34 INVESTMENT ADVISOR OCTOBER 2019 | ThinkAdvisor.com
firm to top-performing advisory businesses of comparable size.
In our example, the father will receive
$2 million from his two successors each
year, assuming the fees from the clients
he transferred remained constant. This
would leave $2 million to cover their
compensation, pay the overhead and
generate a profit. With the estimated
overhead expense at $1.4 million, this
leaves only $600,000 pre-tax to split
between the two buyers.
Again, assuming the fees and the payout remain constant, this would
put the valuation of the $4 million practice at $40 million ($2
million x 20 years). Put another
way, the math translates the sale
price into a 33x price-to-earnings ratio; or a 3% required rate
of return. At this valuation, the
required rate of return is just a
smidge over a 20-year Treasury
yield, which is on the opposite
end of the risk spectrum.
As a counterbalance, I asked
Dan Sievert of Echelon Capital
Partners, a specialist in advisory
firm M&A, how this might be valued on
a Discounted Cash Flow (DCF) basis.
Using a sensitivity model to evaluate
various scenarios of revenue and discount rates, he said a 16% discount rate
would be within the realm of reason,
though he too did not have details on the
firm involved. Applied to the cash flow
paid out to the seller, this would put the
valuation at somewhere between $9.6
and $12.8 million, depending on whether the cash flow grew or remained flat.
Normally when doing a valuation,
professionals consider three core elements: cash flow or earnings, earnings
growth and risk (or uncertainty). In this
circumstance, the earnings are impaired
by the obligation to distribute half the
fees to the founder and the growth prospects are impaired by the average age
of the clients, many of whom will be
entering the de-accumulation phase if
not already there. The lack of physical
capacity to serve more clients also will
impair the capacity to grow.
This deal structure may have been
designed to make it cash-flow affordable for the buyers, but it does not make
Many advisory firm founders face the
same dilemmas: How do I ensure my
clients are tended to when I am no longer
willing and able? How do I transition my
clients and my business on terms that are
affordable? How do I extract value from a
business I built over many decades?
The first question is a non-negotia-ble. When clients come to rely on you
through many of life’s critical choices,
you must assign someone in the firm to
take over these relationships or refer
them to a trusted advisor who is likely to
outlive them. While this is not a regulatory responsibility, it feels like a moral duty.
The question of “affordable terms”
includes consideration of a fair price
and manageable terms. The West Coast
example feels like the old lay-away plans
or a big-ticket sales promotion where
you drive away your new SUV for no
cash down and zero to pay for the next
12 months. As an advisor, how many
times have you had to explain to clients
that nothing is free? You know as well as
I do that making something cash-flow
affordable does not necessarily make it a
wise or prudent purchase. Terms rarely
make it less expensive.
Selling a practice with an aging client
base is much like selling a depreciating
asset. I was always told not to borrow
to buy something that was declining
in value, but rather to use leverage for
something that is increasing in value.
In some ways, the transaction resem-
bles a viatical settlement. In a similar
vein, you no longer have a need for the
expensive insurance policy/firm own-
ership — your children are grown, you
have medical bills to cover, you want
to fund your retirement, the business is
not fulfilling anymore. Much like insur-
ance, you could let it lapse or you could
take a cash payout and relieve yourself
of the burden. And then hope for
For the recent West Coast buyers, twenty years is a long time to
be giving up half of their earnings. Put another way, they are
working until July before they
earn any income. Every year.
For 20 years. At what point does
resentment take over? Or a desire
to re-do the deal?
A good guide for buyers is that
if the cash flow can support the
purchase price over a reasonable
period of time (say five years),
then the purchase price is within the
realm of reason. If it takes as long as 20
years to fund the purchase of a depreciating asset, the deal may not make sense.
A more practical option for the deal
in question would have been to assign a
fair valuation to the practice, then work
out the terms from there. A combination
of bank financing and seller financing,
maybe with some type of discounted
payment of the first tranche (typically
15–40%) would achieve the same goal in
terms of ensuring the clients are tended
to and the business is acquired for a
reasonable price. It would not, however,
ensure such a high income stream to
the seller, which seems to have been the
goal of this deal.
Mark Tibergien is CEO of BNY Mellon’s
Pershing Advisor Solutions. Tibergien is also
the author most recently of “The Enduring
Advisory Firm,” written with Kim Dellarocca
of BNY Mellon and published by Wiley. He
can be reached at firstname.lastname@example.org.
A guide for buyers is that if
the cash flow can support
the purchase price over a
reasonable period of time
(say five years), then the
purchase price is within
the realm of reason.