Boost the value of your business

In any event, could you identify some of the specific things I should focus on if I want to maximize the ultimate value of my business – as well as putting it on solid ground today?

Coach says: you’re absolutely correct in saying that organizing your business to make it as attractive as possible to a potential buyer or successor is just good business sense. You never know what might happen between now and then – I call them the “big Ds” – death, disability, divorce, disappointment, disagreement, disillusionment, disinterest and others. That’s why you should always be working to add value to your business so that you will be in a position to sell it – at any time, for the highest price, to the most-qualified buyer – should one of these contingencies arise.

Here is my “Top Five” list of things on which to focus to benefit your business today and in the future:

1. Increase net cash flow

Cash flow is the lifeblood of every business, and when it comes to valuing a financial advisory practice, net cash flow after all expenses are paid is what really matters. So, look for ways to manage costs better, increase economies of scale, introduce new products and services to existing clients, consolidate assets and increase share of wallet.

In formal practice valuations, discretionary cash flow is the most common measure used to value a business. This measure refers to any cash left over after paying your overhead – staff, office, marketing, etc.’ as well as the direct costs of providing your services as an advisor.

In the real world, most advisors simply pay themselves whatever is left after expenses. Start thinking about what would represent a fair wage to pay someone else to perform your role as an advisor. Anything over and above that should be considered your “owner’s compensation” or discretionary cash flow and be the basis upon which the value of your business will be calculated.

2. Build recurring revenue

The greater the percentage of your revenue that is recurring on a regular basis, the higher the value of your business. Certainty of revenue reduces risk for buyers of your practice, so they will pay more for a practice with ongoing income compared with a practice with the same revenue that has to be “re-earned” each year. Marketing costs are lower in the former scenario, and client retention also is improved.

This strategy obviously speaks in favour of a fee-based compensation model. Bear in mind, however, that all recurring revenue is not of equal value when it comes to assessing your practice.

For example, you may have 100 clients who pay you $500 a year each to update their financial plans for total annual revenue of $50,000. However, because these clients effectively have to “renew their subscription” each year, that $50,000 of recurring revenue will receive less weight in a valuation than would $50,000 of asset-based fees, which are less likely to require a new decision to renew each year.

Similarly, trailer fees from mutual funds, while recurring, are likely to be discounted because of the pending impact of Phase 2 of the client relationship model, which may eventually lead to the demise of trailers.

3. Promote team vs star

Most practices grow up and are sustained through the energy and reputation of the founding advisor. Although that’s easier to manage in the early years, it actually poses a risk as time passes because most of the goodwill in the business is represented by the personal goodwill held by the advisor. When that advisor makes the transition out of the business, much of that goodwill can go along with him or her.

In order to mitigate that risk, you have to work to make your business “bigger than you.” By that, I don’t mean in terms of number of people; rather, I am referring to the reputation, status and presence of the practice. By promoting your support team, building processes and systems that don’t require you to be the primary point of contact or be involved in every interaction between clients and the business, you can, over time, transfer some of your personal goodwill into corporate goodwill.

4. Diversify your client base

Naturally, as you approach your own retirement, the average age of your client base is likely to be increasing in parallel. In addition, as your practice matures, you probably focus on a narrower definition of “preferred client,” with the combined result that the general profile of your client base has become quite specific.

That situation may appeal to a like-minded successor; however, chances are the market for prospective buyers of your practice will narrow as a result. Having fewer potential purchasers generally means a lower price than having a large number of prospective buyers competing for your business.

Similarly, an aging client base often means fewer opportunities for your successor to develop new business from within, as many clients already will have most of their wealth invested or be in the process of transferring their assets to their children. Having a client base comprising various life stages and needs is a sound strategy that will serve you well in the future.

5. Have documented systems

As your practice grows, it inevitably becomes more complex – and the ability to manage it becomes diminished unless you have policies and procedures to ensure efficiency and effectiveness. All too often, we find mature practices in which most of the “how we do it” is not written down. This puts a business at risk in the event that the person with all the knowledge isn’t available for an extended period.

Furthermore, in our experience, many practices have outgrown their original systems, rely on inadequate or old technology and have developed “workaround” processes that, while functional, consume too much of people’s time and often don’t really do the job intended.

Finally, keep accurate financial records. Like most entrepreneurs, advisors generally do not have financial information that truly reflects the viability of their businesses. Balance sheets normally are of little value because most practices have little in the way of physical assets, except some furniture and equipment, and not much in the way of liabilities beyond monthly payables.

More critical is the income (a.k.a. profit and loss [P&L]) statement, which shows cash in and cash out. (Remember: net cash flow is king.) The problem is that for most advisors who “eat what they kill,” “cash in” almost always equals “cash out.”

Furthermore, in many cases, the only P&L statement produced is the one used to file a tax return, for which the objective is to pay the least amount of taxes by decreasing revenue and/or increasing expenses. That’s the exact opposite to what you want when a potential purchaser is valuing your business. When that day comes, you will want to be able to validate the most profitable business possible in order to obtain the highest price.

So, bear in mind that when you expense that dinner for yourself and your spouse as “client entertainment,” that vacation as an “educational conference” or charge your automobile lease to the business, you may be knocking thousands of dollars from the price someone would be willing to pay for your business if your financial information accurately reflects the true worth of your practice.

The decisions you make today to organize your business in order to realize its maximum potential will help you to realize its maximum value down the road. In addition, the journey will be far more satisfying.

George Hartman is managing partner with Elite Advisors Canada Inc. in Toronto. Send questions and comments to ghartman@eliteadvisors.ca.

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