“Coach’s Forum” is a place in which you can ask your questions, tell your stories or give your opinions on any aspect of practice management. For each column, George selects the most interesting and relevant comments from readers and offers his advice. Our objective is to build a community of people with a common interest in making their financial advisory practices as effective as possible.
Advisor says: I recently received an unsolicited offer to sell my practice for what I think is a healthy price. I figured I had at least another five years in this business, so selling has not even been on my mind. However, the offer is very appealing financially and something the potential buyer said makes sense: “It is a seller’s market right now and prices have never been higher. Who knows where they will be in five years? With so many baby-boomer advisors retiring over the next five to 10 years, there will be a lot more practices on the market, meaning prices are likely to come down.”
I know he was trying to persuade me to sell, but his scenario makes sense to me. What do you think? Is now a good time for me to sell?
Coach says: So, your question really is: “Should I cash out now because the market for financial advisory practices might be lower in five years?”
Doesn’t that sound a lot like saying to your clients: “Markets are way up. Perhaps you should consider retiring now instead of waiting five years, as you intended?”
I am not trying to make a mockery of your question or saying you should not take the offer that’s in front of you. I just want you to consider it in a familiar context.
Perhaps we can make the decision a little less daunting by restating your question slightly, to ask: “When is the best time to sell a financial advisory practice?”
The answer is both simple and complex. The easy response is: when your readiness to sell coincides with the highest price. The much more complicated part is to determine when those two conditions intersect.
Your readiness to sell has two dimensions. I have written extensively in this column and in my most recent book, Exit is Not a Four Letter Word, about the need to be both financially and emotionally prepared to exit from or transfer your business. From your description, you apparently feel the financial side of the ledger will be taken care of by this offer. I also am going to assume you have had a formal valuation of your practice completed by a competent professional for comparison to the proposal you have received.
Similarly, I am going to set aside the basic question of whether you are emotionally ready to leave your life’s work behind at this time.
That decision is a very involved one that, again, I have covered extensively in other places. Instead, let me try to answer your question more broadly. You may be surprised to learn that I do believe “market timing,” to some extent, should be part of your consideration regarding when to exit your business.
– FINANCIAL BUYERS VS STRATEGIC BUYERS
This also would be an appropriate forum for me to comment on the different approaches to pricing (and value) taken by financial buyers and strategic buyers. In general, financial buyers are most interested in return on investment (ROI), so they will try to make a deal at the lowest price they can. Strategic buyers, on the other hand, generally are more interested in taking what you have built and combining it with what they have built to create something greater than the sum of those parts.
Think of it this way: all other things being equal, financial buyers prefer to buy a book of business, that is, a client list; strategic buyers prefer to buy a business, including its associated reputation, systems, personnel, etc.
In most instances, strategic buyers will be willing to pay a higher price than financial buyers will.
– VALUE DRIVERS
“Timing the market” with respect to any investment is all about managing the difference between price and value. Sellers are looking to obtain the highest price they can by making a deal with a buyer who thinks there is more value in the asset than is represented by the price. Because the buyer’s perception of value is what determines whether he or she is willing to meet the seller’s price, let’s look at some of the key drivers of value in a financial advisory practice:
– Stable, predictable cash flow. An advisory practice’s value is derived from the expected net cash flow after the sale. Therefore, the higher the percentage of revenue that can be counted on to continue after the practice’s founder or current owner departs, the more a prospective purchaser should be willing to pay.
From a market-timing perspective, if you have not yet maximized recurring revenue in the form of fee-based compensation or other income that automatically renews annually, you still have work to do to qualify for the highest price possible.
– Growth potential. Few buyers want to acquire a practice that has plateaued or stagnated. To get the best price, you want to demonstrate to a prospective buyer that your business is scalable and has capacity for growth.
Making changes in a practice to maximize its growth potential can be a long-term process. So, if you are not at that point, your timing for obtaining the best price is not maximized, either.
– Client demographics. Given that buyers want practices with growth potential, the average age of your clients and distribution across age brackets will affect the price. Many advisors want to counsel clients in their pre- or early retirement years, so they will pay more for a client base largely comprising 55- to 65-year-olds. Younger advisors may be willing to pay premium prices for 35- to 50-year-olds.
Regarding the timing of your sale, you must ask yourself if waiting too long narrows the market for potential buyers, thereby reducing competitive bids. Which would you pay more for: a practice with an average client age of 65, or one with an average age of 75?
– Personal goodwill vs practice goodwill. Buyers know that much of the value of a practice is built on the intangible goodwill of the current owner. They wonder, therefore, how much of that goodwill walks out the door (along with clients) the same day the practice’s owner does.
So, in timing your departure, you have to ask: “What can I do to transform much of my personal goodwill into practice goodwill, and how long will that take? The longer it will take, the further you are from maximizing your price.
In addition to these internal factors that may have an impact on your timing, there are external circumstances, over which you have no control, that can influence your decision to make the transition out of the business.
– General economic conditions. Practices typically sell for higher multiples during buoyant economic times. If you want proof, ask anyone who wanted to sell their business in the midst of the 2008-09 global financial crisis, when assets under management dropped dramatically and consumer confidence in the financial community declined sharply.
– Marketplace competition. When barriers to entry are low or when major firms work aggressively to gain market share, prices for independent practices can suffer.
– Rising regulatory/compliance burden. As regulations and compliance requirements accelerate, costs rise and margins fall, along with valuations.
– Diminishing compensation. Declining rates of compensation mean lower overall revenue for the same amount of work. Less net revenue leads to lower valuations.
– Advisor demographics. Your suitor was right about this one. We are in a seller’s market right now because we have many more advisors wanting to bulk up their businesses through acquisition than we have advisors willing to sell.
Clearly, there is no single answer in finding a good time to sell a practice. Each advisor’s situation calls for individual consideration. So, here is the question I suggest you ask yourself:
“If I sold my business today, would that provide me with the financial security I need and allow me to live the rest of my life the way I desire, secure in the knowledge that my legacy will be what I want it to be?”
If the answer is yes, congratulations! If not, perhaps your timing isn’t right.
George Hartman is CEO of Market Logics Inc. in Toronto. Send questions and comments regarding this column to email@example.com. George’s practice-management videos can be viewed on www.investmentexecutive.com.
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