Is Your Practice Big Enough?

"If someone takes success for granted and no steps whatsoever to ensure the continuity of the business, yes, 10 years down the road they may find themselves sitting on top of a book of business that is worth nothing. But we can take action," Palaveev adds. "We don't have to be the recipients of fate."

And when talking about the "value" of a firm, he says it is important to first consider "value to whom" and "value under what circumstances."

"Surveys tell us that the income of financial advisors is higher than it's ever been. As long as the income of a business is high, the value of a business is high, assuming that income is sustainable. If you have an asset generating high income, even if it is finite in its life, it is still a valuable asset," notes Palaveev. "If you have a business that's going to pay you $1 million a year for the next 10 years, and then it is going to die, is that a bad business? I think not."

Valuing Assets

For the past six years, valuation expert David Grau Sr. has watched one figure hold steady: 8–12% of advisory firms, no matter the size, will sell to an acquirer.

Even more interesting, the remainder of those practices below $1 million in value will wind down through attrition. "It's unfortunate for them and for their clients and it's bad for the industry," says Grau, who heads FP Transitions in Portland, Ore. It's a quite different story for those valued at above $1 million. Most advisors who don't sell are working on internal succession plans with a move to protect and perpetuate their most valuable asset: their business.

"The amount of internal succession planning has accelerated through the roof," he says. "We're seeing a solid 20% increase every year in the number of advisors who actually value their practices." The firm will do 1,300 valuations this year, measuring 100 data points across three indexes: cash flow quality, transition risk and marketplace demand.

"Until you put a number on that practice and what you spent a lifetime building, you can't set up a continuity plan. This is your largest, most valuable asset. Take care of it," cautions Grau. "Not only figure out what's it worth but why it's worth that."

Do you want to put a number on your practice? Want to grow your business? Wondering how to make a merger work? Consider this advice from the experts:

Be realistic. There is an inherent quality in all of us to put a value on our creations that is greater than it should be. "It's that pride of creation. My children are always the best looking. We have a bias, not a flaw necessarily," says Palaveev. "It's only a flaw if unreasonable expectations of the future are based on that bias."

Network. Go to conferences, "shake some hands," "drink some drinks" and reach out to other advisory firms and financial professionals in your region, adds Palaveev. "Start a conversation: How is your business doing and where do you see it going? How do you find new clients? You don't have to walk around with a T-shirt that says 'Looking for mergers.' You network. You wave the flag."

Hire smart. A more valuable practice—one that can be sold to an outside buyer—depends on people, according to consultant Angie Herbers, founder of Angie Herbers Inc. in Manhattan, Kan. "We know for a fact that with any service business, the most valuable asset is the people working in them. That plays right into your ability to sell your firm, to be acquired, or to be transferred internally. Nearly all of my [advisory] firms are looking to acquire or merge right now. I compare acquiring to the hiring process. You have to be an employer of choice. You need to prepare yourself to be bigger."

Spend face time. With most deals, principals spend 80% of their time on the economics and 20% on the people part. Friedman says the equation should be flipped. "The deal structure is the easy part. The bigger issue is how do I get along with these people, their philosophy, their values? It's important to really get to know each other. Grab beers, go to the movie, walk in the park," he advises. In retrospect, Friedman says he would have from the beginning gotten mutual consent on things like roles and responsibilities—and documented it in detail. "Flesh it out. Dig in," he says. "Even if it's not binding, it's helpful."

Compare cultures. Firm owners should meet frequently, visit one another's work spaces, learn about one another's philosophy of advising, and fully understand what the client experience is like, according to Wales. "Part of the business that drives the greatest value is the client relationship and the ability to grow more. You need to understand what the effect would be on your clients going forward," he adds. "You want a complementary culture and set of conditions. That takes a relatively long courtship."

Do the math. Consider the economics that drive value in a business, yours and your prospective partner's: cost structure, income mix and growth trajectories, as examples. Following that, says Garcia, take a look at the client base: the average age, tenure of clients, composition and retention rates. Next, consider the business opportunity. Is there a management team that's managing day to day and professionally? Is this an organization that supports career paths? Is this a firm with a brand and solid reputation in the marketplace? "You've got to look at cash flow divided by risk minus growth," he adds. "What you need to think about are all the things that drive those components."