Doug Johnson of DeVoe & Co. said he hesitates to answer the commonly asked question about how much small advisory practices are fetching on the open market these days.
Although DeVoe is a consulting firm specializing in RIA mergers and acquisitions, Johnson said during a webinar Wednesday that there are just too many variables at play to allow for a simple answer. The deals themselves are often made up of different portions of cash upfront and deferred rewards for retaining clients and income, said Johnson, a managing director at DeVoe.
And firms vary widely in how they make revenue and what they spend money on. All of that influences possibly the most important variable in a firm's value: its growth prospects.
But with that noted, Johnson said there is no doubt valuations have been on the rise. As recently as a decade ago, he said in the "How Much Is Your Firm Really Worth?" webinar, firms were selling for six to eight times
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"And what we have seen is that the normal multiple we see in the marketplace has increased, certainly," Johnson said. "But I can't tell you that it's 15 times. I can't tell you that it's nine times. It's somewhere in between six and 15, probably. But it depends on your firm."
Higher valuations and wealth management's 'dirty little secret'
Concern about valuations is on the rise as advisory firms come to be increasingly viewed by entrepreneurs with deep pockets as high-margin businesses in a relatively unconsolidated industry. So-called RIA aggregators, many of them backed by private equity money, have been
The aggregator Wealth Enhancement Group, for instance, announced earlier this week that it had completed 22 deals last year. Its competitor, MAI Capital Management, ended the year with 12.
The demand for RIA practices has been pushing valuations steadily upward. Even when interest rates rose in 2022 and deals slowed down because of higher financing costs, acquisition prices didn't necessarily come down, Johnson said.
But many transactions did begin to be structured differently. Before 2022, firms might receive as much as 80% of an acquisition deal in upfront cash or equity payments, a second part for bringing over 95% of their clients within a year or two and the rest by hitting certain performance targets in the next three years.
Today acquirers sometimes offer as little as 50% of the deal as an upfront payment, but the acquired firm only had to bring over 90% of its clients and had five years to show required growth.
"We didn't see valuations themselves going down," Johnson said. "What we saw, in terms of multiples, was because cash flows were reduced, that the total dollar amount for an offer did get reduced. However, they changed the terms a little bit to make it a little easier to get to those larger numbers."
Jamie McLaughlin, co-founder of the industry consultant J.H. McLaughlin, said in an interview that one "dirty little secret" in wealth management is that few acquired firms actually end up meeting the performance targets needed to achieve the full value of their buyout deal. Many times oiwners who thought they would get 16 times EBITDA may in fact receive something closer to 10 times after failing to hit revenue and profit goals, he said.
"They'll run out of their close-out meeting exclaiming what they just received in an earnout, and three or four years later they end up with half of that," McLaughlin said. "But we'll never know that."
Adam Levy, also a managing director at DeVoe, said future growth prospects — even more so than current performance — are many times the single biggest contributor to higher valuations. DeVoe reckons a 1% in annual "organic" growth — meaning revenue generation without help from mergers and acquisitions or other extraneous deals — corresponds to a 7% increase in valuation.
Among the many considerations DeVoe takes into account when gauging firms' growth prospects is the consistency of their income sources, Levy said in the webinar. Some practices, he said, make commissions from products whose sale numbers can swing widely from year to year.
"It's really going back to historical analysis, right? If it's been a consistent $50,000 every year as insurance commissions, we're comfortable forecasting out $50,000 a year," he said. "But if it's one-offs — if it's $50,000 one year and $5,000 the next year — we're likely to probably leave those out of the valuation."
Who will take over the shop?
One consideration that too few firms take into account, Levy said, is
Should those rainmakers retire or go somewhere else, the value of the business would evaporate almost overnight.
"It's a big component of risk in a business," Levy said. "Is there single-person risk? Do you have any backup? Do you have a continuity plan, if nothing else? What happens to your clients if you get hit by the proverbial bus?"
Too few firms prepared for retirement wave
Wealth management experts have long said the industry is unprepared for a coming wave of retirements among advisors. A report released on Jan. 15 by the research firm Cerulli found that advisors have an average age of 49.2 and that more than 105,000 will retire in the next decade.
Advisors who plan to retire by 2035 make up just over one-third of the industry's headcount and manage more than 40% of its total assets — of which there are $31.3 trillion at the retail advisory level in 2023, according to Cerulli.
Cerulli, whose results were drawn from 2,000 responses submitted by financial advisors, said more than a quarter of all wealth managers have no firm retirement plans. RIAs were particularly uncertain, with roughly 30% saying they didn't exactly know how they would go about retiring from the industry.
Cerulli said that only 14% of advisors plan to sell their practices at some point. Among various hurdles to arranging a sale, 86% cited the time and effort required to find a suitable buyer and 53% cited the need to value their practice accurately.
Levy said as daunting as these tasks may seem, they're something many independent RIAs will have to undertake at some point. Too many owners of small firms simply assume that the people working for them will one day want to inherit the business. But if they haven't taken the trouble to have the practice valued, they may be unpleasantly surprised to learn one day that their employees can't afford to buy it or are unwilling to take out loans to meet the purchase price.
McLaughlin said those are the type of situations where outside capital is essential. Whether it comes from private equity or some other source, third-party owners many times provide an indispensable bridge from one generation of management to the next.
"There are lots of reasons for people to consider a sale," he said. "The primary one is that the valuations have exceeded the partners' ability to do an internal transition. Minority capital is really important to transition to that next generation."
Levy said some owners also make the mistake of assuming the people working for them actually want to take over the practice.
"It's something I've run into in the past, where founders are sure that their son is going to take over the business," he said. "But when it actually comes time, it's: 'I don't actually want to run the business. I don't want to do this.' And all of a sudden your succession plan is no longer a viable plan."
