Skyview Race Car

What Is The Value Of My RIA?

Get Pre-Approved(Within 48 hours)

Whether you’re making internal equity decisions, or selling your investment practice, understanding the methodology for valuing a financial planning business is a key starting point for many owners.

Factors That Impact Valuation of RIA Firm

There is no shortage of opinions on what qualitative and quantitative factors drive the valuation of wealth management practices or quick adages that have lingered around the industry (2x Revenue, 2% of AUM, 6x EBITDA, etc.). While the final sale price of an RIA firm can only be determined by negotiations between buyer and seller and depends heavily on how the transaction is structured, the value of any business comes down to three main factors: Growth, Profit & Risk.

Depending on the specifics of the financial practice for sale, these factors could be quite different. For example, today’s wealth management industry is quite fragmented due, in part, to the massive flow of advisors who have left the wire-house model to become more independent and adhere to the fiduciary standard. These advisors-turned-entrepreneurs were able to assemble the RIA business models that best fit their unique planning practices.

Some of the key factors that vary between private wealth practices include, but are not limited to:

  • Client demographics
  • Revenue concentration
  • Client service model
  • Rate of client attrition
  • Amount of new assets added annually
  • Fee schedule
  • Investment philosophy
  • Advisor payout model
  • Amount of advisory vs. transactional business
  • Use of technology
  • Amount of staffing
  • EBITDA margins
  • Level of free cash flow generated

All of these factors fall into three primary buckets: Growth, Profit & Risk. So accurately assessing the value of an RIA firm comes down to more than simple math.

Valuation Methodology

  1. Multiple of Revenue

    One of the simplest methods to value a wealth management firm relies on a multiple of revenue. This multiple is most often applied to Trailing 12-month (TTM) revenue, but variations of this multiple have also been applied to 3-year average revenue, quarterly annualized revenue, and projected 12-month revenue.

    The actual multiple applied to determine the value of the practice depends on how the revenue is generated. In general, a higher multiple is placed on the portion of revenue that is recurring (fee-based), and a lower multiple is placed on the portion of revenue that is transaction-based. The resulting values are added together to determine the total value of the advisory firm. With various multiples involved in that calculation, we often see incorrect multiples applied, especially when trying to sell a financial practice.

    One of the main problems with a revenue multiple is that it fails to consider all other aspects of the wealth management firm that make it unique when compared to its peers. Consider the following example:

    Since both RIAs have the same revenue, if we relied on a revenue multiple, we would value each advisory practice the same. But a quick look under the hood would reveal very different expense structures, resulting in different levels of profit. One can very quickly see why these RIA firms should likely not be valued the same.

  2. Multiple of EBITDA

    EBITDA stands for Earnings Before Interest, Taxes Depreciation & Amortization. It is a measure of earnings that eliminates financing costs (interest), non-cash expenses (depreciation & amortization), and taxes. It is often used in the valuation of a financial firm’s operational performance because it removes the impact of the management decisions mentioned above. Many of the earnings-based multiples you see for RIAs are based on EBITDA.

    Based on obvious issues with the revenue multiple, one could reasonably conclude that an RIA valuation based on an earnings multiple would be more accurate. While an earnings-based multiple is often more accurate, it still fails to accurately assess all of the unique aspects of a wealth management firm. Consider the following example:

    Once we move beyond profits and explore other aspects of the financial practices, we can see that the growth of the two firms has been quite different over the past few years. RIA 1 could also have a very high percentage of revenue generated from its top 5 clients leading to higher risk. These are just a couple of examples related to growth and risk, but many of the factors listed above could impact an investment advisory firm's value.

    The advantage of using multiples, including revenue, EBITDA, and others, when valuing an RIA is simplicity. One can get a quick “ball-park” valuation of the practice by doing elementary math. But when it comes to making important decisions, based on this information, multiples fall short of assessing the unique aspects of each financial planning firm. The reason why can be seen in the following chart:

    Multiples are simply a collection of data points: Sale price & Sale price for several completed transactions.

    The results will always fall in a bell curve because each advisory practice is unique, positioned differently, and stronger in certain areas. These differences include some of the factors listed above and can influence the Growth, Profit, and Risk characteristics that impact the RIA firm's valuation.

  3. Discounted Cash Flow

    Another method often used to value financial advisory firms is the Discounted Cash Flow method, which uses historical performance, discussions with management, and a thorough understanding of the specific business model to project future financial performance over a defined period (often 5 years). One then calculates a terminal value and discounts all resulting cash flows to present value utilizing a discount rate that reflects the perceived level of risk present to that specific company. Finally, sum all calculated values to determine the total valuation of the financial practice.

    Although no one can ever predict future performance with 100% accuracy, this method allows a valuation expert to utilize a thorough assessment of the unique factors of each RIA firm to assemble a meaningful calculation of value. The specifics of a good Discounted Cash Flow valuation can be quite complex and will involve many relevant factors specific to valuing wealth management firms, which is why it’s often best to utilize a valuation expert.

Third Party Valuations

Third-party valuations are utilized as a gauge of the firm’s enterprise value for several M&A participants. Oftentimes, buyers and sellers utilize an advisor valuation service as a starting point for negotiating a final sale price. Receiving an advisor practice valuation reflects the fair market value that one could expect in the market when selling an investment practice using an “average” deal structure. This value rarely reflects the final sale price of a financial practice.

Some industry pundits have made an argument that multiples paid for practices are set to rise due to the infusion of liquidity from bank financing and private equity. Bank financing options have proliferated over the last ten years for financial advisors for Small Business Administration and conventional loans each with different structural nuances.

A significant majority of banks and other lenders require a third-party advisor valuation service for assisting their underwriting team. Banks are very judicious in selecting valuation firms from whom they will accept a valuation; consequently, it is important to retain an RIA valuation from a recognized firm with expertise in the RIA industry. Please contact our Credit Team at underwriting@skyview.com to receive a list of approved valuation firms.

Ready for the next chapter in your career?