Amid the busy mergers and acquisitions activity the wealth management industry has experienced in recent years, one number often gets a lot of attention: a firm’s assets under management (AUM).
But AUM is not the sole piece of data buyers should look at, or perhaps not even the most important one. For one thing, AUM doesn’t tell you if the firm is winning new business or attracting additional clients. Rising AUM can reflect a healthy stock market or previous acquisitions rather than true organic growth. According to Cerulli, strong equity markets have buoyed RIA assets and can mask a firm’s underlying business performance. And many firms have struggled to add clients organically.
“AUM is one metric – and frankly not the most important – when evaluating a firm,” said Conor Meehan, Managing Director, Mergers & Acquisitions at Choreo.
Potential buyers should use metrics that more accurately reflect a firm’s performance, growth prospects and culture, including transferable clients, leadership quality, succession plans, compensation structures and scalability.
AUM can say something about a firm’s size. But to measure a firm’s true enterprise value, buyers have to dig a little deeper.
An Imperfect Metric
People associate AUM with size, but even AUM might not give buyers complete insight into that particular metric, never mind the overall health of the firm.
“While AUM may appear to give a reasonable indication of a firm’s size/scale, it doesn’t tell us the whole picture,” said David Reynolds, Partner at Berkshire Global Advisors. “We would also need to understand a firm’s average client size, type of client, service offering and employee base to get a true sense for a firm’s size and level of institutionalization.”
Culture, for example, can tell buyers more about a firm than its collection of assets.
“Understanding the quality of a firm requires looking at how the business was built and what has allowed it to grow,” said Marty Bicknell, CEO and President at Mariner. “AUM is one consideration, but client relationships, organic growth and culture tell us much more about the client experience, how advisors are supported and the durability of the business.”
Said Meehan: “Much like wealth can’t tell you about a family’s values, AUM provides limited insight regarding a firm’s culture. As we originated within the public accounting space, we speak the same language as other wealth management firms that have a strong foundation of integrated tax and wealth planning for their clients, especially those with complex needs for this kind of service.”
Sustainable Organic Growth
Referrals account for approximately three-quarters of new client acquisition, according to Cerulli, making them the most important source of organic growth. But at many RIAs, founders remain key sources of organic growth. A recent WSR story examined how firms can shift growth from dependence on a founder to systems, processes and multiple rainmakers. Therefore, looking at how or even whether a company wins new clients and lines of business will say more about a firm’s growth engine than mere AUM.
“Sustainable organic growth gives you confidence in what the business can become,” Bicknell said. “When a firm can consistently attract new clients, deepen existing relationships and give advisors the capacity to serve more clients and spend more time with them, you have a much stronger foundation for compounding that growth over time.”
Buyers will closely look at organic growth, along with size and scale, when calculating what a firm is worth, Reynolds said.
“While there are numerous factors that determine a firm’s value, sustainable organic growth is one of the two most important drivers of a firm’s valuation multiple, with the other being the size/scale of the firm,” Reynolds said. “The size/scale of a firm generally puts the value of the firm into a defined range of EBITDA multiples (with larger firms having a higher range than smaller firms), while the organic growth rate of a firm generally determines where within that range a particular firm’s valuation will fall (with faster organic growth causing higher multiples than lower organic growth).”
Meehan said organic growth ultimately reveals how well a firm knows its clients.
“While many seem flustered by organic growth, it really comes down to understanding your client base and the specific services they need,” he said. “There is no trick or tool that will magically turn on organic growth. A clear understanding of this kind of approach, one that centers client value and specialized service, is extremely valuable.”
Along For The Ride
Buyers will pay more for a firm if they know the company’s clients will stick around after a sale. And that tells us a lot about the quality of the firm’s advisors.
“Personal Advisor-Client relationships are critical,” Meehan said. “However, understanding a client’s needs will often help an advisor make this transfer successfully. Our focus on transformational builders – owners of closely held businesses, executives of rapidly growing companies, among others – enables our team to help transfer these kinds of clients seamlessly. A focused service offering makes this process easier.”
Client transferability strengthens a company’s quality, which, in turn, allows the firm to retain more clients, Reynolds said.
