Rethinking top advisor lists: What metrics really matter

Top advisor lists usually rank RIAs by assets under management and occasionally by the number of employees.

But these metrics can be quite misleading.

Many firms high on the AUM list are really multifamily offices that work with ultra-affluent clients who have somewhere between $25 million and $100 million in investable assets. While a few billionaire clients can move an RIA high on the list, it does not mean these firms make money or have high quality scalable businesses.

Since my firm, Savant Capital Management, made a number of acquisitions, I often get to look at pitch books that investment bankers prepare when they sell multifamily offices with high AUM. What I have learned is that while they may have lots of assets under management, the highly competitive nature of the ultra-affluent marketplace means these firms, on average, charge low basis points.

Their UHNW clients also demand lots of customization. As such, firms advising the megawealthy need to hire many expensive professionals. This makes it difficult to scale a business and maintain healthy margins.

What about having lots of employees? Well, that can be a good or bad thing. The number of employees you have needs to be evaluated relative to total revenues, not AUM.

For example, Savant has over 170 employees managing a bit over $6 billion in AUM, which seems like a lot of people. But, when you consider that we advise nearly 5,000 clients, and have an average fee (inclusive non-AUM fees) that approaches 1%, we are actually reasonably staffed.

Of course, we would be grossly over staffed if our average client had $50 million in investable assets paying 20 to 30 basis points versus an average client with $1.3 million who pays closer to 1% in fees.

So, how should you think about size?

What really matters is top line revenue, revenue growth and bottom line EBITDA. Over time, your business is worth a higher multiple if you can demonstrate consistent best-in-class revenue growth and a healthy EBITDA.

The beauty of revenue is that it’s easy to measure. And if you don’t have enough revenue, you just need to add clients, or raise your fees, to improve this measure of size. Of course, all revenue is not created equal. Recurring revenues — that is, basis points on AUM — represents higher quality revenue than commissions, fixed or hourly fees.

And then there is revenue growth. I’ve long been a proponent of investing for 15% annual revenue growth. This assures you can grow your business and attract and retain top next-generation talent.

EBITDA, which is a measure of cash flow, is more complicated.

To calculate EBITDA you first add state and federal income tax, depreciation and amortization back to your earnings. It’s worth noting that EBITDA is not nearly as simple to measure and optimize. Most advisors' financial statements are a mess.

Too often advisors use their business checkbook as a personal checkbook. And RIAs too often use their business to pay for Cubs season tickets, for their spouse’s Porsche, or to fund boondoggles. What's more, most advisors also don’t pay themselves a market wage. Sometimes they over pay themselves, which results in subpar profit margins. In other cases they underpay themselves so they can be proud of high (but misleading) profit margins.

To be a good financial manager you first need to normalize EBITDA. This means adding back expenses that are really personal in nature, and adjusting your wage to a market rate, in other words what you would have to pay someone else to do your job.

Once normalized, you then calculate what percentage your EBITDA is of your total revenue. If normalized EBITDA is $300,000 and your revenue is $1 million, your EBITDA percentage is 30%.

Once you calculate a normalized EBITDA percentage, it will give you a more realistic picture of your business’s financial health. While there is no magic “right” number, from my experience evaluating prospective RIA acquisitions, an optimally run RIA will typically have an EBITDA percentage between 25% and 35%. I call this the “EBITDA sweet spot.”

For example, an EBITDA percentage of 25% may be a good number if you are investing significantly back into the business. Thirty-five percent of revenues may be a stretch for small firms, but certainly attainable for larger well run firms. And multibillion dollar RIAs who are able to scale their business can even reach 40%.

What should you do if your EBITDA percentage is below 25%?

The best strategy may be to build your revenue base by bringing on more clients without adding new fixed costs. You may also be overstaffed or might be overpaying your staff.

But don’t start patting yourself on the back if your EBITDA percentage is over 35%. In this case, there is a good chance you are understaffed, are paying your team below market wages, or have very limited capacity to grow. While you can brag about having a high EBITDA percentage, the value of your business is likely lower than you realize. Prospective buyers will not want to pay a high multiple for your firm if your growth opportunity is limited.

Unfortunately, having robust revenue growth, and managing your business so you are in the EBITDA sweet spot does not give you bragging rights in the top RIA lists, which don’t consider actual revenues or know your EBITDA.

But, unlike rankings based only on AUM and your total staff, revenue, healthy revenue growth and a solid EBITDA percentage creates real wealth — both from ongoing cash flow and by building enterprise value.

I will take that over AUM bragging rights any day!