By Sam Hull, CFP®, ACC
Perhaps the time is approaching when your personal life plan dictates that you should sell your practice and move on with the next phase of your life, or maybe health, family or business issues simply tell you "it's time." Whatever the reason, once you decide to start the process of selling your business, where do you start?
The first critical action you should take is improving the value of your business in the open market. This article will highlight the steps involved in a business value improvement program, which was briefly mentioned in "Anatomy of an Ownership Transition" in the September/October 2009 issue of Practice Management Solutions.
To illustrate how to boost the value of your business, consider the story of a financial planner who is preparing to sell her business in about four years. Kathy started her financial planning business more than 20 years ago and has successfully guided her clients through the roller-coaster market and historic civic events of those years. She loves what she does, but at age 60 she is ready to move on.
Kathy turned to us for guidance on how to make her transition a success. We suggested she first engage an independent consultant to evaluate her company and give her an idea of what her business would sell for today on the open market. This gave her a benchmark and was a reality check as to what her years of hard work were worth. We then showed her what elements of her business could be improved by the time she finalized her deal terms with the future buyer of her business.
To do this, Kathy started a business value improvement program, a series of actions over the next few years that would improve the character and quality of the revenue stream and make her business more efficient. Improving her client demographics, income sources, business expense ratio, technology usage and other business metrics could improve what her company would be worth by as much as 25 percent.
Mind map of Kathy's business valuation improvement program:
As shown in red on the mind map, Kathy needs to examine five business areas that will impact the value of her business-client risk, revenue classification, market demand, business efficiency and continuity risk. After spending time with Kathy and her staff, we realized that the areas of client risk, revenue classification and business efficiency were the three most critical elements of her business value improvement program-the areas in which she could make the most significant changes.
Client risk is basically the buyer's risk that the primary asset being purchased-the stream of future revenues expected to be generated by the client relationships being transferred in the sale-could substantially erode during or shortly after the transition. The factors, or client metrics that Kathy can change include:
- Age distribution of the client roster. Big "lumps" are bad, such as a large number of clients older than 70, but this can be changed through target marketing and focused criteria for accepting new clients that will add more young clients over the next four years. She may need to shift the image of her company, or she could hire a younger planner to be responsible for this new demographic.
- Client concentration. Having a few big clients that dominate the revenue flow is a risk that can be reduced. Kathy is fortunate to have two families each representing about 8 percent of her annual revenue. That's good and bad. Kathy needs to focus on adding new clients during the next four years to lower the risk of potential loss of one of her big clients during the workout period.
The second area Kathy needs to work on is her revenue classification, the source and durability of her revenue stream. Her current annual revenues are about $500,000, with 60 percent derived from asset management fees, 30 percent from periodic financial planning preparation and annual review fees, and the remaining $50,000 from security and insurance product commissions and trails.
Because of its "stickiness," the recurring revenue portion (asset management fees) has a much higher value in the transition marketplace than the more unpredictable, transactional income from planning fees and transactions. We recommend that over the next four years she shift her business model to a fee-only basis with either all-inclusive retainer fees to cover all her client services or a mixture of asset management plus retainer financial planning fees. This could impact her custodial and compliance relationships.
The last area that Kathy needs to manage is business efficiency-not only how much of her top line drops to the bottom line, but also how transferrable her business operation would be to the buyer. Here are some considerations for improving business efficiency:
Operating Procedures. The office currently has a patchwork quilt of client management, compliance, business operations and marketing procedures. Some procedures are captured in individual desk files or even on sticky notes in file folders; others are in an unorganized "procedures" file on the server. Too many solutions seem to be re-invented whenever the need arises.
Kathy needs to establish a major office program to create standard operating procedures for critical activities, and client workflow needs to be established and made easily available to all employees. Many CRM systems allow workflow procedures to be directly integrated into client records; management review and monitoring can also be implemented.
A good standard operating procedure will allow more efficient use of staff time and talents and free up Kathy's time. Kathy has a lot of client details in her head, and she will have to make a concentrated effort to write it down so that as much information as possible will be available after she leaves. This will be a big plus in improving her valuation and will make her business more attractive to a buyer.
CRM Software. Kathy has a new client relationship management (CRM) software system, but she and her staff have not found time to add the significant client history and information they've accumulated over the years in various notes, e-mails and paper files. However, having the new CRM up to date will make client relationships in a "life without Kathy" better.
Upgraded Technology. Kathy's business has grown rapidly over the past five years and various systems are not as integrated as they could be. For example, her quarterly client AUM billing is done on Quickbooks by her administrator. This task could be integrated with her Web-based portfolio performance reporting system. Likewise, her client letters are printed and mailed to all clients, however she could set up a system whereby her letters are sent as PDF files via e-mail. Client portfolio reports could be posted into secure mailboxes on the business' Web site where clients access them at their convenience.
Expense Drag. Finally, the company's expense ratio-the cost of doing business before the owner's salary and perks-must be carefully and objectively analyzed to see if it can be better managed over the four-year transition planning period. While there are certain costs that are basically fixed, such as rent, utilities, key person salaries and insurance, the variable costs of doing business should be examined. Some things to consider include:
- What parts of Kathy's business are now being done in-house that could be sub-contracted to a reliable, outside vendor?
- What business activities or programs are either no longer needed, not cost effective or are inconsistent with her vision of the company at transition?
Almost every business activity, from marketing programs, client communications and bookkeeping to plan preparation, asset management, compliance consulting and strategic planning can be done by someone else usually better, or cheaper or both. Kathy has a four-year goal of reducing her expense ratio from 43 percent to 35 percent.
Kathy's business value improvement program was geared to improving the health of her company. As you would get your car repaired and detailed, or your house fixed up and painted before you sell to improve market appeal and value, shouldn't you do the same for your financial planning business? After all, this is a once-in-a-lifetime opportunity; a chance to maximize the payout from your life's work and realize maximum gain from what may your largest, single financial asset.
Sam Hull, CFP®, ACC, is a co-founder of Whitewater Transitions LLC, helping financial advisers navigate ownership transition issues. Contact him at firstname.lastname@example.org.