Selling Your RIA: Valuation and Hidden Value

February 16, 2022 | Selling Your RIA

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Selling Your RIA – Part 4: Valuation and Hidden Value

With the year after year record number of transactions involving the sale of Registered Investment Advisors (“RIA”) and the continuing consolidation of the industry, we continue our series “Selling Your RIA” with a look at the importance of valuation and what we call “Hidden Value”.  Hidden Value is “beyond the EBITDA and multiple” and is that value you have created, and a buyer can realize exponentially as they consider the combined firm post acquisition.

The Industry

RIA’s are a hot commodity and in great demand. With approximately 165 RIA M&A transactions through the third quarter 2021, nine months of 2021 has already surpassed 2020’s 159 transactions and the RIA M&A activity (by # of transactions) has increased in each of the last eight years (Devoe & Company).

Not only has the number of transactions increased in recent years but the makeup of the buyers has changed.  No longer is it the big wire houses acquiring the RIA “book” or transactions simply the mergers of RIAs to “bolt-on” additional business, what we now have are firms that are “Active Acquirers”, with sufficient deal capital, quality client service offerings, modern infrastructure, efficient operations, tested integration plans and yes attractive valuations to help attract and close deals with sellers. These firms are in the business (or it’s a large part of their business) of acquiring RIAs. These Active Acquirers are both public and private companies and are efficiently built to acquire RIAs and merge their practices so that the client and advisors are comfortable with the transaction and new combined firm.  The Active Acquirer does multiple transactions a year, have a M&A and transition team in place to guide the entire process from identifying target firms, preliminary offer, due diligence, negotiations, final offer, closing, and facilitate the integration of clients, personnel, compliance, operations, finance, and all aspects of the transition.

These Active Acquirers are built to move through and execute these transactions, but are you?

One of the key points in the sales process that we identified in Part 1 of this series was Valuation and Hidden Value, we will explore these key areas a little deeper below.

Valuation and Hidden Value

We have all heard about valuation as a multiple of EBITDA and we have recently seen ranges reported as wide as 8x-18x (even 20x!)  EBITDA? Being on the low end of the range can cost you significant value in a transaction.  But why is there a range?  Why do some companies get the higher end of the range while others the lower end?

Valuation

Perhaps the most important thing in your preparation, before going to the market, is to understand not only the appropriate valuation range of your business but the value that will meet the expectation and acceptance of the business owners.  The market will dictate much of the valuation but as stated above there is a wide range that may be offered for your firm and most likely a narrow range that is acceptable to you.  While many factors can determine the value (see below) the three broad areas of determining value are 1) Growth 2) Profit and 3) Risk.  A buyer will spend much of its due diligence reviewing your financials, historical growth, client demographics, fee schedules, margins, fixed vs. variable cost, revenue concentration, investment performance/philosophy, compliance program, marketing plan, technology, and operations etc. to model and assess your growth, profitability, and risk.  The buyer will not only look at these items (and more) over recent history, but they will model and proforma your business, projecting into the future and more importantly using an integration of your business onto their combined firm which will benefit from scale, economies, operation/technology efficiencies, overall growth strategy and other benefits of the buyer’s business model.  Be prepared by understanding your income statement and the drivers of revenue and expenses, as well as making integration assumptions based on your meetings with the buyer to support your valuation position.   Support for your historic growth and execution of prior growth plans along with mitigating risk such as advisors/client turnover, legal or regulatory matters will support your valuation “ask” as you negotiate.  Hidden Value are those items deeper in the numbers or perhaps non-financial elements of your business that the buyer hopes to find in due diligence or in combination with the larger firm, you should prepare by identifying those items in your own firm which the buyer will most likely value.

Hidden Value

Where will a buyer find your “Hidden Value”, or more importantly will you find it first and be able to present it and “sell it” so that you realize the value you have created. Above we mentioned growth, profit and risk as the key elements that impact value.  A buyer will have those elements in mind not only when they simply apply a multiple to your EBITDA, but as they review all areas of your business.  The buyer will review your firm through the lens of a new combined firm, growth and profitability will not only be of your firm but that of the combined firm.  For example, do you have an investment platform, industry expertise, financial planning model, or an operation efficiency that they could incorporate, scale, and use or cross sell across the larger firm.  Expanding services, operations or intellectual knowledge across the company can have an immediate and exponential impact on both growth and profitability.  Does your investment philosophy, compliance program, client reporting, etc. bring additional risk that needs to be mitigated or do they bring “better practices” that will reduce risk across the firm?  Understanding not only the value of your offering but how it “stacks up” inside the combined firm is important to the seller to gain some edge in the valuation negotiations.

