Rising costs, revenue pressures and regulatory change are all contributing to the restructuring of the advice industry. We have seen large numbers of advisers moving around within the industry or exiting it altogether. These same pressures are impacting the price of business valuations, providing further headaches and uncertainty for practice owners who may be unsure of their future. Our research indicates that nearly half of all single adviser practices and more than a third of two and three person practices are willing to sell their business, but premium price expectations should be tempered because valuations are not what they used to be…
Adviser Ratings research presented in our 2019 Landscape Report indicates that 17% of practice principals surveyed identified as willing sellers of their business, representing 1,500 practices advising $190b wealth on a full market equivalent basis. The practices most willing to consider a sale were overwhelmingly those with three or less advisers, as Figure 1 illustrates.
The marketplace has shifted significantly with regard to advice business valuations. Three to five years ago a client base was seen as a whole and generally speaking the various revenue segments carried similar valuations. In many cases, this was also underpinned by institutional BOLR schemes that valued all revenue equally between three to four times. This has changed in recent times.
With the collapse of the institutional market, an arbitrary 2.5 times revenue outcome imposed by AMP, and the pending abolition of grandfathering there is now a stark difference in the valuation of different revenue segments.
- Revenue subject to grandfathering is virtually worthless.
- Revenue with compliance risk and potential fee for no service risk varies significantly depending on the issues but may only fetch 1-1.5 times.
- Revenue with clean compliance but perhaps less active and potentially older attracts 2-2.4 times.
- Better quality active revenue is holding up much more strongly in the 2.5-2.9 times range
The institutions are rapidly extracting themselves from single adviser practices with $200-500k of revenue. In addition, older advisers have weighed up the FASEA requirements and decided to exit now to give themselves certainty. The supply of businesses is very high and that is placing downward pressure on valuations in this business model, even if the revenue is of high quality. In addition, we often see new conditions and warranties to protect the buyer against an increasing risk environment. These clauses and the potential revenue clawback associated often stretches out for two years. Previous upfront payments of 80-90% look more like 50-70%. The buyers are typically above the $2m turnover mark with strong balance sheets. But key lenders are Macquarie, NAB and Westpac are heavily scrutinising the risk before lending versus the past where it was a simpler 1.75x on the total revenue.
Due diligence in the current environment is literally line-by-line on every client looking at date compliance on FDS, opt-in, last statement / record of advice (SOA/ ROA) and evidence of fulfillment of ongoing service agreements.
A transaction involving a going concern is usually based on a normalised EBIT basis. Valuations of well run, compliant businesses can still attract multiples of 5-6 times. In this type of transaction valuation tends to follow the strategic intent of the buyer. This strategic intent could involve expanding into various markets or talent and succession depth that comes with the deal. Once again, payment terms have also shifted markedly to protect the risks of the buyer.
With the withdrawal of the institutions the succession challenge is even larger, and we would expect more activity in this area.
The Practice Experience
The practice experience has to some extent depended on the segment (institutional, aligned or private) in which they reside. Larger practices in the large institutions have left in large numbers and many have obtained their own license. Overall, it’s a feeling of gaining greater control of their destiny having experienced uncertainty in their previous environment.
Practices of small to medium size have been less likely to obtain their own Licence and have often joined larger, privately owned licensees. As a general comment, practices coming from the institutions have been through considerable transition stress. In addition, they have often seen their costs rise substantially as they move from a subsidised model to a more user-pays model, particularly regarding technology and compliance. On the other side, where they came from have re-priced in this direction as well. This means advisers departing and staying in the large institutions have felt substantial cost pressures.
Within practices the combination of the Royal Commission impact, collapse of the institutions, rising costs, FASEA education standards and the pending code have led to a telling tension and fatigue in many firms. It has meant there is a stark difference between walking into a practice that feels on top of these issues versus the opposite. This is often felt within the practice and its staff, impacting culture. There are a number of mental health issues emerging. Like many changes, some practices will be significant winners whilst others will not survive.
It’s the hope of many in the industry that the overall community including advisers, licensees and its professional associations will be able to help guide the industry through the most turbulent time in its history. The coming period will see the Hayne recommendations implemented, FASEA unfold and the current market trends continue at the same pace. It will be a year like no other with big winners and losers.