Understanding the Value of Your Revenue
One of the services that we provide at Sell My Financial Practice is a business valuation. Our valuation takes the gross recurring and transactional revenue from different lines of business and assigns a specific multiple to each.
One of the first questions that comes up when we review it with an advisor is why do you weight this type of revenue higher than another revenue? The short answer is, it is based on the client relationship, and different types of revenue are generally a good indicator for the type of relationship between the advisor and client, and how long we can predict the revenue to continue.
Let us start by defining the different types of revenue. There are 4 general types that I will define for the purposes of this example:
1) Transactional Revenue: A commission revenue received for the sale of a product, or new deposits into existing accounts - it is a one-time payment.
2) Asset trails: An ongoing commission payment for the sale of a product, generally you see this revenue generated by mutual funds and annuities. With the sale of a product there may have been an upfront transactional commission and then an ongoing asset trail. Many advisors are now selling annuities and are taking ongoing asset trail revenue instead of the one-time transactional revenue.
3) Asset Management Fees: Fees that a client agrees to pay out of their investment account in exchange for the advisor to manage that account. This fee is generally a % of the assets managed by the advisor and the revenue continues as long as the advisor manages the client account.
4) Planning Fees: Fees that a client pays for advice or planning from a financial advisor, these could be a one-time fee, monthly, quarterly, or annual, depending on the service being provided by the advisor.
Now that we have established what the 4 general types of revenue are, lets talk about why one type of revenue may be weighted higher or lower.
Transactional is straightforward, because it is the only one that requires a transaction or additional investment to generate revenue. This makes the value to the buyer very low because there is no future revenue being generated. The assumed value is in additional opportunities the advisor may be able to find with the client moving forward. A higher weighting is given to transactional revenue that is derived from regular transactions like periodic investment plans or ongoing paycheck deposits into 401(k) accounts. However, those are still not classified as recurring because they require the transaction and are not generating revenue based solely on the assets in the account.
The primary discussion about weighting revenue usually focuses on asset trails and asset management fees. When you talk valuations on multiples of revenue, generally asset trails will come in around a 2Xs revenue while asset management fees may come in as high as 3Xs revenue. So why the difference, both are recurring and in the case of asset trails they will continue to be paid as long as the product remains in force. The answer goes back to the client relationship and how these products/services are sold. In the case of an annuity and mutual fund that is paying an asset trail, it was sold under the suitability standard, and the relationship between the advisor and client is that of a product sale, while an asset management fee, the account is established under the fiduciary standard, and the client is agreeing to pay the advisor for ongoing management of their portfolio. In this case the client not only values the ongoing advice enough to pay for it, but also remains actively engaged with the advisor because of the ongoing requirement for reviews. These factors generally lead to a stronger client relationship on the asset management business, greater client retention in a transition/business sale, greater opportunity for future revenue for the buyer, and why the higher multiple.
Now that being said, I am not saying that if you have asset trails you don’t or can’t have the same or deeper client relationships than client with asset management fees. These numbers are based on averages and experience in implementing succession plans. The way you can increase the multiple of revenue on asset trails, is to be able to evidence to the buyer those clients are still engaged and evidence the relationship is ongoing, through reviews and multiple client touch points.
Financial Planning revenue is the newest type of revenue that we are now measuring for a practice sale and is also the most variable. If there is one time planning revenue, the client may have already gotten what they need from the plan or may not have seen the value. However, when a client is paying ongoing planning fees it can return some of the highest multiples of revenue. When the client is paying ongoing annual fees, it means they are engaged and see the value. Additionally, ongoing monthly/quarterly subscription fees show clients engagement with the advisor, see value in paying for advice, and this model generally is being implemented by younger clients which leads to great revenue opportunities down the line. If an advisor can demonstrate client retention in the ongoing fee for service model, they will receive a high multiple of that revenue.
While the multiple of revenue valuation is not perfect, because it can’t quantify client relationships, it can help set a baseline valuation, and then based on practice factors such as client engagement, demographics, and retention information, it can be an accurate indicator of future revenue. For advisors who are looking to convert their valuation into an actual offer or bid to share with buyers, we use this baseline as the starting point for cashflow modeling. This approach allows us to show a seller what a buyer can afford to pay for their business vs. what a valuation of any type may say it’s worth.
If you are interested in getting a business valuation and then seeing how we can use a future cash flow model to create a business offer, complete our quick confidential questionnaire and we will run it for you.