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  • Writer's pictureKevin Elvington

Succession Considerations, Part 1

Lifestyle Practice vs. a Business

Most people think about the sale of a financial planning practice as a transaction or an event. In fact, this is not the case. For a succession plan to have the greatest likelihood of success, it’s a process that, when properly planned, should take place over a two to three year period. Owners should operate their practice with the notion that it’s actually a business. They should be willing to make long term investments based on the business that they hope to become.

So, what does it look like to have an “owner’s mindset”? An owner might consider allocating a portion of profits to retained earnings. This will provide staying power during volatile markets and allow them to capitalize and acquire when less thoughtful operators find themselves financially strained after a quarter or two of reduced billings. That said, while primarily an issue of semantics, the notion of referring to a practice as such, and not a business, gets to the heart of the issue because of the implications and behaviors that result as a function of that mindset.

To differentiate, a traditional lifestyle practice might be described as one in which the advisor hires an adequate amount of staff to do the job, covers firm overhead and expenses, and pays (themselves) whatever remains. There’s nothing wrong with this concept but for the fact that the advisor, in neglecting to reinvest, likely dilutes not only the client experience but, ultimately, the terminal value of the book. On the other hand, the business owner/CEO of a wealth management firm builds a blueprint of how they want their business to look. They make investments in human capital, infrastructure, and technology. They’re willing to take a step backward in order, to take three steps forward, which sometimes means a temporary reduction in income to further the long-term goals of the firm. They consider the client experience and long term enterprise value equally or more important than current take-home pay. Consequently, they are typically rewarded by the market with a higher enterprise value for building a business that can endure after the founder is gone.


Shockingly, while a greater understanding of value has evolved over the last 3-5 years, the vast majority of the industry still speaks in multiples of gross revenue or GDC. This methodology fails to recognize the unique variances in profitability that can occur based on client demographics, average account size, and the cost of doing business (rent, staff salaries, etc.). A rural or suburban based practice with a reasonably adequate but cost-efficient service model could garner dramatically different margins than a slightly more sophisticated practice with greater staffing, higher wages, and expensive real estate. The simple “regional effects” of operating a practice in the Midwest vs. NY, DC, San Francisco, or LA would likely significantly impact the bottom line. A reasonably efficient practice in a “low-cost region” could experience EBITDA margins of 50-60% as contrasted with a slightly more sophisticated practice located in a “high-cost region”, where margins of 30-40% would be considered admirable on a relative basis. So, what’s the point? The multiple of revenue model, with general market standard terms, could suggest something along the lines of 2.5X gross revenue as an enterprise value. This means that a wealth management firm in the Midwest with $2MM in Gross Revenue/GDC and a similar firm in NYC, could both have an enterprise value approaching $5MM. Not a bad payday!

However, in an extreme case, if we acknowledge the regional and structural influences that could affect profitability, the Midwest shop could be dropping $1.2MM to the bottom line vs. the NY shop with a potential profit of $600k. This assumes each firm has a fairly constructed P&L, includes a reasonable owner’s comp, etc. Simply stated, all else being equal, the Midwest shop may be worth twice as much. Bank loans and seller notes can’t be repaid with revenue, only profits! When exploring opportunities as a buyer or seller, it’s important to understand all the factors influencing value. I’ve often told sellers that they can name their price as long as we can set the terms. The devil is often in the details, and thorough due diligence on both sides of a transaction will increase the likelihood of a great outcome for all parties.

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