It’s a myth bought by RIA principals across the globe which can really harm them when the time comes to sell: many principals believes that valuation multiples are relatively uniform among buyers, based purely on their size and profit margins. This is far from true.
While most buyers will use valuation multiples based on these factors, the multiples can vary dramatically based on a firm’s sustainability.
What makes a firm sustainable?
James owns a practice with $550 million worth of assets and derives an annual revenue of $3.5m, clearing 50%. He has one $110m client and two $35m clients. The rest are under $10m.
He creates custom portfolios based on hedge funds, stocks, ETFs, mutual funds, SMAs, and more. His staff consists of two support contributors, two junior planning advisors, two client-service associates, and two operations staff. There is no successor in place. He focuses on working with his existing clients and managing his team, so the business hasn’t grown much in the past five years.
Joe only has $400 million worth of assets, but also generates $3.5m of revenue with a 60% net margin. Most of his clients generate under $20m, averaging around $7m. Two young advisors have been recruiting to succeed him, and Joe spends half his time finding new clients. He combines ETFs, SMAs and mutual funds in standardized portfolios. He also employs a head of operations, two client service associates and an office manager. He spends about half of his time finding new clients.
In spite of their similar sizes and revenue, Joe’s business is likely to be valued much higher when the time comes to sell, as it has so many more sustainable factors. His standardized portfolios are seen as more reliable and he has a higher net margin. He has successors. He’s not too reliant on a single client. He has a growth strategy and has built a business model which helps new clients to be constantly acquired. This is a business which is far more likely to remain successful (probably even more successful) in the future.
Buyers will typically calculate a profit margin subtracting the cost of paying a firm’s advisors from the revenue, then paying a multiple on the result.
Based on the current market, James’ business might receive an offer of four or five times the profit margin. (That’s if he sells at all. More than half of businesses with a ‘lifestyle’ model like this end up being wound down instead of sold.)
As Joe’s businesses is far more sustainable and the potential for growth is far bigger, he is more likely to receive offers with a multiple between six and eight times the profit margin.
Building and growing sustainable business isn’t simple. It will require a bit more initial work from the RIA owner. Still, the decisions made now will have a huge impact on the selling price later on down the road. Those who create truly sustainable firms stand to reap the rewards.
At Succession Link, we make it simple to find the perfect individual to sell your business to. Click the link to learn more about our business model.