To pump up volume quickly, many advisory firms acquire books of business from other advisers. Practice acquisitions are a great way to go, providing you don’t overpay. Sellers will almost always rely on a rule of thumb—a multiple they read in the trade press or hear at a cocktail party. Your responsibility is to define the economics of the target practice-with charges to both fair compensation for the owner as well as all overhead expenses.
In financial terms, value is measured by projecting cash flow and discounting it at an appropriate risk rate (or required rate of return). To simplify this process, you can apply a capitalization rate to current free cash flow to come up with a value. For a buyer, this would be the most conservative way to measure value. Each year, we receive inquiries from advisers interested in unraveling deals they committed to several years before.
Most of these dissatisfied owners have assumed a substantial book of clients who do not fit their target market but whom they now feel obligated to serve; others find there is insufficient cash flow from the practice to support the terms of the buyout and still have enough left over to pay themselves adequately for their time invested. Clearly, the “greater fool theory,” which says that there will always be a buyer regardless of price, lives large in the advisory world.
The causes are legion, but the biggest reason may be the lack of understanding of how businesses are valued and what the economic drivers for advisory firms are. The problems we see with practice acquisitions typically fall into five categories:
So, is buying a practice a bad idea? Not necessarily. In spite of the risks, growth through acquisition still presents a viable opportunity for advisers to expand their practices quickly, but they must apply the same common sense to acquiring a practice as they do to counseling their clients. Investing in due diligence and critical analysis, including financial analysis, is essential before signing on the dotted line. Before buying a practice, every buyer should consider at least these six questions:
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Business Management For Financial Advisers Tutorial
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Defining The Business
The Value Of Surveys
The Challenge Of Growth
Human Capital: The Fulcrum Of Strategy
The Care And Preening Of Staff: Professional Development
The Payoff For The Firm: Compensation Planning
The Tools That Count: Financial Management
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