Too good to be true?
Almost since financial planning began in Australia, advisers have been creating new dealer groups in the belief it will make them rich.
Becoming a part owner of a start-up dealer group has been seen as a logical way of growing an adviser’s business.
But our research has shown this couldn’t be further from the truth.
In practise, we found that when an adviser buys into a new dealer group — no matter what size the shareholding being offered — it is impossible not to be worse off compared to running their own practice without a shareholding.
Our research shows that where the dealer group focus is on giving advisers the resources to help them run their business more efficiently, these practices grow by at least 4 to 6 per cent more than when compared to ‘low adviser service’ dealer groups.
Let’s compare two advisers. Both have recurring revenue of $800. After 10 years:
~ if the adviser licensed through a dealer has just 4 per cent better business growth on an assumed valuation multiple of 2.5, he can expect his business to be $1 million ahead; and
~ for the adviser who is a shareholder in a new dealer group to achieve the $1 million figure, assuming there are 160 advisers in the group, they will need to achieve a sales figure of at least $200 million for them to achieve the same result.
Too often the deal to join a new dealer group looks like an offer you cannot refuse.
The advisers in the new group will own between 50 and 80 per cent of the shares, with the rest owned by the people who had the original idea of forming the group; founders that provided seed capital and others at the formation.
We have often found the fees for the adviser are set at lower levels to attract people to join the new group.
But as the dealer group grows, the low fees means it hasn’t the scale to develop the business, as all the income goes to providing essential services. Until the dealer group reaches 100 advisers there is generally not enough scale to fund development of the business.
And the adviser shareholders have to pay for their own specialist services, such as business coaching, as there is not enough income in the group to fund these extras.
But the dealer group will have to achieve scale if it is going to attract a buyer.
This means any extra revenue the group brings in will be used to secure more members to reach critical mass and become an attractive proposition for sale.
To achieve a value of more than $10 million, a buyer usually wants at least 70 advisers and 50 businesses.
Assuming key management, initial members and financiers have a minimum holding of 20 per cent and the adviser will have the rest; the adviser could achieve anything up to $400,000 from the sale of the dealer business. Nothing even close to the earlier $1 million example.
The expectation is the larger the group, the greater its value.
However, the larger the group, the smaller the individual shareholdings.
If the early advisers in the group have secured larger blocks of shares, which is often the case, it makes it impossible to attract new members, as later advisers may only receive a token shareholding — between 0.25 to 0.5 per cent — which means their share of the sales proceeds are negligible.
Based on past sale records of dealer groups, usually a group has to wait at least 10 years to achieve enough scale for all the shareholders to achieve a good value for their component practices.
Often there is a retention period for advisers of three years after the sale, which is a long time to be locked into one business model.
And according to our research, no dealer group of more than 120 advisers and 70 businesses has successfully sold the business in less time.
The big question is: can the adviser wait 13 years to realise the value of their investment in the new dealer group?
At the end of the 10 years, there is no guarantee that a purchaser will exist who is willing to pay the price the dealer group wants.
Another question concerns the business model of the dealer group. Will it last for 10 years in today’s changing environment?
With the removal of conflicts of interest and preferential arrangements, the future premium of a new dealer group will be less if compared to sales over the past few years.
So the dealer group will spend on average one-and-a-half times more than the adviser pays in fees to service the adviser, funding the shortfall by other revenue or subsidies from the parent company.
A key advantage of joining the larger dealer group is the potential extra business growth and value each and every year. Also, there is no need for a 10-year or more wait to realise the value of the practice.
Table B (please see Money Management Magazine November 23, 2006 page 28) shows potential capital growth over 10 years.
In conclusion, advisers should not join a new dealer group because they expect to gain an overall financial benefit as a shareholder because it is unlikely to eventuate.
It is far better to make the decision to join an established small dealer group or a start-up based on service levels and positioning in the marketplace.
Andrew Wheeler is director of Dealer Group Advisers.
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