And how do we get there?
The market turmoil of the past three years has caused many owners of wealth-management firms to reassess their own retirement-planning assumptions. Some acknowledge that they just don't have the energy or the desire to keep at this for another 10 or 20 years. Most of us realize now that the options for monetizing our years--or decades--of work building our firms are much less certain than we ever admitted. Understanding the concept of enterprise value will be critical to developing a realistic and workable succession plan for a wealth-management business owner.
A recent white paper, "Creating, Measuring, and Unlocking Enterprise Value in a Wealth Manager," created by Fiduciary Network and available on its website, (www.fiduciarynetwork.net) is the place to start. Written for advisors by Mark Hurley, et al., it identifies the primary variables (in their opinion) that determine enterprise value, how to measure it in wealth-management firms, and the four options for unlocking or realizing this value in a succession plan. While the conclusions of this paper are consistent with the business model of Fiduciary Network, which is to provide passive capital to the successor professionals to facilitate internal business succession of these firms, the concepts and discussion in this paper are eye-opening.
What is Enterprise Value for a Wealth Manager?
The enterprise value of a firm is what the market believes is the value of the ongoing operations of the firm. In another sense it is the price an investor would pay to take over the firm. In a nutshell, it is the future profits of the firm, after the current owners have left. In order to have any enterprise value, the firm must generate sufficient, sustainable profit to pay future owners a market level (and above) compensation and produce sufficient cash flow to pay out the current owners.
According to the authors, only firms with a fee-only business model have the potential to create true enterprise value for their owners. Whether you agree with this or not, it does make sense that keeping an annual-fee client year over year represents a more certain revenue stream than having to sell additional products to existing clients or to new clients each year to generate revenue.
The types of activities that build enterprise value over time include:
* Recruiting and developing the next generation of professionals.
* Building relationships between clients and the firm rather than between clients and a single advisor.
* Building a client base that is profitable, demographically diverse, and not concentrated in terms of one or two characteristics.
* Building the brand of the firm, not the individual founders' reputations.
* Embracing the evolution of management that relies less and less on the founders.
* Creating and maintaining a culture of compliance.
* Reinvesting a substantial portion of the founders' profits back into the firm.
How is Enterprise Value Measured?
If some rule of thumb comes to mind, such as a multiple of gross revenue, a percentage of AUM, or a multiple of EBITDA, chances are you have a less than realistic idea of your firm's value. The three most important variables for determining enterprise value for succession planning are:
1. The projection of future profitability without the current owners.
2. A discount rate that incorporates the risk that this profit may never materialize.
3. A deal structure that allocated the risk appropriately between buyer and seller.