Succession planning in any profession is really hard but arguably more so in financial services. Just ask any small-practice owner in an accounting, legal or a financial advice firm.
Of the three professions, though, the gift horse for valuations has been planning because of its distribution power. But now some would argue this is going to change as the advice profession emerges to reflect the characteristics of the other professions – the reason is without the distribution benefits, the valuation model may fail to match the others. In accounting, it’s as low as 80 cents to the $1.00 but in general terms, six times EBIT becomes the mantra for most firms. Why would pure advice be any different?
But with the cost of advice delivery likely to go up thanks to regulations, litigation and compliance requirements, many argue EBIT could also be a more difficult target for planning firms in the future.
Excluding vertical integration benefits (an unlikely consideration one might add) the challenge to improve the bottom line is pretty obvious. Theoretically, the solution may be equally as simple – digital delivery, the use of managed portfolios in a managed account platform, staying away from investment as a value proposition and working hard on goals based advice = Bingo! Systemised efficiency, recurring income unrelated to markets, lower compliance costs and paperwork and client engagement with matters that are relevant to the client. End of short story, victory for the theorists.
However, in the real world it’s never that simple. Taking all of the above and dissecting each issue shows it’s easier said than done. Firstly, not all existing clients fit a managed account offering – existing arrangements may incur capital gains tax considerations, sometimes Centrelink payments are hardwired to old platforms and can’t change, and MDA’s and SMA’s aren’t always the preferred route. So, it means an old legacy base and a new client base – inevitably losing many yards of efficiency, scale and sub optimal portfolio outcomes.
So if advisers can’t bring costs down, efficiency gains aren’t easy and ebit is challenging… then values are going to go down, not up and successor planning is going to get really tough for those thinking high valuations.
This brings us right back to the elephant in the room today. Professional standards (i.e. advisers requiring tertiary qualifications by 2024) will likely result in lots of practice heads looking to step back/retire or sell. When this happens there will be an oversupply of sellers and possibly a short supply of buyers – certainly at yesterday’s prices… so, EBIT better reach 30-40% of gross rev or advice practices in the future will sell at similar rates to other professions.
The difference to other professions of course is advice tends not to be transactional, it’s a lifetime journey and it often involves dealing with retirees which is exactly the opposite to say legal and to a lesser extent accounting. They tend to be jettisoned more easily at retirement.
This takes us back to succession planning the options and the solutions. Firstly, there’s no silver bullet despite the wishful thinking of a few believing someone with a chequebook would be looking to solve their retirement problems. Love that thought, but dance with the devil and there is a price. Someone wanting to buy a planning practice for investment returns or income only …. when human capital is at risk of departure? Would they be that silly or is it plain old fashion Trojan horse for future distribution. More likely one thinks.
The gold bullet is more challenging more realistic and more suited to a profession. It’s the possible amalgamation of a number of practices with partners of equal standing, equal professional behaviour, similar culture and same client empathy. They band together to get scale, reduce their back-office costs by sharing infrastructure and they invest into the future with young employee advisers who eventually become partners and take equity at 6 times ebit. It’s a long route but the right road and for those interested enough to observe it’s how the partners in major firms all work.
The challenge is finding the time, the energy and the market to make it work …. but it is the future and maybe, just maybe, it’s never been better for a long-term professional.
*Ian Knox is the managing director of Paragem. The views expressed are his own.
First published: 29 November 2017