5 Essentials to Secure the Best Valuation for Your Firm

Written by Rick Kent, CEO & Founder | Article originally appeared in Investment News.

If you’re thinking of selling, you should be considering factors like the rate at which your firm is growing, your relationship with your employees, the age of your clients and the state of your tech stack.

Mergers and acquisitions are at an all-time high in the wealth management industry. As CEO of a firm that’s actively acquiring, the questions we hear most often from firm owners focus on getting the best valuation possible for their firm.

Here are five essentials I believe every seller should institute.

1. Focus on Growth

Valuation experts, consultants and investment bankers agree: Growth is by far the single most important driver of a firm’s value. Just as the buyer of a stock is interested in its future performance as measured by the net present value of all expected future cash flows, advisory firms are also valued on their future cash flow.

  • Metrics matter. Key growth metrics for buyers of advisory firms include average annual revenue growth; net organic growth, or total assets under management growth before mergers and acquisitions and investment performance; and the number of net new clients a firm adds each year.
  • Benchmark yourself. Keep track of industry benchmarking studies for metrics like revenue, assets and new clients as reported in annual reports from firms like Charles Schwab and Fidelity. You’ll want to at least match the industry benchmark. Your valuation will be greater if you’re above, lower if you’re below.
  • Bigger is better. Key corollaries of growth are size and scale. The more your firm grows, of course, the bigger it becomes and more likely it is to achieve efficiencies and scale, which are qualities buyers covet. In the M&A market, bigger is better.

2. Never Forget: It’s a People Business

Your monetary assets are listed on the Form ADV you file with the Securities and Exchange Commission, but the assets that make your firm what it is are the people who walk through your doors (or can be seen on Zoom calls) everyday! Your employees bring in revenues, serve clients and represent the firm to the outside world. Your relationship with them will be scrutinized very, very carefully by prospective buyers.

Here are some key considerations:

  • Do what’s necessary to attract and keep the best people. Keep in mind that this is a sellers’ market for talent. Demand for quality employees, especially for experienced advisers and wealth managers, far exceeds supply.
  • A competitive salary is only table stakes. In addition to a base salary, consider performance incentives and if possible and warranted, offer equity.
  • Job seekers also expect generous benefits, a defined career path and a flexible work environment.
  • When recruiting, cast a wide net. Make a dedicated effort to recruit younger advisers, women and a diverse range of employees who will reflect the country’s rapidly shifting demographics. Hire on potential — not just experience. Buyers will expect no less.

3. Keep Tabs on Your Clients’ Birthdays

Since acquirers are buying future performance, it stands to reason they’re more interested in younger clients than older ones. The older your clients are, the less value they have. If more than a third of your clients are over 65, that can be a major red flag for buyers.

That makes bringing in younger clients imperative. You may have to spend more on target marketing and updating your website and your client portal, but it’s well worth it.

Boomer clients and older, especially those with substantial assets, shouldn’t be ignored, of course. Buyers also look at client retention and fee generation, so you want to have best practices in place for optimal client experience and satisfaction. Set up a system to have aggregate client data organized and ready to deliver to potential buyers.

4. Make Sure You’re on Top of Your Tech Stack

In the digital age, you can’t afford to become a tech laggard. If you have a small or midsize firm, you won’t be expected to have all the latest bells and whistles, but you should be thinking about your tech stack as a mean of differentiation.

If you’re catering to younger, tech-savvy clients, your client portal should be state of the art. If you’re targeting high- and ultra-high-net-worth clients and want to give them a white glove experience, you should have a top-notch CRM. If you specialize in alternative assets, make sure your portfolio management software is best in class.

And don’t neglect traditional tech offerings such as performance reporting and financial planning software. The former is the engine that’s driving your car: It has to be up-to-date and reliable. The latter is essential for holistic planning efforts and represents an indispensable tool for clients ranging from mass affluent to UHNW. Don’t fall behind.

5. Do Too Few Clients Have Too Many Assets?

It’s great to have a lot of high-net-worth clients but make sure they don’t represent too much of your book of business. Beware: Asset concentration is high on a buyer’s checklist. A standard firm valuation will assess the top 10% of your book and the portion of assets controlled by those clients. A top-heavy book represents a big risk because prospective buyers will take a hit if a few of those clients leave. Buyers don’t like concentration risk — a handful of clients controlling a disproportionate amount of revenue.

Ideally, the top 10% of households you serve shouldn’t be responsible for half or more of your total assets. If the AUM is highly concentrated in a small group, prospective buyers may balk. The ratio of revenue from the top 10% of clients, ranked by number of households, compared to the total revenue of the practice, is another key valuation metric. If the concentration is too high, market value dips.

Firms looking to sell should spend more on business development efforts in order to diversify their client roster and add more clients with accounts that match the upper quartile of their book.

Of course, so much more goes into achieving the best valuation for your firm, but these are a few of my “must do’s.”