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Forward Thinking Magazine : August 2011
16 post-FOFA, as well as at the effort that will be required to ensure the practice being acquired will comply with the new rules," she says. According to Winton, practices whose revenue is largely based on commissions and which don't routinely conduct annual reviews with clients will trade at a discount compared to practices with more integrated clients and revenue. She says buyers are becoming more discerning and there is a wider spread of valuations for advisory practices being seen than in the past. Terms of sale under review Aside from a wider variation in the valuations practices are attracting, Winton says the price paid will depend on the terms of the sale. The lower the risk for the vendor, the lower the price paid for the firm. The price for practices tends to be higher where they have a sale contract that includes a fall clause where a percentage of the payment will depend on the business hitting its previous revenue results 12--24 months post-sale. "We're seeing more discerning risk assessments around what the purchaser is buying, and vendors are wearing that risk. Vendors who are able to negotiate a price and walk away are achieving lower valuations because the sale is risk-free to the vendor," Winton explains. Another shifting part of the advisory market is the supply and demand dynamic. Whereas previously demand for practices exceeded supply, this is now in the process of switching. Winton expects this trend to continue, especially as the returns from advisory businesses are now less certain than they may have been in the past. "The market needs time to adjust to how new revenue streams will impact a practice's bottom line. It's also possible there will be more sellers in the market as some owners won't want to adapt their business model to comply with the proposed reforms," Winton advises. Determining a value According to Winton there are two main ways a financial advice firm is valued. In the first scenario, known as a 'bolt-on' acquisition, the business that's acquiring another practice may have the resources and the capacity to absorb another firm without having to spend any money on new premises or staff or new back-end systems. In this situation, the purchasing firm will see acquired revenue flow mostly through to the bottom line. "Under these circumstances the price of the practice will be based on a multiple of recurring revenue, with the multiple based on how sticky the revenue will be post-FOFA," she indicates. "Firms that have moved early and intuitively to negotiate a fee-for-service with clients are way ahead of their commission-bound peers and they are the businesses positioned to capitalise on growth opportunities from these reforms. Importantly, businesses that have taken the high road early on will be well placed to secure funding should they need it, because banks will be able to see a track record of successful migration from commission to fee-for- service and see evidence of what drives revenue and profits in the business in the 'post-FOFA world'." A scaled approach FOFA's adoption of the concept of scaled advice is intended to enable advisers to more easily offer ad hoc advice to clients. "This is a real opportunity for advisers because it is possible to offer more affordable advice, as and when clients want it," says Fiona Mackenzie of Macquarie Practice Consulting. This will potentially open the door to the accumulator market: those who may not have an appetite for comprehensive advice, but who do want advice on specific issues. "The idea is to get smart about targeting the clients who would most benefit from receiving scaled advice and ensure your business can deliver effectively and profitably over time. Advisers might be able to offer scaled advice to younger clients who want mortgage or insurance advice, or estate planning advice to other clients. And while some of the other proposed reforms could reduce income streams, this is one part of FOFA that could open up a new revenue source," says Mackenzie. Practice values: the impact One of the most significant impacts the FOFA reforms will have is to change the nature of the way advisory practices are valued, especially as the new rules will alter the revenue mix of most businesses. This is an especially important consideration for advisory practices that are considering a sale or merger. Winton says, aside from the FOFA reforms, advisers should be mindful that the dynamic of the funding market for advisory practices is shifting. "We are witnessing a substantial tightening of the lending market, although some lenders are still willing to take a view over goodwill. The tightening of the lending market appears to be impacting the price acquirers are prepared to pay for a practice. Because of the uncertainty the FOFA reforms present for future revenue projections for firms, we are seeing buyers taking a more qualitative approach to valuations. Purchasers are taking a harder look at what's driving a business's profits and the sustainability of revenue