How to Value A Financial Advisor's Book of Business

When speaking with independent financial advisors, I'm often asked “what is my business worth and how can I make it MORE valuable?” There are many ways to value a business, Google, an old university/college textbook or your local public library are all great resources to learn more about this topic. 

There are several reliable ways to value a business. The most common are based on Price to Earnings Ratio, Multiples to EBITDA (earnings before income tax, depreciation and amortization), Discounted Cash Flow of future earnings (using an appropriate risk-adjusted discount rate) or using market comparables. 

The Valuation Conundrum

The issue with most valuation methods is that no single approach is 100% correct. Many involve making assumptions that can each impact many “sensitive" variables. In my simple world, the value of any business or transaction for that matter is what a seller and buyer agree is a fair price. To reach an agreement on a fair price, both parties need to see value in the deal. 

In the wealth management business, the most understood, predictable and reliable variable for an advisor is income earned through “trailer fees, fees for service, renewal commissions and referral fees.” For simplicity, lets refer to these as “recurring revenues”. 

The Art versus Science Valuation Methodology

Now that we have a common view of revenue, we can apply a “multiples” approach to determine a fair price that makes sense for both parties.

This is where the concept of “art and science” comes into play. Let’s first look at the science (math, in fact). In this realm, we’re interested in identifying the key factors that will impact recurring revenues, and hence, the value of the book of business. I will address five of these variables here, but you could easily apply many others when valuing a book.

Science and the Quantitative Analysis

1) The average age of the clients: the younger the average age, the greater the predictability of your future recurring revenues.

2) The average asset size of the clients: the larger the average asset size of the clients in a book, the more lucrative the client base.

3) The depletion rate of the book of business: this is the percentage of assets that are in a payout mode (i.e. RIFs/LIFs). The lower the percentage the better the stability of the book and its recurring revenues.

4) The extent to which the book earns “fee-based” versus “commission-based” income: a fee-based book of business has greater predictability for recurring revenue compared to the unreliability inherent with so-called “lumpy” commissions.

5) The average number of investments per client: this is a good measure of the quality of an advisor’s portfolio management services. Does the advisor have hundreds of product offerings on their shelf or a smaller selection that targets the specific goals-based investment objectives of their clients? A lower value indicates a very disciplined approach to managing a client’s investments.

In reviewing these five criteria, you might now decide to take a weighted average score for each variable (e.g. a variable with a low score gets X points, a medium score gets Y points and a high score gets Z points). Here’s a helpful example on how to calculate a weighted average.

Then all you have to do is add up these points. It will give you a “score” that’s aligned with your business objectives. This total will also give you what I refer to as the “top-end” of the range of valuations. The “low-end” is simply a percentage of the top-end value (like 75%).

Qualitative Analysis: The Art of it All

Before we can determine an exact price for the book of business, we need to first look at the qualitative variables that can influence the valuation. So let’s take a look at the “Art” side of this equation, or what I refer to as the qualitative components of a great business. Others refer to this as due diligence. While there are many qualitative factors to consider, here is a list of some to consider:

1) Does the business have a systematic and well-documented client experience process?

2) Does the business have a strong, knowledgeable team with defined roles and responsibilities?

3) The practice is run as a professional office. It’s a proper business that’s not out of the advisor’s basement or from a coffee shop. Like any lawyer or accountant, clients have scheduled appointments and are met in a professional setting.

4) Does the business have a proven track record of using technology solutions for its business processes and client service capabilities?

5) Does the business create and maintain up-to-date financial plans for its clients?

6) How effectively has the business documented and maintained meeting notes and records for all client meetings?

7) How strong is its compliance audit history? 

Putting a Price to your Valuation of the Book

Now that we have a fairly robust view of both the quantitative and qualitative components needed to evaluate a book of business, you can proceed to calculate an actual price for what this book would be worth. This will involve using the recurring revenues from the book as the basis for this calculation, which we noted earlier.

To come up with the purchase price for the book, you will need to apply a multiple to the recurring revenue figure. Multiples ranging from 1.5x to 3.5x are usually the norm in this scenario. The resulting output would give you the “Valuation Range” for the book of business – the high and low price for what the book is worth as a dollar value.

So how do you come up with the specific multiple to use for a given scenario? Since the multiple is really a scale from 1.5x-3.5x, you would use the quantitative and qualitative factors you evaluated earlier to select the specific multiple you feel most accurately reflects the value of this book of business.   

Hence, a very attractive book that received high quantitative and qualitative scores would very likely get paid closer to the multiple of 3.5x. Conversely, a book that scored low on both components would receive a multiple towards the bottom of the scale (1.5x). It’s important to note that market conditions and other related factors could also impact your selection of the multiple.

By applying this simple yet reliable approach that combines the art and science of evaluating a business, you will have a system that can inform and benefit both the seller and buyer in a transaction – one that can provide a clearer picture of the actual value of a business.  

Making the decision to buy or sell your business is never an easy or simple one, and it often involves taking into consideration a multitude of factors. Feel free to reach out to us if you’d like some guidance or advice on how best to approach valuating a book.