A Guide to Valuing Your
Financial Advisory Practice
A Guide to Valuing Your Financial Advisory Practice1
If you’re one of the many baby-boomer advisors in the financial services industry starting to think about
succession planning—or if you’re an advisor considering growth through practice acquisition—you may be
asking yourself:
• What is the value of my practice or book?
• What price should I pay to buy a practice or book?
• What are the best terms for structuring a deal?
The answer to all of these questions is the same: It depends! Many variables go into determining the value of a
practice or book. Of course, the value calculated is not necessarily what a buyer will pay or what a seller would
consider accepting. Negotiation according to each side’s interest results in the price. And once a price is agreed
upon, the terms of the deal influence what the buyer ends up paying and what the seller ends up receiving.
Valuation Overview
What am I valuing?
The first step is to understand exactly what you are valuing. Are you valuing a list of client names or a full
practice? A majority or a minority share? If valuing a practice, are you including the office furniture? The staff? A
clear picture of what is at stake is critical to arriving at a reasonable valuation.
Why am I valuing it?
The valuation process can be costly and time consuming. Valuations also have a limited shelf life. As a result,
you want to know why you are valuing the practice at a particular point in time.
Some reasons why an advisor may want to value a practice include:
• For legal reasons, such as divorce
• To use as a management tool
• To use as a basis to grant equity to partners
• To sell or buy a practice or book
• Out of curiosity
In addition, the reason behind a valuation can help you decide how many resources to dedicate to the process.
Not all cases demand an expensive valuation from a third party, but back-of-the-envelope estimates may be
too rudimentary for some. Right-size your resources to your purpose.
A Guide to Valuing Your Financial Advisory Practice2
Due Diligence
There are many subjective aspects to valuation. For example:
• Should I use average multiples, or should they be higher or lower?
• What discount rate should I use?
• What return should I expect?
• What level of growth should I expect?
Once you are clear about what you are valuing, conduct adequate due diligence to reveal aspects of the book
or practice that may command a higher or lower weighting based on long-term prospects for growth.
Key questions to bear in mind when performing due diligence on a book or practice include:
• What are the demographics of the firm’s clients?
• Is the book well diversified?
• What effect do economic conditions have on the business?
• What competition exists?
• What are the strengths and weaknesses of the practice?
• Is it a seller’s or buyer’s market?
• How strong are the internal operations?
• How available are the firm’s financial statements?
• How detailed are the financials?
• What is the condition of the income statement?
You’ll also want to consider licensing and regulatory information, including recent audit findings; tax
information; and any agreements that may exist.
A Guide to Valuing Your Financial Advisory Practice3
How Do I Determine a Value?
There are numerous ways to determine value. Following are several common approaches:
The multiple method
This method values a business by comparing its key statistics with those of similar businesses that have sold
in the marketplace. For advisory practices, the multiples of revenue and multiples of cash flow methods are the
most common.
• The multiples of revenue method applies a multiple to the selling advisor’s trailing 12-month (or
longer) revenue. A common multiple used in recent years is 2.3 times recurring revenue and 1.1 times
nonrecurring revenue. These multiples are presented as averages, and advisors adjust them based on
the quality of the book. This number is then discounted based on an assumed retention rate of the
transferred assets.
This is an easy way to determine a starting point for negotiations, but it is limited in that it doesn’t account
for expenses.
• The multiples of cash flow method allows buyers and sellers to account for expenses, which are of
particular importance if there is more for sale than just a book of clients.
For example, under the multiples of revenue method, a practice with $500,000 in recurring revenue and
$200,000 in expenses would be valued equal to a practice with $500,000 in recurring revenue and $50,000
in expenses. But using the multiples of cash flow method, advisors could instead use EBITDA (earnings
before interest, taxes, depreciation, and amortization), EBIT (earnings before interest and taxes), or NOI
(net operating income). According to the Alliance for Registered Investment Advisors, a wide range of
multiples (i.e., from 3x to 10x) are applied to these metrics.
Although the multiple method approaches have the advantage of being relatively easy to calculate—and are
commonly understood by market participants—they have significant weaknesses. Chief among them is the fact
that this method doesn’t forecast future cash flow to the buyer, which is essentially what is for sale. In addition,
there is a lack of accurate information available on the sale of advisory practices, since most sales occur privately
and aren’t publicly disclosed. Because of these issues, you may need a somewhat more sophisticated approach.