“Client transferability’s relationship with firm quality is somewhat circular: increased client transferability causes a firm to be a higher quality, while a higher quality organization increases the transferability of clients,” he said. “When clients are transferrable from one advisor to a successor advisor seamlessly, there are fewer lost clients / asset outflows whenever an advisor retires or departs the firm. This leads to lower annual redemptions, which increases organic net new business.”
“Buyers can measure this by looking at previous advisor transitions and seeing what percent of departing advisors’ books stayed with the business post-transition,” Reynolds said, “and how repeatable was that transition success.”
Leaders And Succession
Assessing leaders and their potential successors can reveal a lot about the company, including factors that impact valuation.
Reynolds said the quality of a firm’s leadership is reflected in its culture, growth, operational efficiency and client satisfaction. Strong leadership, he said, tends to help firms grow faster, attract and retain top talent, deliver higher-quality client service and experience fewer client losses.
For example, Meehan said, what do leaders want to do after a sale? Such information helps reveal their goals and general approach to business.
“First, what do they want out of this sale?” Meehan said. “Are they leaving the business, aiming for growth, positioning themselves in a new market? Answering these questions helps buyers understand the value of the team and what they want to do after the deal. Secondarily, a firm grasp of current management’s business strategy provides meaningful insights into the value of leadership.”
Said Bicknell: “When we evaluate leadership, we want to understand the organization they have built around them including the talent they have developed, the culture they have established and their vision for continued growth. A credible succession plan should already be visible in the business, with future leaders taking meaningful responsibility, developing client relationships and creating opportunities for the next generation to lead and grow.”
Reynolds said buyers can use several factors when evaluating succession plans, including the level of detail in the plan (do advisors have known/named successors), the lead-time before the plan needs to be implemented (are you planning for something years away versus months away) and the track record of previous transitions, including what percentage of clients left or assets were redeemed during those transitions.
Pay To Grow And Share
A firm’s compensation policies can affect its value to a buyer. Meehan said a uniform compensation structure closely aligned with the buyer’s existing plan adds value.
High advisor payouts of 50% or more can still work if they mirror the buyer’s structure, he said. Inconsistent payouts and compensation methodologies that are misaligned with the buyer’s plan can make integration into a unified structure more difficult.
Reynolds said the right compensation policies can effectively motivate advisors to generate more growth, which increases the value of the firm.
“Compensation structures are valuable if they provide market-rate compensation to employees based on role, seniority and revenue produced (if applicable) while providing appropriate alignment for the people responsible for growing the business,” he said. “Common structures include an element of revenue-sharing, either by creating a pool for the client-facing team or by paying advisors a direct percentage of their revenue. Buyers will often include equity or equity-like awards as part of the compensation program, deferring current-pay cash for long-term participation in value-creation.”
Bicknell said the strongest pay packages don’t isolate advisors but integrate their success and expertise into the overall value of the firm.
Such structures connect “individual success with doing what is right for clients and the long-term success of the enterprise,” he said. “We value models that reward growth, retention, collaboration and leadership development. Structures centered too heavily on individual production can make it more difficult to share expertise, deepen client relationships across teams and develop the next generation of leaders.”
Scaling To Growth
“Scalability is directly correlated to enterprise value, in that scalable firms often exhibit faster organic growth, which generally leads to higher valuation multiples,” Reynolds said. “Scalable firms also typically have higher earnings margins and greater margin expansion as the firm grows, which leads to higher earnings and thus higher valuations. Many factors are used to measure scalability, including average client size, revenue per advisor, clients per advisor, clients per client service associate, compensation ratio and EBITDA margin.”
“Scalability directly affects enterprise value. If the Seller’s existing advisor base has limited capacity to grow, Buyers will need to hire incrementally to service new business, weighing on valuation. Conversely, advisor teams with a demonstrated growth track record and capacity to scale — supported by a larger organization’s resources — are more valuable to Buyers,” Meehan said.
Bicknell said AI can help advisors build out their capacity.
“The right infrastructure should allow a firm to grow without adding expenses and complexity at the same rate. We look at productivity, margins, technology and operating capacity, but the real opportunity is creating more capacity for advisors. If technology and AI can take work off their plates and give them more time with clients, we can deliver a more differentiated client experience, serve more people and positively impact more lives.”
Larry Roth is CEO of Wealth Solutions Report and Founder and Managing Partner of Ascentix Partners.