Hidden Value, some areas to look include:

  • Profitability and Revenue – Not only a review of the P&L but an analysis of the historical growth as it relates to your strategic plan, the industry, and the financial markets. How has the revenue and profits changed over the years? How are client fees determined? How do you compare with the buyer and industry?  What are the drivers of revenue, how do we expect this to change based on the markets or an acquisition? How are your cost expected to change based on growth, the market, or an acquisition (see EBITDA and Scalability)?
  • Growth– How has the firm grown and why? Is growth organic to the firm, its people and business development or from some other factor (acquisition, new hire, retirement of key advisor, etc.)? What are the drivers of the growth or setbacks, how does it compare to the industry and financial markets? What is the long- and short-term projected growth and the assumptions for those projections? How will the projection change based on the buyer’s business model, infrastructure, and business development?
  • EBITDA– Review EBITDA and determine any non-recurring cost, run-rate, or current EBITDA and a proforma of EBITDA considering scale with a buyer. The buyer will be looking at EBITDA differently than you do, they will not only look at your current or historical EBITDA but what it will be once integrated with the acquiring firm letting economies of scale, and the buyer’s business model “take hold”.  The seller’s due diligence on the buyer is key here, so sellers can proforma the EBITDA post acquisition.
  • AUM– How have the assets under management changed over time? What are the reasons for the change in AUM? How does it compare to your peers and the market? How does your AUM growth compare to the organic (non-acquisition) growth of the buyer? What are the net flows vs. the industry?
  • Expertise – What is it that makes your firm special? What value is there in your services, advisors, or other offerings? Does the buyer have a need for your expertise?
  • Clients and Advisors– How does your client makeup stack up against your peers, potential buyers and others looking to sell? How diversified is your client base? How long have the clients been with you? Who are the key advisors and what is the number of clients, revenue, and AUM under their relationship?  Is there a special niche or industry in your client base? Is this a niche the buyer hopes to enter? Are your clients open to a transaction that will add infrastructure and stability? What is the likely client retention rate to be presented to the buyer?
  • People– Review of professionals and staffing? How many layers are there to the organization? What is the “cost” to service a client? What is your expertise?  Is your expertise, services and advisors properly priced vs. your peers? What education, licenses and specialties does your professionals possess, are they needed by the buyer to service existing accounts? What roles or departments are redundant to those of the buyer?
  • Compliance– Have you been examined by the SEC? Has a third party reviewed your compliance manual procedures and testing? What risk have been identified and how have they been mitigated? A strong compliance program adds value to your firm and the buyer.
  • Investment Platform– What has been the performance of your platform? What’s your investment approval process and supporting files for the due diligence and research of your investment offering? Do you have a special investment niche, any favored nation agreements, or access to investment managers that the buyer would be interested in?
  • Infrastructure– How do you report to your clients? How are bills prepared and fees collected? How does your office space, operations and technology compare in quality and cost to others?
  • Scalability– A buyer will look at the infrastructure, real estate, processes, technology, vendor contracts, software licenses etc. of your business and determine how it will scale and offer economies to their existing model.
  • Deal Terms– Deal terms can have a major impact on value, the terms must be compared to your goals and your risk tolerance. Such decisions as 100% vs. partial sale, cash vs. equity, installment sales, client retention bonus, earnout targets, equity vesting, compensation or staffing adjustments, etc. can affect the sales price.  Sellers should evaluate the deal terms and valuation vs. the risk to realize it and their future obligations.

Sellers should be prepared to properly present their business, and Hidden Value, to highlight and enhance the quality of what you are offering and the value of what you are selling.  If the sellers have an edge over the buyer in any category or an understanding of the proforma post acquisition EBITDA, growth plan and “cross sell” of the business they are selling they will be able to use this value (being looked at by the buyer) to negotiate and increase valuation.

Prepare Now

Prepare now, while the market is hot.  RIA owners should start review their financials and their business vs. the industry.  Have a good understanding of your valuation range and the acceptable valuation for your owners is a key pre-sale step to selling your RIA. Knowing where a potential buyer will find valuation and Hidden Value will give you an advantage in negotiations.  Sellers should review the items above with their deal team and work toward a presentation to highlight and sell their business and Hidden Value to potential buyers.

Please see our related blog post

Selling Your RIA
Part 1: Sales Process and Pre-Sale Planning
Part 2: Building your Deal Team
Part 3: Due Diligence and Reciprocal Due Diligence

Simply stated, how long will demand last?

Help is Available

We know you are busy advising clients, running and growing a business, if we can help be a seat at your table, roll up our sleeves and work with your management and staff to presale prepare please contact Four Leaf Business Consulting, see https://fourleafbc.com/  “We will help you consider, prepare and analyze the sale of your business, working with and for you while you concentrate your efforts on servicing your clients.”