(2 December, 2004) The price is right: what is my planning business worth?

There is much irony in the fact that most advisers cannot agree on what a financial planning business is worth.

For a profession that makes a living largely on its ability to judge the value of investments, the fact that financial planning has yet to fully adopt a uniform model for how value is best measured in a planner’s practice would be amusing, if it were not so serious.

The contradiction is not lost on consultant Stephen Bingham of Bingham Martin, who recently wrote an article on the topic, which was included in Credit Suisse Asset Management’s latest research paper into the financial planning industry, HyperValue.

In his piece, titled ‘Drivers of Value for Financial Planning Businesses’, Bingham states that advisers don’t know how to value a business or what they should consider when conducting a valuation.

“Although the financial planning profession is part of a wider industry that in part justifies its existence by its superior ability to judge value and investment strategy, valuation techniques and sales strategies often appear surprisingly unsophisticated. For example, relying on ‘rule of thumb’ multiples,” Bingham says.

“Nonetheless, it can be observed that the prices paid for planning practices with broadly similar characteristics have covered a wide range of values — from approximately 1.25 to four times trail fees, for example — indicating that buyers will recognise and reward other drivers of value than recurring income, even if this is simply expressed as a higher or lower ‘multiple’ of a single valuation factor.”

One of the reasons for this variation in pricing is the question of what is actually for sale: the company, the business or a book of business?

Bingham says there are different implications for both vendor and buyer as to whether the sale is of the shares of a company, the defined rights and obligations of a ‘business’, or the ‘servicing rights’ with respect to certain clients - the ‘book of business’.

The valuation of a financial planning practice will centre on exactly what is intended to be sold or bought and what that means in terms of legal and tax implications.

However, regardless of what part of a practice is on the market, there are some fundamentally clear drivers of value that purchasers look for when it comes to buying a financial planning business.

Industry consultant and adjunct professor of financial planning at RMIT, Wes McMaster, says valuable practices bear similar hallmarks and chief among these are business systems, a clearly defined client base and an identifiable sustainable income.

This is something also recognised by Bingham, who says while some purchasers prefer to seek opportunistic acquisitions of poorly run businesses and add value by introducing their own proven business systems, the majority look for well run practices that can be integrated with little disruption and management effort.

“Buyers are impressed by organisation in the business which means in most cases the client base is segmented with a service offering for each segment and a pricing model in place for each type of service offering,” McMaster says.

“This means the practice can state what type of clients it has and which of those clients are, or will be, in a draw down phase in retirement or pre-retirement and preparing for that draw down phase.”

The reason for seeking this information McMaster says is that purchasers are looking for a business with long-term sustainable income.

“Recurrent income is the core business and a purchaser is buying the rights to future income which is remaining with the business after the sale,” McMaster says.

According to McMaster, profitability and efficiency are also key characteristics purchasers look for — areas where many financial planning businesses struggle.

“Most practices are not profitable and many are overstaffed, which is a function of poor management and poor skills. There is an idea that more work means more staff but it does not look at the processes needed in a planning practice and how it can be made more efficient,” McMaster says.

“Often this is because financial planners are good at that task but find managing the business a different skill which they may not have.”

Inefficiency can also creep into the very heart of the business — the client base, with Bingham stating that many planning practices grow opportunistically and take on new clients who present limited business opportunities and often take more time to service than other clients.

Research by the Boston Consulting Group found that typically 20 per cent of clients drive 120 per cent of profit, and 20 per cent or more of clients actually destroy value.

This statistic prompts Bingham to ask: “As a vendor, how much can you expect a buyer to pay for clients that cost more to serve than they earn?”

To deal with this, McMaster says more practices, particularly those above the $2 million revenue mark, are now using practice managers more effectively to ensure they are extracting value from their clients.

The areas usually targeted by these managers are client servicing and the pricing of the service offering.

“Advisers are flat out doing planning and are unable to objectively look at their business. They understand the need for change when they receive an external, detached view but nothing will change unless they are prepared to commit to that change and are driven by something to make it happen,” McMaster says.

Overall, most consultants agree that the market for planning businesses is more hard-edged, with vendors finding that buyers’ desire to buy adviser muscle is these days tempered with commercial realities and better insights into what makes good planning businesses work.

“Many vendors are disappointed not to be able to achieve ‘full value’ for a business they have worked hard in for a number of years. But buyers are dispassionate, and increasingly cynical. They know what drives value, and what dilutes it,” Bingham says.

“And while they don’t like to buy problems, they hate to not know what they are buying. A clean, well-run and transparent practice, followed by a clean, well-run and transparent sales process is the best way to achieve full and fair value.”