What is your practice actually worth?

Even if the truest test is on the market, Hong outlined some of the methods advisors can use to value their own businesses. The easiest way, he says, is to apply a multiplier. A multiplier could be applied to revenue, EBITDA, or AUM to determine enterprise value. Hong prefers to look at EBITDA as it’s a little higher up the income statement and the underlying variables below EBITDA can be changed more easily.

The multiplier applied, he says, has drifted down from around 2.6x to around 2.1x over the past ten years. That drop, Hong says, can largely be explained by fee and margin pressures from the rise of robo-advisors, as well as a reflection of generational wealth inequality. More wealth is held by older generations, who are approaching retirement and drawing down on that wealth, leaving less to manage overall. Even high earning young people are struggling to save amidst a cost of living crisis, which dampens the future growth prospects for advisory practices.

The multiplier method, Hong says, is quick and gives you a good starting point, but can be a bit too simplistic. Advisors may also consider a discounted cashflow method which is significantly more robust, though it is more complex and time consuming to use.

Outside of the hard numbers, other intangibles in a practice can play a key role in valuations. Hong breaks those into the “tangible intangibles” and the “intangible intangibles.” The latter category includes things like the individual relationship an advisor has with their clients, the happiness of their staff, the reputational value of the practice, and the culture of learning and service that exists on the team. The former category includes questions like client concentration, the proportion of total AUM does the biggest client represents, the average age of the clients, the age of the company, and the employee turnover. All of these factors will play into exactly what multiplier is applied when a valuation is arrived at. 

Market sentiment and other outside macro forces will always play a role in a practice’s valuation, as well. Dealmaking is often cyclical and there can be periods when buyers are few and far between. In those periods dealmaking can prove difficult because there are fewer similar deals to inform valuations. Sellers and buyers may have greater price divergence and coming to an agreement may prove difficult. Interest rates can play a role in deal volumes, too, and the expectation of interest rate cuts coming soon may be positive for practice valuations.