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This article is the second in a three-part series on practice valuations and will unpack some of the simpler calculation methods used to establish a ‘fair’ starting point for sale price negotiations in the ‘income-based’ valuation model.  The first article, published last month, explained the more familiar but relatively complex ‘Discounted Cashflow’ method. Our third article will help you understand what you should do to increase the value of your practice.

In our first article, we unpacked valuations that use a discounted cashflow calculation to arrive at a capital value, typically expressed as a multiple of either current profit or current recurring revenue.  In this article, we’ll take a look at simpler methods attached to the income approach in more detail, and present an alternative that doesn’t require the complexities related to discounted cashflows.

Before we do so, it’s important to make the distinction between price and value.  Warren Buffett famously said that “Price is what you pay; and value is what you get “.  So, for the purpose of a valuation, price is what a buyer is willing to pay in exchange for a business or client book.  Value is what he or she gets out of that ownership; and the two are often not closely aligned.

Often, buyers and sellers go into negotiations, each with their own perception of the ‘book’ or business value.  Sellers aim for as much as they can reasonably get for their years of hard work, whereas buyers want to pay the least amount possible so that they can generate the best return on their investment.

It’s important to understand that valuations are about future revenue, and that no method is 100% accurate because nobody knows exactly what the future will bring.  Whether you using a formal valuation calculation or simply settling on a multiple of revenue or profit to establish a value, you’re still going to be making assumptions about the future revenue that is being purchased – you cannot know for sure whether this will actually materialise.  As a result, the resulting value will always be higher if the buyer has more certainty about what they can realistically expect to get out.

Let’s consider the simple calculations you can apply if you choose to forego a formal valuation:

  • The Revenue Multiple calculation is based on the business’s revenue over the last 12 months and an agreed multiple. While this is relatively straightforward, easy to understand, and effortless to apply, it doesn’t distinguish between upfront and ongoing income, nor does it take profitability into account. Since buyers are looking to purchase future flows earned but not yet paid on the transferring clients, the uncertainty about the future flows means that the valuation will use a lower multiple.

Sale Value = (Upfront income p/a + Recurring income p/a) x market-related multiple

  • The Profit Multiple calculation is much like the revenue multiple calculation, except that you multiply the bottom line by an accepted multiple. The challenge here is that the costs in the sellers business are unlikely to be the same as the costs in the buyers business, which means that the profit realized by the buyer will be different to that realised by the seller.  You can compensate for this by adjusting the multiple, but it makes it harder and harder to objectively justify the valuation.

Sale Value = Profit p/a x market-related multiple

  • The final option is Referral Fee calculation that avoids the risks inherent in making assumptions about future cashflows entirely. In this approach, the seller gives the practice to the buyer in exchange for a % of future revenue or profit.  There are a number of permutations, but typical arrangements are 50% of gross or net (after lapses) revenue for ten years or 30% for the remainder of the seller’s life.  In many cases, the seller will remain in the practice in a relationship role, which has advantages for both the buyer and seller as well as for the clients

Annuity income = X% of gross or net revenue or profit for Y years

As you can see, there are a number of different methods to arrive at a ‘fair’ value for a practice or client base.  For the buyer and seller to reach an amount that is agreeable to both, you must first agree on the approach and then on the relevant variables.


Practice valuations.  Part 3 – Increasing the value of your practice

This article is the third and final in a three-part series on practice valuations and will help you understand what you should do to increase the value of your practice.   The first article, published 2 months ago, explained the Discounted Cashflow approach to arriving at a capital value often expressed as a multiple, while the second unpacked the simpler calculation methods to arrive at multiple without requiring the outside assistance of a valuation specialist.

Now that you understand the basis for valuations and the actual mechanics of the various calculation methods, it’s time to think about how you can increase the value of your practice or client base.

Before going into the specifics, it is helpful to think about this with the same mindset that you would have when advising a client who wants to build wealth.  Key to that conversation is that the client must grasp the concept that they will never build wealth if they are not prepared to sacrifice something today.  Similarly, if you are not prepared to give up upfront commission today, then your practice will be worth very little in the future.

Step 1: Increase recurring revenue

  • Start transitioning your fee models from upfront income to recurring income over a sustainable period.
  • This can be done by reducing upfront fees and implementing recurring or ongoing fees with new clients onboarded into your business first.
  • Then start phasing your fee agreements with existing clients from upfront to recurring income, when new business is implemented as a result of financial review meetings over the next year or two.
  • This allows you to transition at a sustainable pace, ensuring that operating costs remain covered while the business gradually builds up its recurring revenue during the transition period.

Step 2: Increase client stickiness

  • Prepare clients for your exit (both unexpected, and eventual) by introducing them to your nominated successor or, at the very least, to the idea that you have identified or will select a successor based on a good fit between their needs and what your successor can continue to deliver to them in your absence.
  • Introduce the succession discussion during new client onboarding and at every existing client review; reminding clients of the importance that you attach to their uninterrupted access to advice and services – even (and especially) when you’re no longer around.
  • Increase the number of engagements with clients through in-person meetings, virtual meetings as well a regular communications, updates and newsletters.
  • Build client value with the end in mind. Deliver advice, services and value that clients are willing to pay for (through recurring or ongoing advisor fees), and that buyers are able to replicate easily and cost-effectively.
  • Develop a service matrix that drives profitable client engagement, replicable client advice and services, and active client advocacy.

Step 3: Remain open to the buyer’s strategic objectives

  • As the seller, you should always aim for your ‘first prize’ in terms of the exit arrangement. In other words, an exit that meets your plans and objectives.
  • However, by understanding what the buyer is trying to achieve, you may be able to offer them something that another seller cannot – which makes your business much more attractive to the buyer.

In conclusion, look at your business and clients through the lens of a buyer and ask yourself what you would be willing to pay.  Identify client engagement patterns and behaviours that might help or hurt the strategic objective of potential buyers.  If you can increase the attractiveness of your clients, their transferability, and their long term retention, then you will increase the value beyond market norms.  By no means are we saying that you should compromise your dreams and goals, but it is possible that you can build a client base and structure a sale in a way that enhances the return on investment for both you and your buyer.