Life
isn’t fair.
Advisers
spend years of their lives building a business and then when they are ready to
retire; all that hard work does not transfer into a nice capital sum. But that
has continually been the weakness of owning a professional business; it has
always been a good way of earning an income but how does the adviser create an
end game when the clients depend on individual advisers and their personal
service?
Real
capital returns always go to those businesses big enough to have a resilient
profit based on serving a wide range of clients over a wide range of advice
areas with a significant number of advisers. Sadly due to regulatory and other
pressures many IFAs have retreated in ever smaller niches. This makes it even
more difficult to find a purchaser proffering a good price.
That’s
not just my view, corporate investors see the sector as “small, personality dependent, undercapitalised, with poor
productivity, poor systems and poor marketing”. It is a revealing and
accurate assessment. IFA practices are not very productive places. Few market
themselves well, if at all. Systems are poorly exploited and the amount of time
an adviser spends on his key task of advising clients is usually less than 20%
of the time expended.
Much
of this can be put down to size which demands that every significant task falls
on the principals of the business. If an IFA wants to extract real value he
needs to demonstrate that his practice bucks these trends but it is not easy
without access to corporate capital and management know how.
For
the sake of establishing some figures, let me introduce you to my sample IFA
firm. 6 advisers turning over £1,000,000 of which £120,000 comes from renewal
income. Gross Profit of £300,000 netting £125,000
If
its principals wanted to retire now; the only establishable value in the
practice is the renewal commission. A commission warehouse would take this
regular income and either share it with the retiring adviser typically 66/33% or
capitalise the adviser’s share of the income typically at 3 times the shared
figure. So the principals would get £240,000 or share of a perpetual pension of
say £60,000 less surrenders and absconders.
This
sounds OK but you get nothing for the goodwill of the business and have no
guarantees that the clients, many of whom will become long term friends, will be
properly serviced or will be able to receive ongoing advice. Typically warehouse
owners will cherry pick the odd high production client but will not have a
strategy for the majority of the clients. A retiring adviser is also likely to
miss out on any ongoing income from acting as an introducer to the business. The
warehouse only buys the agencies and the database. Any future claims for poor
advice will impact on the retired principals.
Alternatively
more shrewd principals may have been bringing on the next generation within the
practice but there is no guarantee that when they are ready to hang up their
boots this team will be willing to fund the pay off or pay anything like the
value the business might attract.
Let
us presume 3 out of our 6 adviser team want to retire. This presents us with the
pivot point. If you were one of the 3 ongoing directors what would you offer for
the £125,000 profit - a multiple of 3 times? £375,000 split three ways which
gives you £125,000 on your mortgage? Hardly a fortune for the retiring
directors but a bit better than the renewal commission route and issues such as
continued servicing and claims should be accommodated.
Home
grown succession plans require ongoing directors to fund the buyout. Their
resources will always be small and the whole plan can be easily compromised. To
obtain a real payout the retiring directors must sell their business to someone
with real money and that takes us into the corporate world and eventually the
stock market.
For
consolidators with access to corporate funds there is a nice arbitrage between
what practice owners will accept for the profit they generate and what value the
market places on that combined profit. Typically
a multiple of around 4 times profit and a market valuation around 8 times.
Remember
the market criticism; “small,
personality dependent, undercapitalised, with poor productivity, poor systems
and poor marketing”. The real way forward is to join a disciplined
consolidator who has a very clear idea what they are trying to create in terms
of the overall shape of the business, it’s marketing, systems and economies of
scale and then wants to find acquisitions that fit that model.
This
disciplined approach not only benefits the consolidator but also the principals
of the acquired business as they will be offered incentives based on the value
that the market places on the parent’s shares. This may be in actual shares or
in the case of a private business a process that mirrors that type of growth.
The
game plan is for principals to take an interim value for the existing business
around our baseline figure of £500,000 and then plug into the wider resources
of the parent for 5 to 6 years to create a larger business that can demonstrate
far higher profit levels from sales and economies of scale. These will then be
valued by the market at least twice the multiple than undisciplined approach.
This
team approach can really produce dividends. I have been studying such operations
in the United States and typically profits increase by 25% pa compound creating
3 times the profit in a 6 year timeframe. I would expect the UK market to easily
match this performance.
In
our sample business the profit would grow from £125,000 to £380,000. That
would value the business using the 4 times baseline at £1.52m or a net £1.02m
after the original purchase sum; three times the best previous outcome.
But
the Group would be valued at its market multiple which should be in the late
teens and if we presume that principals have taken their incentive scheme partly
in shares those shares would be worth 4 times this baseline valuation. As part
of the group our model company is now worth £6m.
The
biggest issue is the relationship between the acquired and the parent. Too much
interference and the parent becomes another distraction from advising clients.
Too little support and the acquired will not be able to make the growth
expected.
This
strategy is not for everybody. Some advisers will value their independence so
highly that they will not join anything. Wiser heads may see their existing
businesses as a stepping stone to creating a far greater value.
In
the end the numbers are peripheral. The wisest consolidator will invest in the
people; their existing businesses are just an asset.
Garry
Heath CEO Inspiring Financial Planners
garry@financialinspirations.co.uk