How to Value Your Practice

Sunday, May 16, 2010 13:56
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How to Value Your Practice

OK, let’s talk about practice valuations, and, more specifically, the value of the independent financial services practice or business that you own.

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Here are the basics that you need to know: 

  1. As a business owner, you don’t have to spend $6,000, $10,000, or $75,000 (actual prices for valuations that I’ve come across in the past 12 months) for a formal, written valuation of your financial services business to accurately determine its value;
  2. As a business owner, you also cannot rely on a multiple of value to accurately determine the value of your practice ,unless you like being wrong;
  3. The value of an independent financial advisory practice is unique – applying methods that are commonly used by appraisers and experts on wholesale bakeries, manufacturing facilities, or restaurants just doesn’t work in this industry.
One of the most frequent questions I’m asked is "What’s the average multiple of gross revenue for a financial services practice? Is it 2.0 times trailing 12 months GR/GDC, or 2.2, or higher?" My response is, "That’s like asking for the average value per square foot of a home in Portland, Oregon, or wherever you live. A big home or a small one? Old or new? Remodeled or a fixer-upper? Great view, lots of privacy, or backing up to a major freeway? Wood siding or stone? Yes, there is an answer to the question, and I’ll give it to you, but it bears no relevance to your situation."
 
Gross revenue multipliers — or industry "rules of thumb" — oversimplify the complexity and diversity of advisory practice models, thereby overvaluing some practices while grossly undervaluing others, often by as much as 30% to 40%. Professional appraisals, using traditional valuation methods such as income and asset approaches, as would be applied to a manufacturing business or wholesale bakery, have long ignored many of the subtleties involved in evaluating a financial advisory business, such as the transition risk or the demographic qualities of the client base being transferred. Undervaluing or improperly valuing a financial advisory practice has profound implications on succession planning, including issues related to life insurance, family business perpetuation, internal sales, buy-sell agreements, partnership buy-outs, and more.
 
Over the past few years, practice value and valuation have been part of a rapidly changing landscape, as the financial services industry has shifted from theory to practice. The independent side of the industry has witnessed an evolution in valuation approaches, moving away from simple gross revenue multiples towards a more comprehensive approach that takes into account many of the complexities in valuing a privately held independent financial services practice. At the same time, the new methods have reduced the cost of an accurate, industry-specific valuation to around $1,000.
 
Today, the value of a financial advisory practice is determined by analyzing a broad range of parameters over three major indexes: Transition Risk, Cash Flow Quality, and Marketplace Demand. In addition, deal terms and length of financing are taken into consideration to produce a final, realistic, market-generated value. The best news is that there is now a sufficient body of comparable sales data on privately held financial service businesses to accurately determine value.
 
As I’ve said in my previous postings, equity management, or professionally managing the equity in your business large or small, starts and revolves around determining and monitoring value. If you don’t understand what your business is worth, and why it is worth that amount, the rest of your practice management goals quickly become irrelevant. Value and valuation is the single most important thing to know as a business manager. Do it right.

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