It's time

It's way past the time for the earnings before interest, tax, depreciation and amortisation (EBITDA) valuation model to replace the recurring-revenue model when an adviser practice is being sold.

The EBIT method is better than on recurring-revenue valuations because it’s based on the bottom line business profit and so is a much more solid basis to use. I’m telling prospective sellers – and buyers – that FOFA makes potential buyers apply greater scrutiny of advisory businesses’ ongoing revenues.

Until recently, the profit-based preachers – including me – have been drowned out by a noisy marketplace happily trading on multiples of revenue. The argument went that, if buyers were willing to pay three-times recurring revenue (based on embedded annual advice fees), then vendors were under little pressure to prove the profitability of the underlying enterprise.

Hand-in-hand with FOFA, we’re only just recovering from the GFC hangover that has squeezed costs squeezed in all industries – including financial advice businesses.

By March this year, about 160 practices had used the Business Health/ No More Practice Business Valuator to estimate their business’s value based on self-supplied metrics. The aggregate data shows an average practice value of 2.8 times recurring revenue while the EBIT profit multiple stood at 6.7 on average. When you multiply the ‘average profit’ by the 6.7, you’re getting a much bigger number than multiplying ‘recurring revenue’ by the 2.8 – and that’s surprising.

I think business owners need to question the received wisdom about practice valuations.

So, if a practice owner isn’t positioned well for this change, then what should they do? As scale has grown in the industry, buyers are purchasing parts of businesses based on profit. Advisers won’t always be able to leave the industry by selling their book at three-times revenue to the guy down the road.Buyers are realising they need to look at return on investment and you need an EBIT methodology for that.

Also, advisers are realising they can’t rely solely on growth of funds under management to justify prices. The focus is on profit and cost control.This change to a more rigorous, profit-based valuation model won’t be easy for all advisers, but it will smooth the exit path for many. The more profitable a business, the easier any succession process is.

So, what do you think? How will this help in your business?

About Peter Fysh

Peter Fysh has been assisting advice businesses with their succession plans for over 10 years, from his time when working with large dealer groups, and more recently with his own business, Financial Planning & Succession.

He has worked in the Financial Services industry for over 25 years, including roles with BT, Prudential and AXA.