m definitely not suggesting that client segmentation be based on asset values alone – that is only one factor to be considered and used. However it is usually one of the more heavily weighted factors used by advisers in segmenting their clients.

 

Develop your service packages

Develop service packages for your business that reward clients depending on their value to your business. Make your high value clients feel really special, reward them for trusting you with their money by giving them a truly rewarding client experience. Build a moat around them and pull up the drawbridge from your competitors by providing a second to none service.

Let your mid-tier clients feel valued by your business, while making them aware that there is lots more you can do for them (if they are willing to pay for it).

And of course your no/low value clients will begin to realise that it’s a business you are running and that they don’t have 24/7 access to you. If they want access to superior service (ongoing advice from you), they pay more for it. The same as when they book a flight or a hotel room.

 

Don’t be afraid to say no

Yes, your lower value clients may want a better service possibly than you are offering and might try to demand it from you, without paying for it. Don’t be afraid to say no. You’ll only be doing this with your no/low value clients… And they are of little or no value to your business. Put your time into those clients that are of value to you – this is what your clients deserve and what your capacity allows.

The days of a “one size fits all” approach are over. Give your clients a service that they want and deserve.

 

Cough, cough – I need to talk to you about our fees…

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One of the areas of greatest challenge for financial planners in Ireland today is increasing the level of your fees / trail commission from the levels that you are currently charging. But time marches along, and often when you actually turn to really examining the issue, many advisers find that their charges haven’t increased at all in the last 10 years! There are very few other professions where this would be the case.

The comments that I hear are,

“It’s all well and good that UK & US advisers charge 1%, as their asset management fees are so low” 

and “You can’t charge more than 0.25% / 0.5% p.a. (or fees of €1,500 / €2,000 p.a.) and justify it”.

However, there are growing numbers of Irish advisers that do charge more and their clients happily pay more. So how do they do it?

 

Their proposition stacks up

Please note, this article is not about the merit of trail v fees, that’s a whole other conversation! For the purpose of this article, I’m simply going to call them both fees.

Advisers that attract higher levels of fees tend to have superior propositions. They have put a lot of time and energy into really thinking through their client proposition and the value that clients experience from working with their firm. There’s no grey in the proposition – they are crystal clear about all of the value areas.

When this work is done properly, very quickly all of the new areas of value that you provide become apparent, and you see where your proposition has grown and how you provide more value today than you did when your fees were set. All of this added value at no extra cost (currently)…

Once you start to clearly identify these areas of additional value, you’ve taken the first step to increasing your fees.

 

They actively communicate their value

This is often the area of biggest challenge, particularly with existing clients. Actually having that conversation with a client about the value being added. It’s always easier just to talk to the client about their financial plan, their cashflows and their policies – it all feels a bit “American” to have a chat about the value being added!

But if you don’t have this conversation, all you can do is cross your fingers and hope your clients see the value they are getting…

This conversation has to be highly structured (by you) and very well practiced. You need to be able to clearly demonstrate that you’re not just “winging it”, hoping to increase your fees on a case by case basis. Instead by clearly articulating the services that you provide, the value derived from them and the cost of them, clients can see what they are getting for their fees.

From experience, this tends to work best when advisers offer multiple (2 or 3 usually) service packages. The higher value packages show the increased services being offered for the higher fee levels. Also if a client is not willing to pay a higher fee level, they clearly see the services that they won’t be getting.

 

They justify their fees

The communication is critical, but a slick sales pitch is not enough. Advisers who charge higher fees clearly justify those higher fees. This is achieved through providing a range of evidence,

  1. A statement of financial improvement is where you demonstrate to your client the actual € value of your advice – this might be in a net worth statement, portfolio increase, tax saved, costs saved or other such metrics
  2. A client calendar of all the interactions that you carried out with / for them over the last 6 or 12 months such as the meetings you had, the phone conversations, the newsletters you sent them and the events you invited them to etc. Not forgetting of course the updates to their plan and cashflows, the portfolio rebalancing and ad-hoc service requests.
  3. Timesheets are provided by some advisers to demonstrate the level of work carried out on the client’s behalf and providing a justification of fees in the process.

When you start pulling all of these strands together, it can seem like a lot of work to be undertaking. However the prize is huge. You will quickly realise the value you’re adding and this will give you increased confidence to have that conversation about higher fees with your clients. They see the fantastic value they are getting from working with you, while you earn more in the process. A win-win situation.

Can you stand over your charges?

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Lots of the conversations that we’re having with financial advisers are in relation to the ongoing value you are providing, and the cost being charged for delivery of that value. However if we are to be completely truthful, it doesn’t always start out from that point….

 

Quite a number of the conversations start out from the point of, “I’m charging 25bps / 50bps and I’m not comfortable that I can really stand over it and justify it if pushed”. Advisers are looking over the horizon and seeing potentially greater levels of scrutiny from clients and the Central Bank in relation to trail commission. You recognise that you must be able to comfortably justify your trail commission if you want to grow the levels of it, or even to maintain it. This unfortunately often results in advisers remaining in the supposed easier place of a low trail commission rate, in order to avoid any pushback around price.

 

After all, trail commission has been extremely good to many advisers, who have seen recurring income rise substantially for relatively little effort in some cases, while also building long-term value in your business. Investment markets have delivered excellent returns over the last decade, and your trail commission has increased accordingly. You don’t want to lose this growth, hence the pressure to justify it. However you’re now looking at investment markets today and recognising the significant fall in your income that will happen, should there be a biggish correction in the market. Also if your income is very tied to the investment of your client’s assets, any under-performance against benchmarks also raises a question over the validity of your fees.  These issues arise when the only determinant of your trail income is asset levels. The problem is that when you’re only thinking about asset values and your costs, you’re starting from the wrong place.

 

The only place that this whole conversation can start is with the value that you are providing. Otherwise, it is a serious case of the cart before the horse… When you work out in detail the different levels of value that you are providing to your different clients, it is only then that you can start to price your services in a structured and robust way. Your income is now tied to the services that you are providing, giving you certainty and control over your income stream. Many advisers who do this properly continue to collect their income via trail commission, however now they have minimum charges for each of their service levels. These minimums protect them against falls in the market, and indeed enable them to meet the demands of clients for high service levels where their asset levels alone do not justify them.

 

When you get crystal clear about your service levels and can easily articulate and communicate the value that you are adding, that nervousness around your trail levels subside. Instead it goes the other way – it gives you the confidence to maintain and increase your trail levels, when you know that your services warrant these higher levels.

 

Now you can be firm and brave in relation to pricing. When you are clear about your services on offer, you can stand over your pricing as a premium advice provider to relevant clients. With clients who demand premium service levels from you, you can demonstrate the breadth and value of your services, and then justify that you are more expensive. Yes you can have lower cost packages, but within these packages the clients should be left in no doubt about what is included and more importantly what is not.

 

Clarity around your value gives you a strong position when negotiating your price. Without it, you’re forced to keep watching your competitors and make sure you are undercutting them. A race to the bottom… However if you want to charge higher prices than your competitor, you have to able to deliver more. So it is very important that you can actually deliver what you promise. The last place you want to end up in is the dreaded “over-promising and under-delivering” experience for clients. This is the certain road to losing clients.

 

Spend your time now looking at the value that you add. Do this piece well, and the cost side will fall easily into place, giving you confidence to stand over your charges all day long.