Three Drivers that Maximize Practice Value
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For the past nine years, I have served as a succession planning consultant and valuation expert to financial advisors. During that time, I have seen the key drivers of value that increase or decrease a practice's value, and, as a result, a practice owner's return when they sell their practice.
Specifically, three drivers increase a firm’s value and another three can decrease it.
The drivers that increase a firm’s value are recurring revenue, operating profit and the percentage of high-net worth clients the practice serves. Recurring revenue, versus transactional revenue, provides a predictable and regular income stream for the business. The more stable the business’s income from month-to-month and year-to-year, the more valuable it is to a prospective buyer. Operating profit derives from a firm’s overall efficiency, especially as it relates to expenses. High expenses and narrow margins negatively impact a firm’s profitability and its cash flow. Low expenses and high profit margins improve cash flow and operating income throughout the year.
High-net worth clients drive up a firm’s value largely because of the significant return they provide in relation to the investment it takes to service them. It takes the same amount of resources, if not more, to service low- and middle-range clients as it does to serve high-net worth clients, yet much of the revenue for a firm comes from those high value clients. It’s a prime example of the Pareto Principle, which states that 80% of your return comes from 20% of your effort. In this case, the majority of your income comes from a smaller percentage of your client base. If you increase the number of high-net worth clients you serve, your return per client will increase, as will the value of your practice.