(Dynasty Financial Partners) The market value of RIAs is through the roof these days, with earnings before interest, taxes, depreciation, and amortization—EBITDA—producing margins of 20% or more.
In part, this reflects the fact that independent advisors manage three times more in end-client assets than they did just a decade ago. But there’s more to reckoning the value of an RIA than assessing its current cash flow; especially in a market where benchmarking to publicly traded companies is at best approximate, other facets of an RIA’s value take on greater importance.
Accurate internal underwriting. A 2020 Fidelity Investments study found that of nearly 150 RIAs sold in the 18 months through mid-2019, sellers went in expecting EBITDA multiples of eight to 10, while the actual deals garnered a median EBITDA multiple of seven. Notably, the real-world result was up from five times EBITDA for completed deals a few years earlier. Still, the rift between sellers’ expectations and actual results is sobering. The picture gets murkier when you realize the price tags on publicized RIA transactions often hinge on reaching specific growth targets, which aren’t always achieved.
But it’s worth remembering that the sell-side disconnect Fidelity underlines occurred among RIAs that actually completed M&A transactions. In other words, even the most attractive and best prepared RIAs went into sale negotiations with different outcomes in view than their suitors. Crucially, accurate internal valuations bring sell- and buy-side expectations in line. The parties spend less time bridging gaps in price assumptions, leading to more successful outcomes.
Don’t wait to valuate. Besides buy- and sell-side considerations, having an accurate and credible valuation of your firm is crucial for RIAs in search of capital from outside lenders or investors and as a means for assigning equity in the firm to internal players—perhaps as part of a succession plan. In short, having an accurate valuation of your own before it’s absolutely required is a bedrock element of good governance. In addition, opportunities around M&A and raising capital can emerge unexpectedly. If your RIA isn’t armed with an accurate valuation and prepared to take action, these opportunities can disappear just as quickly.
Keep in mind that independent RIAs also lack an underwriting shortcut available to other businesses because they lack publicly traded analogies. Besides one strategic investor in RIAs, Focus Financial Partners, the closest some large RIAs come to publicly traded firms is to investment-platform providers like Envestnet and Assetmark. But these are vendors to the wealth management space, not client-facing wealth managers in their own right.
With all these factors in mind, we offer what we believe to be five core metrics for RIA owners seeking a business valuation. Our goal is to present a new and simpler standard that allows for accurate underwriting of the financial risks associated with an SEC-registered firm.
- Revenue Growth Potential. Earlier, we alluded to current cash flow. Here, the emphasis is on growth potential and future cash flows, with organic growth valued at a premium over growth by acquisition because organic growth speaks to performance that is less likely to be impacted by market conditions. Sample metrics for this part of an RIA’s valuation include three-year compound annual growth rate and the latest 12 months’ net new flows as a percentage of AUM at the start of the period.
- Percentage of Revenue That’s Annuitized. This refers to recurring revenue as a percentage of total revenue. Recurring revenue sources, such as fee-based advice, have a premium over commission-based fees because they’re more likely to recur, making them more predictable.
- Size/Scale. In the context of RIAs, this refers to total assets under management. The concept is comparatively straightforward: Larger firms command higher valuations because AUM is considered a strong proxy for revenue diversification and a lower operational risk profile.
- Concentration Risks. A diversified and stable client base implies a lower risk of revenue erosion. Sample metrics considered here include percentage of revenue derived from a firm’s top 15 clients (the lower the better) and the average age of its client base (again, the lower the better).
- Operational Efficiencies. Stable operations and strong margins lower the risk to future cash flows. Sample metrics under consideration in this area include: gross margin percentage (how much a firm makes in gross sales minus how much it costs an RIA to sell products and services); the number of advisors at a firm (which speaks to succession potential); the extent to which the firm deploys technology and/or outsources its operations; and its compliance track record.
While these are the essential elements of a thorough RIA valuation, the actual use case typically informs the real-world approaches and which elements take precedence. That said, there is no such thing as an easy approach to underwriting. While the complexity and the duration of the process will vary, it’s always going to be a deep dive—which is good because the deeper the dive you take in a bid to understand your RIA’s value, the better you can position yourself for success.
Harris Baltch is head of M&A and Capital Strategies at Dynasty Financial Partners. Prior to joining Dynasty, he spent nearly a decade at UBS Investment Bank where he was an executive director in the firm’s Financial Institutions Group.
