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,
- A multiple of recurring income
- 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.
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.