Two years ago, Catherine Gough, FPFS, increased team meetings for her practice from monthly to weekly and invited staff members to add items to the agenda in advance. Six months later, the five-year MDRT member from Shrewsbury, England, UK, also began quarterly update meetings to provide her team with a financial forecast and allow for the staff to discuss recruitment, marketing, turnover and emotional intelligence.

The enhanced communication and consistent focus on team unity led to year-over-year increases in scores for evaluating team relationships, clarity of objectives, resilience and more.

“A consultant gave us ideas about how to grow by stabilizing the business both psychologically and financially,” Gough said. “We’ve received great feedback from the team and can see the impact in the accounts, the increased profit number and the lower staff turnover. So, we can see that it’s all growing.”

Such engagement by Gough’s staff in strategizing and problem-solving is one part of determining the value of a practice. This enterprise strength along with the revenue picture are the ingredients that can determine the value that a business stands at today and into the future, according to Scott Leak, CFP, a senior consultant at FP Transitions with more than 20 years of experience assisting independent financial advisors.

“When we talk about enterprise strength, we talk about the physical and organizational structure, which supports future growth and enduring value. Do you have the necessary people and resources in place? Are they adequately compensated to sustain efficient growth rates into the future and beyond the founding owner’s career?” Leak asks, adding that the number of employees, households handled per professional, overhead costs and expense ratios as just some numbers to assess. “If you lose key people, it could negatively impact the value and growth trajectory of your business.”

To help practices monitor, measure, protect and grow their business, FP Transitions provides a valuation driven by customized benchmarks against 50 to 60 key performance indicators. The revenue side looks at factors like recurring revenue, growth rate over the past three to five years, cash flow quantity and profit per household. Leak recommends undergoing annual valuations because of potential changes in revenue and market tailwinds.

Mixed signals

But it’s important to remember, Leak says, that the numbers can be misleading.

For example, revenue could be growing while net new client growth is slowing, a warning sign for declining business value. Or two businesses might have the same valuation even though one has more assets under management (AUM), the total market value that a practice manages on behalf of clients. That could be because the higher AUM practice is not charging enough in fees, relying too much on nonrecurring revenue or overpaying staff. If it’s the latter problem — a more difficult one to solve than underpaying — Leak says it may be time to add responsibilities to employees or shift the structure of compensation to add an owner into the practice — supporting that person’s compensation off the bottom line rather than the top line.

“I have data galore that supports the notion that firms with more than one owner grow faster than (those with) a single owner,” Leak said. That observation is in line with the 2021 MDRT Financial Benchmarking Survey of Top of the Table and Court of the Table members (See mdrt.org/2021-benchmarking-survey) where the top 25% of respondents’ businesses were more likely to be partnerships and silo businesses that share operating costs but not profits. “Internal succession planning can lead to greater growth,” he added.

In fact, these considerations are partly why Robert A. McCullagh, a 21-year MDRT member from Calgary, Alberta, Canada, who is eight years from retiring, does not do regular valuations. Instead, he monitors factors that would be relevant for a potential buyer when the time comes, like process, documentation, CRM, training and compliance so that he is replaceable, and another person could take over without missing a step. That exercise includes annually reviewing how much business was generated, semiannually monitoring the AUM created, and regularly ensuring the ability to explain where the business comes from.

“By focusing on those things, the value will take care of itself,” said McCullagh, who handles wealth management, group benefits and risk products for 1,500 clients, focusing on business owners and entrepreneurs. “I always remind myself that a business’ value is not something that is consistent. It’s based on what I’m prepared to let it go for and what somebody else is prepared to purchase it for, and there’s usually a gap between those two numbers.”

Numbers don’t lie

McCullagh meets weekly with his team members (one dedicated to mutual funds; one who manages risk; and an assistant who’s retiring after 33 years) to review their process. He also meets with a business coach twice per month to explore new ways to engage with clients and staff and discuss his monitoring process.

Rather than an impending sale, it was regulation that inspired Gough to adjust the approach in her practice, which now has three advisors and 10 support staff members handling pre- and post-retirement for business owners. By tightening their back-office process and using the Entrepreneurial Operation System — a strategic planning method that advocates making short- and long-term plans by identifying strengths, weaknesses, opportunities and threats to your business — they have a better definition of where clients are coming from, the consistency of their investment approach, quantity and origin of referrals, and more. This system includes an automated monthly report that identifies all the above, as well as first meetings and client reviews, AUM, payments and workflow.

“Before we made the change, we had clients who were engaged, but if we were trying to demonstrate that to somebody else, it probably wouldn’t have been documented as well as it is now,” she said, adding that this has allowed for increases in clients and the tripling of support staff members. “What gets measured gets improved.” 

Additional factors that can impact a practice’s value

Leak also noted these areas to consider:

• What are the demographics of the clients? Leak breaks down clients into four buckets: younger than 30, 30 to 50, 50 to 70 and older than 70. Obviously, a practice with 80% of assets dedicated to clients over 70 will be valued differently than one consisting of more clients 30 to 50 who can remain with the firm for a longer period.
• How will the practice be sold? An external sale will be driven more by revenue strength than by enterprise strength because the business’ revenue will be plugged into existing enterprise value, Leak said. An internal succession plan is more dependent on legacy enterprise value.
• How long has the practice been around, and how long have the clients been clients? Not surprisingly, there is a direct correlation between the longevity of clients and the likelihood they will stay after an ownership transition.

Find more techniques to determine value and the future of your business in MDRT’s Business Continuity Decision Tree at mdrt.org/decisiontree.