Valuing your RIA (or any business for that matter) is a nuanced exercise that requires an understanding of many aspects of the business being evaluated.
Approaching this task with a “back of the envelope” mentality can result in a significant gap between the value of the business being purchased and the actual price that is paid. While each situation is different, there are several items that are key drivers of value that must be understood in every transaction. The first, and often most critical, step of this process is breaking down the quality of your revenue base.
Understanding the split between fee and commission revenue is necessary to beginning the valuation process. Fee revenue is valued more highly than non-recurring, commission-based revenue because of its predictable and sticky nature. Fee revenue, which is generally a simple percentage of the assets being managed, is paid for the ongoing advisory and investment management received by the client. This not only allows the advisor to continue to receive payments in perpetuity, regardless of the need to transact, it allows the revenue to grow and compound with the market.
The unpredictable variability of transactional, commission-based revenue drives increases in the risk profile of a firm relative to fee revenue. All else being equal, the higher the percentage of commission revenues (vs. fee based) the lower the relative valuation
Once the breakdown of the revenue is properly understood, additional dynamics of the underlying book of business must be further examined. Client retention, age and asset concentration must also be considered to get a more complete understanding of the risk of the revenue streams.
Advisory firms that have high client turnover, older client ages (distribution vs. accumulation phase) and a large degree of concentration may have a lower overall valuation because of the risk each of these characteristics pose in predicting the future cash flows of the company.
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