Understanding Top Valuation Factors for Investment Advisors

Top Valuation Drivers in the Wealth Management Space

Advisor Growth Strategies (AGS), an M&A advisory and management consulting firm for Registered Investment Advisors (RIAs), recently set out to explore the top valuation metrics impacting wealth management mergers and acquisitions (M&A) and their effect on firm valuations. In their study, sponsored by LPL Financial, AGS compared valuations between registered investment advisors (RIAs) and independent practices leveraging a shared ADV on a corporate/national RIA model.

They found that affiliation model — whether through an independent RIA, a shared ADV corporate RIA model, or other wealth management firm — has little impact on business valuation for most firms. This discovery reaffirms prioritizing the business model best suited to an advisor’s needs and goals, and alleviates unnecessary worry regarding a particular model’s potential ramifications on business valuation down the road. 

“Today’s M&A market favors growth, efficiency, and talent over whether an independent firm does ‘everything in-house’ or outsources certain functions such as compliance and risk management to a platform provider,” said Marc Cohen, executive vice president of Strategic Programs at LPL. “As the industry has matured, we’ve learned more about what drives value based on the significant number of transactions that have been completed in recent years. AGS’ findings in this study provide a strong roadmap to independent advisors seeking to maximize their value, including a compelling argument to increase their utilization of outsourced providers for non-core functions to allow them to direct their own efforts directly at growth.”

True Drivers of Value

The study evaluates the largest factors impacting firm valuation, defining these as “true drivers of value:” 

• Profitability: The firm’s ability to drive profit margins
• Growth: The firm’s organic growth, net of market performance
• Target Client Market: The firm’s geography and the market available for future growth opportunity
• Team: How firm culture, client service model, talent management, governance and support structure create synergy throughout the transaction

Financial:

The most significant driver in this category is organic growth. Organic growth (excluding market returns) counteracts client drawdown and market risk, while demonstrating a value proposition attractive to prospects. Buyers look for more than AUM aggregation and additionally focus on the potential to grow together post-transaction and realize increased returns.

A practice that demonstrates organic growth is then measured on profitability. Profit margins are linked to pricing philosophy, expense management, productivity, and efficiency of the client service model. Buyers evaluate the historical financial success of a practice to understand the risk and opportunity. Organic growth and profit over the last three years will be either a positive or negative factor to the valuation of the practice.

Target Client Market: 

Buyers also consider factors beyond the pure financial metrics and evaluate the geographic location of the office and client base to understand growth potential and risk. Locations attractive to the buyer will be additive to valuation. Wealthy and growing locales provide opportunities for post-transaction growth and the long-term sustainability of the practice. Conversely, practices in declining markets, or in less attractive geographies, will decrease the relative valuation of the practice versus peers with similar metrics.

Target client market factors also include the firm’s unique capabilities that appeal to specific client segments or a niche. For example, firms specialized in working with dentists or families with special needs children have unique market positioning that would be attractive to a buyer. Market positioning increases valuation as it increases the opportunity for buyers to expand and grow with the addition of the target.

Team: 

Talent has become one of the most important valuation factors as buyers increasingly use M&A as a talent acquisition strategy. In the current tight labor market, acquiring a practice with talented next-generation professionals increases the value to the buyer. Practices made up of partner advisors and support staff may leave succession as an open issue for the buyer to address post-transaction.

Office management, the transition of the client relationships, and eventual partner exit require talented next-gen advisors — value for the seller is increased if they are already in place before the deal. Governance, orderly financial participation, and partner roles create clarity for all parties, and demonstrate professionalism in the firm’s operation. Team capabilities and structure can significantly enhance or limit value if the firm lacks structural clarity or non-partner professionals.

How LPL Can Help

“Whether they’re looking to enter the M&A market or not, business owners have exciting opportunities ahead in the independent wealth management industry,” Cohen said. “LPL’s robust support platform and consulting services can help advisors improve their long-term options and achieve their business goals, including seeking maximum value when it comes time to sell.”

Connect with LPL Financial to learn more.