Advisor Legacy: What Buyers and Sellers Need To Know About Practice Sales Multiples

Successions and acquisitions activity in the financial advisor space has increased dramatically over the last five years. The initial surge was fueled in part by an aging advisor population and by strong practice valuations on the seller side, and a desire to grow exponentially on the buyer side. As the market for practice sales grew, so did speculation and wild claims of excessive multiples and high dollar transactions. Although these claims are either exaggerated or based on rare outliers, they have garnered a great deal of attention in the media and market. This has led to many sellers entering into negotiations with unrealistic expectations and buyers struggling to make deals.

Multiples Are Misunderstood And Misused

In their simplest terms, multiples represent the sale price in relation to total gross trailing 12-month (T-12) revenue or GDC. It is not a means of valuing a practice, only a means of communicating the potential or actual sale price based on revenue. It also ignores critical qualitative data that convey the attributes of the client base and the efficiency of the practice.

Another misuse occurs because reports from one source or one deal on multiples are often misunderstood as an industry wide standard. However, each of the M&A firms are only able to provide data for their respective market segments and deals. There is not a unified data gathering body that represents the entire advisory market. Exaggerated and unsubstantiated reports are often widely publicized and shared. These exaggerated reports appeal to sellers looking to maximize their sale price and lead to a skewed reality when entering discussions with a buyer.
Cash Flow Trumps Multiples

Our data, which is comprised of 3 years of actual transactions and practice valuations, clearly demonstrates that the main driver of determining the true value and ultimate sales price of a practice lies in cash flow. First, cash flow demonstrates whether the investment made by the buyer provides the proper return relative to risk and opportunity cost. Second, it determines whether a deal can be financed and the debt obligation adequately cash flowed.

Cash flow is demonstrated through an earnings model or pro forma that includes practice revenue with an annual growth rate assumption, operating expenses with an annual growth rate assumption, and the debt service for the acquisition. Net revenue after practice operating expenses and debt service should exceed a hurdle rate for a buyer to purchase. This hurdle rate, or minimum acceptable rate of return (MARR), is the target return on investment the buyer expects to receive.

What The Data Tells Us Is Really Happening

Our team leveraged our database to compile a detailed report of actual sales and valuation data for the past three years. We then used 36 different earnings models to determine the likelihood of multiples of 3x passing the cash flow and hurdle rate tests. What we discovered is that cash flow scenarios that garner 3.5x and higher are difficult to achieve and rare. Instead, most deals fall in the 2x-3.5x range. We also discovered that practices sold on the open market with the assistance of a Succession Consultant garner a 20% to 40% higher sale price than those on the closed market. All deals, whether open or closed, also have a higher rate of completion and smoother transitions than deals advisors do on their own. This means that buyers and sellers should leverage third party support and base negotiations on an objective practice valuation and cash flow model to achieve a successful deal.