The Methodology Behind a Financial Advisor Practice Valuation Calculator

How much are you worth? It’s a question advisors spend every day discussing with their clients, often without considering that question for their own firm. That’s where a valuation comes in.

The most common reason advisors seek a valuation is to prepare for a sale or merger of their business. There are other motivations to proactively pursue a valuation, such as granting internal equity to next-generation advisors or a business partner.

Yet you don’t have to be making a big change to benefit from a valuation. In fact, one of the best purposes for a valuation is simply to get into the habit of benchmarking your business. By tracking key metrics on an ongoing basis, you can set goals and measure your progress – for example, aiming to reach a certain percentage increase in net new assets year over year.

Carson’s Firm Valuation Calculator is a useful tool to delve deeper into your business, obtain an initial estimate of your market worth and more keenly understand your opportunities for growth. But what’s the methodology behind a financial advisor practice valuation calculator?

Let’s look at the various metrics that comprise a valuation and what they can tell you about the health of your business.

Six KPIs That Can Help You Evaluate Your Business

Carson’s Firm Valuation Calculator consists of six quick questions designed to give you a clearer picture of your firm’s market value. Here are the factors it explores, along with a brief summary of the insight each metric offers.

1. What assets under management (AUM) does the firm represent?

For this metric, it’s important to note Carson’s Firm Valuation Calculator specifies AUM, rather than assets under administration (AUA). That’s because AUM is a better indicator of recurring revenue as the amount you’re actively managing on an ongoing basis.

There’s no question that offering comprehensive financial management requires a holistic view of a client’s entire financial picture, which is the argument for AUA. However, including those assets that are outside your purview, such as commission-based and 401(k) investments, provides an inflated estimate that may not accurately reflect the reality of your firm’s revenue.

Since there is often confusion between AUM and AUA, it’s vital to distinguish between the two to make the data as accurate as possible.

2. What percentage of the AUM is advisory business?

This metric helps an outsider evaluate where your revenue and profit are derived from, giving preference to the recurring revenue that comes from fee-based advisory services. A potential suitor will also assess whether your accounts are primarily in growth mode or distribution mode, where clients are drawing down on retirement savings.

3. What is the gross revenue of the firm?

While this seems like a straightforward metric, annual revenue is not the sole factor determining your profitability. Although valuations used to be considered as a straight multiple of revenue, that methodology is now largely outdated. Today’s buyers have become more sophisticated as increased data availability allows valuations to be more accurate. Profit alone can offer a top-line look, but the devil lies in the granular detail. The goal is to buy for the future, not just today.

One metric to consider is earnings before interest, taxes, depreciation and amortization (EBITDA), a common measure of profitability that gives a snapshot of a company’s cash flow. However, there are factors that can throw that off.

For example, consider a firm that has recently been on a hiring spree to bolster the team with top talent. Due to those ancillary expenses, the EBITDA might not look as favorable at a glance, yet when examining the particulars more closely, they might discover a business with strong AUM and good revenue that has wisely staffed up for its next stage of growth. So maybe they have $200 million in AUM and, with this expanded team, they’ve built the infrastructure to support $400 million.

If Carson were making this valuation, we wouldn’t punish the business for what might appear to be temporarily relatively low profitability because we see the benefit: The buyer is unlikely to need to invest time and financial resources to source a deep pool of talent.

On the other hand, if we see that higher-than-usual expenses can be traced to an elite advisor and one operations team member, we might question how quickly that firm will be able to grow, or the repercussions if that advisor were to defect.

The point: The character of expenses is what drives the multiple, and low profitability doesn’t automatically equal a low valuation.

4. How many clients does the team serve?

Again, this is going to be a metric that will take some context. The number of households served can be a great indicator of growth and potentially serve as a powerful vehicle for future referrals. Yet it doesn’t tell the whole story.

Let’s say a firm has $200 million AUM, but the average account size is $100,000. That’s a lot of clients who probably require a considerable amount of service. It can be difficult to achieve economies of scale without larger clients, given that smaller account sizes often indicate clients who need more education. On the flip side, an advisory firm that serves just a few large clients could be at risk if these clients (or their beneficiaries) depart.

5. How many employees are on your team?

This metric helps determine the productivity of each team member, which ultimately has an important effect on profitability. As mentioned before, firms that have staffed up for future growth can be appealing to a prospective buyer, especially if they are actively acquiring new AUM.

6. What is your ownership percentage?

The more of the business you personally own, the larger your ultimate payout. Often, a buyer may prefer a firm where one owner isn’t dominant. That could foretell client defections if their prominence was the reason for the firm’s success.

What the Calculator Doesn’t Tell You

At first glance, arriving at a valuation seems like an easy exercise – just plug in these six metrics, and voila, an answer. Yet, once you look deeper, it’s easy to see how subjective it is and the high level of nuance in otherwise straightforward numbers.

While the valuation calculator offers a fine 30,000-foot view, you need a more granular perspective to pinpoint an accurate valuation. That’s Carson’s specialty.

We realize that much of a firm’s value is derived from the goodwill it has built with clients. This is why we want to spend time immersing ourselves in the details of your practice and how you run it. Then we can determine the story behind your profitability and whether you are poised for future growth.

How engaged are you with your next-gen clients? Have you increased your marketing budget to attract net new assets? These are the types of expenses that a smart buyer will appreciate, as they can be applied toward future growth.

Certainly, every advisor wants to see the most value they can, so it’s vital to consider how valuations are derived. It’s a bit like how comparison figures are used in real estate to help value a home.

Everything about two houses might look equal – a similar size and layout – but one might be priced higher because it was far better maintained, with lavish upgrades. That’s why advisors might hear of a firm being valued on a huge multiple and be puzzled when their firm doesn’t garner the same.

There’s no question valuations are complex, and since each situation is unique, now is the time to burnish the KPIs that matter. Consulting Carson’s Firm Valuation Calculator can be a crucial benchmarking exercise that allows you to set goals for the upcoming year. You can then prioritize the elements that will ideally drive higher enterprise worth down the road.

Are you ready to talk to Carson about how to fine-tune your advisory business to prepare for growth? Contact us today to learn more.

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