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Business Valuation

Most financial planning practices are not publically listed companies and are not traded on the stock exchange. Business Valuation. Hence, valuing these companies is not a straight-forward process.

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Business Valuation

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  1. Most financial planning practices are not publically listed companies and are not traded on the stock exchange Business Valuation • Hence, valuing these companies is not a straight-forward process • At the outset, it needs to be understood that a valuation is not a objective guarantee of the true worth of the business • This is especially true if the seller has obtained a valuation for the business! • Valuations therefore do not provide a precise estimate, but rather provide a guide, along with various disclaimers and fine print (to ensure that the person or company providing the valuation does not get sued as the result of the valuation being grossly inaccurate...)

  2. Methods of Business Valuation Business Valuation • There are several methods to value a business – these include: • Asset method. • Income method. • Market method.

  3. Methods of Business Valuation Business Valuation • There are several methods to value a business – these include: • Asset method. This method analyses how much was paid, or would be paid, for the assets of the business? Book value is an accounting measure of historic value, while liquidation value focuses on a market measure of assets. • Income method. The income method looks at what is the present value of the estimated future returns from the business. This can be generally achieved by two methods – 1.discounting cash flows or 2. capitalizing earnings • Market method. This method address the issue from the angle of what do others pay for similar assets or returns? Valuations of comparable businesses can be used to extrapolate the value the business that is being evaluated.

  4. Methods of Business Valuation Business Valuation • Asset Method • What is Book Value? It is an accounting concept and based on the amount of the company's assets (net of depreciation, depletion and amortization) and total liabilities. • Therefore, it is reflected in the company’s balance sheet • This balance sheet figure does not measure the firm's earnings potential and often diverges from the market value of its net assets • It is seldom used in isolation, but forms a useful part of the contract of sale • Critics of book value argue that it is conservative by its very nature and does not take into account issues such as: future appreciation, trade-marks and good will – some of these factors can be eliminated by “adjusting” the book value to reflect this.

  5. Methods of Business Valuation Business Valuation • Income Method • The most widely-used method to compute the value of a business looks at the present value of anticipated future income or cash flow generated by the business.  • Here, the valuation is based on the capitalisation of the company's current earnings. This method relies on the discounted cash flow (DCF) model. • Earnings projections, extrapolated from the company's accounting statements, are discounted using a capitalization rate (or multiplier) that takes into account the buyer's required risk-based rate of return and a factor for future growth. • DCF needs to be supported by reasonable assumptions. Often DCF valuations will be based on "best," "worst" and "most-likely" case scenarios.

  6. Methods of Business Valuation Business Valuation • Market Method • How market participants have valued other comparable businesses is one of the best measures of how much a business would fetch in an arms'-length negotiated transaction. • For publically listed companies, Valuators and stock trading markets often refer to data on public company acquisitions and trading prices. • In valuing a private company, information on comparable private sales or past transactions in the company's shares offer useful points of references. • This method is widely used for valuing smaller financial planning practices

  7. Business Valuation • Multiple of Earnings Method (combination of Market & Income methods) • Prior to FOFA it was not uncommon for smaller and medium sized practices to “trade” on a multiple of earnings based on 4 to 5 times annual on-going revenue. • Based on this, a practice that generated a revenue of $250,000 could fetch a price of $1 million or more . • The price was also based on the fact that there were more buyers than sellers. • The uncertainty surrounding FOFA and other changes, along with the GFC dropped the multiple to 3 or below.

  8. Business Valuation • Multiple of Earnings Method (continued) • The multiple also depends on “sticky” business – for instance, businesses having a larger a component of personal insurance revenues, could expect to fetch a higher multiple for that component. • Furthermore, if the life insurance is on level premiums, the revenues would be more “sticky” – i.e. The client would be loathe to cancel or switch the policy. • The client profile would also be a factor – for instance, a practice with FUM’s of $50 million, with 100 clients would have an average client FUM of $500,000. • Compare this with a practice that has FUM’s of $50 million with 750 clients – here the average FUM is reduced to $66,666

  9. Business Valuation • Multiple of Earnings Method (continued) • These examples are simplistic, but are useful to illustrate a point. • With FOFA and the move away from asset based commissions, some may argue that FUM’s are no longer that important. • However, it is reasonably to counter this, but stating that FUM;s are still a useful indicator - it would be more reasonable to charge a client with a balance of $500,000 a higher on-going fee for service than a client with a balance of $50,000

  10. Multiple of Earnings Method (continued) Business Valuation • Also important is the GOODWILL of the business and: • The likely hood of the clients continuing to remain with the new adviser (i.e. the buyer) • Most astute buyers would therefore structure the final negotiated price into two or more instalments or components • The first instalment would be payable on sale – this could usually be 1/3 or 1/2 of the negotiated price

  11. Multiple of Earnings Method (continued) Business Valuation • The second instalment could be payable after 12 months and would be based on the number of clients (i.e. the revenue generated at that time) that are still with the new owners. • It could be based on the number of clients (i.e. the revenue generated at that time) that are still with the new owners. • In a similar vein, the third or fourth instalment could be based on the state of the revenue in 2 or 3 years time.

