Fair Market Value Inc. presents Valuation of A Financial Advisory Practice

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Fair Market Value Inc. presentsValuation of A
Financial Advisory Practice

• Presented by Darren Miles, CBV
• June 4, 2009

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Fair Market Value

• The highest price available, in an open and
  unrestricted market, between informed and prudent
  parties, acting at arms length, under no
  compulsion to act, expressed in terms of money or
  moneys worth.

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Fair Market Value

• Highest Price Available
• Open and Unrestricted Market
• Informed and Prudent Parties
• Acting at Arms Length
• Under no Compulsion to Act
• Money or Moneys Worth

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Discount/Capitalization Rate

• Importance
• Single most important factor
• Area that focuses on risk tied to investment
• Inverse of a multiple i.e. 25 rate 4x multiple

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Discounted Cash Flow Technique

• Preferred method in current environment
• Comment Capitalization of discretionary cash
  flow
• Forward Looking
• Assumptions Professional Practices
• Purification
• Receivables
• Debt
• Normalization of Statements

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Discounted Cash Flow Technique

• Buyer Beware - Overly Aggressive Projections
• Market Remuneration
• Discount Rate vs. Capitalization Rate
• Terminal Value

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Market Comparison Approach

• Use of public market multiples to subject
• Requires adjustments for differences
• Price to Earnings Multiple
• Price to Revenue Multiple
• Various industry specific others (i.e. AUM)
• Issues with the Market Approach

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Tying it all together

• Weighting (historically)
• Capitalization of discretionary Cash Flow Not
  Applicable in current environment
• Discounted Cash Flow 90
• Market Comparative 10
• Debt Retirement Analysis
• Cash Flow
• Target between 5 to 10 years depending on the
  industry
• Ideally have a buffer cash flow position

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Incorporation

• MFDA Rule 2.4.1
• Suspension of rule extended to March 31, 2010
• Provinces approving extension include British
  Columbia, Saskatchewan, Manitoba, Ontario, New
  Brunswick and Nova Scotia.
• IDA advisors are not allowed to incorporate under
  current regulations.

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Benefits Of Incorporation

• Sale of Assets vs. Shares
• 750,000 capital gains exemption
• Application of lower taxation rate for valuation
• Greater after tax dollars to pay down debt
  principal after acquisition
• Section 85 Rollover must be executed properly

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Current Environment

• Historical analysis less reliable
• DCF has become the method of choice
• Projections under greater scrutiny
• Higher risk factors (cap rate) due to uncertainty
• Buyer / Seller Ratio
• Current breakdown in this market
• Discounted Cash Flow 90
• Market Approach 10

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• Valuation Issues Specific to Advisory Practices

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Typical Valuation Misconceptions

• Todays Rules of Thumb for valuing your
  business
• Very large range of multiples and rules of thumb
• Executed 2-3 months prior to expected sale date
• Based on AUM, revenue or earnings

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A Closer Look at Rule of Thumb Valuation Models
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A Baseless Estimate

• Using the standard Rules of Thumb
• Assumes that all advisor firms are equal
• Produces wide ranges margin for error
• Does not take into consideration that practices
  are much more complex than AUM, Revenue and
  Earnings
• Will sell yourself short
• Provides no logical basis for value conclusion
• Using standard Rules of Thumb could result in a
  huge risk of over / under payment

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What About YOUR Value?

• Understand the value YOU have in your Business
  BEFORE you sell it!
• Rule of Thumb approaches have NO rationale
  behind them
• The financial industry will eventually come in
  line with proper valuation metrics
• Due diligence aims to answer the buyers questions
  before they are asked

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Impact of Value on Your Business

• The valuation of an advisory practice is similar
  to the valuation of any service-based company.
  Goodwill represents the greatest portion of value
  within such a company, due to the lack of
  significant tangible assets. Goodwill is not
  based on revenue levels so much as its based on
  the resultant earnings and qualitative aspects of
  those earnings, such as its consistency and
  sustainability, which is driven by the strength
  of the underlying client relationships coupled
  with a recurring and predictable fee structure.

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Understanding the 3 Critical Thresholds
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5 Factors for an Optimal Valuation

• Lead time 5 to 10 years
• Think of your business as a business vs. a
  book
• Understand critical thresholds 300,000, 2
  million, 5 million
• Implement process / structure and document
• Move to recurring revenue
• By understanding what your Valuation is and
  having it documented, you can limit negotiation
  with potential buyers when discussing what your
  practice is worth.

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Capitalization Rate Factors Considered

• Risk free rate of return (yield on a 10 year
  government bond)
• Recurring to non recurring revenue ratio
• Product mix
• Client age
• Fee based vs. transaction based
• Number of clients
• Continuity of business
• Number and tenure of employees
• Institutionalization of the business
• Earnings growth and stability

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Transferable Value 4 Areas of Impact

• Other than the financials, there are 4 areas
  within your practice that can provide the
  greatest impact on your business valuation
• Sales and Marketing Process
• Overall Business and Operations
• Compliance
• Documents and Files
• Institutionalizing or focusing on improving
  these areas provides greater Franchise Value
  which is transferable during the business
  succession process.

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Specifics of Institutionalization
Institutionalizing or improving these areas can
positively impact the Cap Rate which is used to
determine your business Franchise Value
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A Before and After Case Study Building a
Business vs. a Book

• After Addressing Key Concerns
• built practice over 27 years, AUM 100 M
• 215 clients avg. age 46, avg. assets
  761,000 each, half with estate plan in place
• knows children/beneficiaries of clients to align
  himself with eventual wealth transfer
• primarily recommends fee-based products
  derives recurring revenue of 112 bps
• steady profit margin consistently growing
  revenue firm grip on expenses
• systematic client service model
• instituted sales and operational systems
  trained staff to handle day to day operations
  keeps diligent records
• compliance regimen is up to date and
  communicated to all employees

• Original Story
• in business for 23 years, AUM 100 M
• 1000 clients avg. age 42, avg. assets 100,000
  each
• wide variety of individual securities and MF
  which means her average turn ratio of 88 bps can
  be volatile
• considerable client service pressure due to of
  clients with unique portfolios
• marginal increase in cash flow due to client base
  and no system in place to manage this process
• lack of time driven by heavy client base, results
  in lax compliance and uninformed employees about
  latest developments

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A Before and After Case Study Scorecard
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A Before and After Case Study Scorecard
A move to higher, recurring revenues coupled with
a 5 reduction in risk levels can translate into
more than 500,000
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Contact Information

• For further information please contact
• Darren Miles at
• 604-637-3898 - Vancouver
• 905-315-5054 - Burlington
• 416-238-2229 - Toronto
• 514-904-4045 - Montreal
• darren_at_fmvi.ca
• Thank you for your time and have a great day.

Distributors Summit 2009