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.
There are many factors involved with projecting the future profitability of a firm. One of the most important, and often overlooked by current owners, is the increase in bargaining power and share of economic resources that the successor professionals at the firm will be able to demand. This means that some of the current profit margin enjoyed by the founders will usually have to be allocated to retaining and motivating the other professionals at the firm, in order to keep current clients and acquire new ones.
Negotiating and agreeing upon a discount rate and an ultimate deal structure in terms of cash payments, time frames and overall valuation is complex and can be time consuming. Many things can change during these types of negotiations and many potential deals are never finalized.
Four Paths to an Exit
Unlocking the enterprise value of your firm, assuming you actually have build any true enterprise value is a very real challenge. This is even more likely to be true over the next decade as more than half of all owners are pushing age 60 and there are likely to be many more sellers than buyers. Hanging on and sucking out as much cash flow as possible while you and your clients age and your practice implodes over time is less than an ideal retirement and certainly no bargain for your clients.
Participate in a Roll-up
A roll-up is essentially where you trade your controlling interest in your firm for some cash and a non-controlling interest in a larger cooperative that includes your firm, among others.
Sell to a small bank
Small banks have a natural interest in wealth managers who can take advantage of the banks' existing infrastructure.
Sell to an internal buyer
The most appealing option for many owners, this usually involves selling to the professionals in their firms over time.
Sell to another wealth manager
This option represents selling the clients (revenue stream) to another, usually larger firm that will strip out as much cost from the seller as possible to unlock maximum profit.
How to Choose?
The ultimate path chosen by the current owners will reflect their understanding of their firm's enterprise value (of lack thereof), their level of effort and success in addressing the creation of enterprise value in their firms, their outlook for the firm in the future, the market for similar firms at the time, as well as a whole host of emotional factors.
It should be obvious to any owner that no one option is best in all circumstances, but the authors do provide a very thorough review of each option, including a comprehensive discussion of the pros and cons of each and specific recommendations for avoiding the more common pitfalls. This discussion is well worth the time to read and re-read this 117 page report. By the way, the author's insight into the motivations and apprehensions of the typical owner of a wealth-management firm provided a powerful reality check for me. Whether you agree with the researchers' conclusions or not, you will learn something useful about succession planning, and maybe about yourself.
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