  12. Multiple of Earnings Method (continued) Business Valuation • This instalment approach offers a safety net for the purchaser • If existing clients leave within this stipulated period, then the purchaser does not need to pay for these clients. • On the other hand, the seller could be disadvantaged, if clients left the practice after the sale, mainly as a result of poor service or other factors on the part of the buyer, (i.e. Factors that are beyond the control of the seller)

  13. Multiple of Earnings Method (continued) Business Valuation • It is common for the multiple to be reduced, in the event that there is no clawback period (a clawback is when the purchaser can clawback or take back some amount from the seller, as stipulated in the contract) • For instance a buyer may offer a multiple of 2.5 upfront with no clawback, or: • Offer a multiple of 3, with 2 payable upfront and the rest over two years, based on the number of clients and revenue generated during this period • A purchaser may also insist that the seller stay with the new owners for a period of time (i.e. 30 to 90 days) to assist with the transition. • During this period, the purchaser should ensure that they meet up with as many key clients as possible, in the presence of the seller, so that the seller can personally introduce the purchaser to these clients.

  14. Most financial planning practices grow in a haphazard and unstructured way Business Valuation • There is no clear vision or business plan • The principal’s main focus is to acquire clients, sometimes at considerably expense of time and effort (remember time = money) • As discussed previously, some of the clients may not actually fit the profile of the practice and could be unprofitable • An astute buyer would therefore demand a discount or reduction in price, for purchasing a business which had a proportion of these clients

  15. Also, practices that are fully computerized (i.e. All information stored on widely used CRM’s such as COIN or XPLAN), could fetch a premium price – sometimes up to multiples of 5 times earnings..... Business Valuation • Similar, if the majority of investments are via one or two platforms, this is easier to manage and control and this premiums could also be factored into the sale price • The buyer would request the on-going commission/revenue statements from the seller’s dealer group. • These statements would provide a monthly or fortnightly detailed tally of the revenue generated by each client during that period.

  16. In relation to business valuation Katz has the following advice: Business Valuation • Don’t over estimate the value of your business, especially during periods of a buyer’s market • Price may not be the sole factor – buyers could also be interested in process, amount of systems in place, sources of revenue and staffing • Obtain a professional evaluation from an widely acknowledged industry expert, so that it could be judged to be unbiased • Don’t overestimate the goodwill aspect of the business – there is generally no correlation between the number of years a principal has spent in the business and the amount of goodwill.

  17. The more the practice is dependent on one principal, the less attractive it would be to a buyer Future Trends • The practice should be designed to run as a business – i.e. A commercial enterprise • In future, it is reasonably to expect that single person practices will die out • Practices will get bigger due to growth and consolidation • Principals have a tendency to not delegate and micro manage most aspects of the business • As practices become larger, this flawed behaviour trait will be even more damaging

  18. Practices will need to focus on their key competencies - Future Trends • That is, “What do we do best?” • The emphasis is to spend as much time in doing this and this should be the key focus on senior and higher paid staff (i.e. Authorized representatives and advisers) • Most other duties should be performed by supporting staff (paraplanner, administration etc) or outsourced to experts (i.e. Payroll, HR, marketing etc) • The sole focus of the principal or CEO is to ensure the future viability and profitability of the business

  19. In future, compliance will be even more important Future Trends • This is not negotiable and should be built into the core of the business – i.e. First compliance and then everything else, such as profitability etc • Software and systems will play an even bigger part in the business as product providers and advisers communicate directly via their respective systems • Financial Advisers may have to specialize in one particular area, in order to find a niche and remain profitable. • Mergers and Acquisitions will increase the size of financial planning businesses and one person practices could become a thing of the past

  20. In conclusion, lastly and most importantly, if you commence the first day in your business knowing that one day you will sell the practice, and hopeful get the best possible price, then... Conclusion • You would build an effective business from day one, focusing on clients that fit your profile of growth and profitability • You would also have appropriate systems and procedures in place from day one and not wait to implement or purchase these till your practice has reached an adequate size • This would create issues in relation to data management and data entry – i.e. In the case of advisers that commenced without an effective CRM, once they purchased a CRM then hundreds of clients’ data would have to manually entered into the new computer system during a very short period of time, leading to errors and omissions.

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