The income approach
This approach is based on estimates of the income that the practice will actually produce. Within this approach,
the discounted cash flow and single period capitalization methods are used most often.
• The discounted cash flow method involves forecasting cash flows for a certain period of time and
discounting them back to the present day using a discount factor. In addition, a terminal value is
calculated using an assumed long-term growth rate. This method allows the parties to account for future
internal and external risk. Buyers and sellers can predict what will actually be produced by the business
going forward and make adjustments based on their analysis.
Though this method may be the most accurate predictor of value, it is also the most complicated.
Accurately calculating cash flows, growth rates, and discount rates is a challenge, especially given
unpredictable market cycles.
A Guide to Valuing Your Financial Advisory Practice4
• The single period capitalization method is a shortcut of the discounted cash flow approach that assumes
a normalized growth rate. This method calculates value by dividing next year’s adjusted cash flow by the
capitalization rate (discount rate minus growth). As with discounted cash flow, the challenge is to fairly
project each input.
Terms
Once a price has been agreed upon, the parties to a transaction must agree on the terms of payment. This
process is just as important as the valuation. For example, would you rather pay or receive $1 million today or
$20,000 over 25 years? The terms of the deal will directly impact how much the practice actually sells for, as well
as who bears the risk of the transition.
Because deals in this industry are primarily seller financed, there are three principal methods of payment. Most
deals incorporate a combination of two or three of these methods.
Down payment
A down payment serves as security for the seller of a practice. By requiring an up-front payment, the seller is
guaranteed a minimum sum and protects him- or herself from buyers who are only interested in skimming
off a book’s best clients. The amount of the down payment is a risk to the buyer of a practice because future
revenues are not guaranteed. A common down payment is calculated at from 30 percent to 40 percent of the
agreed-upon price.
Promissory note
Promissory notes guarantee sellers a fixed sum payment across a set time frame. The note will list the principal
to be paid and the terms of repayment. Much like with down payments, the buyer assumes most of the risk
through a promissory note because of the lack of guaranteed future revenue and the fixed and predictable
payments to the seller. The seller is essentially assuming the credit risk of the buyer. To compensate for the
assumed risk, buyers may look to have a promissory note adjusted at some time after closing to consider the
realized client retention.
Earn-out
This is currently the most common financing method for at least a portion of the payments. The seller receives
a percentage of future revenues for a set amount of time or up to a certain amount. Payment distributions can
range from monthly to annually and usually span from two to five years. Percentages are often applied to net
revenues (after broker/dealer payout and transaction fees) and can vary over the life of an agreement. Because
payments are contingent upon future revenue, both parties have motivation to successfully retain clients. The
dependence of payments on future revenue places some risk on the seller, however. Occasionally, the parties
set a ceiling or a floor for the payments in order to manage the risk.
A Guide to Valuing Your Financial Advisory Practice5
Your Unique Value
Valuations serve as snapshots of your ever-changing business. And like every book or practice, each valuation
is unique. Simply implementing the current year’s multiples or discount rates could never account for the
valuable services that only you offer to clients or your distinguishing business structure. Consideration of these
elements is necessary for sellers and buyers to arrive at a fair price.
With the high number of advisors across our industry anticipated to retire in the coming years, succession
and buy-sell planning will be increasingly important. At Commonwealth, we have a team of home office
staff—including members of our pioneering Practice Management team—dedicated to assisting advisors with
practice transitions. Our Buy-Sell Task Force facilitated 40 transitions in 2013 alone, and we stand ready to assist
our affiliated advisors in making the decisions that are best for the legacy of their firms.
A Guide to Valuing Your Financial Advisory Practice6
Founded in 1979, Commonwealth Financial Network, member FINRA/SIPC, is the nation’s largest privately held
independent broker/dealer–RIA, with headquarters in Waltham, Massachusetts, and San Diego, California. The firm
supports more than 1,487 independent advisors nationwide in serving their clients as registered representatives,
investment adviser representatives, and registered investment advisers, as well as through hybrid service models.
For more information, please visit www.commonwealth.com.
Waltham Office
29 Sawyer Road
Waltham, MA 02453-3483
Toll-Free: 866.462.3638
Phone: 781.736.0700
Main Fax: 781.736.0793
San Diego Office
110 West A Street, Suite 1800
San Diego, CA 92101-3706
Toll-Free: 866.462.3638
Phone: 619.471.9700
Main Fax: 619.471.9701
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Commonwealth Financial Network®
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