Forte Asset Solutions
The expertise of Forte is forged from the personal experience of Steve Prendeville selling his own national Dealer Group and Financial Planning Business Deloitte Financial Services in 2001 when he was a partner of Deloitte Touche Tohmatsu. Steve was the founding partner of Kenyon Prendeville in 2003 and in May 2011 Steve sought to evolve the business model to the next level and created Forte Asset Solutions.
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Forte Asset Solutions
Tel: 1300 858 996
2011 Market Commentary:
The last 6 months of 2011 was the most volatile from a price perspective ever seen in my 9 years of facilitating business sales, with the greatest spread from Indicative Offers to final negotiated acceptance.
• Market sentiment moved with each release of FOFA and subsequent press release.
• Sentiment was largely negative and certainly cautious until early November.
• Offers on good profitable businesses with A and B class clients in metropolitan locations were as low as 2.2 times (more reflective of a business in administration or liquidation). These low offers were rejected outright and not accepted.
• In many cases the market closely reflected the current property market where vendors rejected offers preferring to wait for improved market conditions and more commercial offers.
• A dichotomy of value was created with C and D client book selling with similar or even higher multiples than full business sales.
• An institutional war is being waged for books to retain and recruit advisers and this is supporting book sale prices, plus the attractiveness of just picking up a small book and putting in into the existing infrastructure with no personnel and business costs being transferred over.
• The average multiple of recurring revenue achieved for the 6 month period ending December was 2.88 times.
• Combined with the first 6 month average of 3.2 times in 2011, the calendar year 2011 delivered 3.04 times recurring revenue.
• The 12 month period for the financial year 2010/11 was 3.29 – 12% higher.
• The average Australian financial planning business therefore fell in value by $144,000.
• This discount is unlikely to be repeated with multiples recovering in late 2011 anticipating the continuation of volume overrides in some shape or form.
• There is an expectation of greater cost of delivery well above the $11 nominated by the Government and this is very likely to be passed to the consumer.
• Buyers are generally confident with their own value proposition.
• They do not see a fee increase posing a problem in relation to client retention or new client generation.
• Advisers recognise they need greater size and scale to maintain profitability and to compete and this is fuelling buyer demand.
• The price variation from the low offers received and the subsequent accepted offer extended negotiations and increased the average duration of a transaction from 4/6 months out to 9 months, the longest gestation period ever seen.
• Substantial negotiation was required and often revenue was segmented and different multiples applied to them.
• This extended settlement timeframe was also due to more time spent on due diligence with an increased focus on risk mitigation, especially in the area of product exposure.
• Contributing to the extended timeframes was the buyers’ requirement for substantially more information and modelling be provided to the banks. Greater focus has been on business models in a FOFA environment and free cash flow after debt servicing.
• Compounding the settlement timeframe for sellers was that the banks were dealing with internal bottlenecks and service delivery issues given the increased refinancing and demand for new overdrafts and business loans from financial planners, but to be fair this was a small contributing factor.
• The press and industry advocates have been seeking commentary from Forte linking FOFA to increased sales and wanting to point to the potential devastation due to the government’s proposed actions, and the legislative uncertainty has certainly lead to the above anomaly in what multiples have been offered in the six month reported period.
• Forte’s view is FOFA is primarily responsible for business or multiple/times devaluation over the last 6 months but at best it is only a contributing factor and not the primary reason for principles selling.
• The corporate super sector has however been devastated with valuations halving from 3 times to 1.5 times recurring revenue since the release of The Ripol Report and not recovering, and being predominately withdrawn from the market totally as no vendor seeks to sell at these levels.
• There is no mass exodus from the industry, nor does Forte expect there to be due to FOFA solely and whilst we do expect further job losses in the financial services sector in 2012, the primary reason for sales and job losses is the economic and market volatility and the absence of new business generation.
• There is no doubt many advisors are disillusioned with the industry but this is less to do with FOFA concerns and is more due to continually being the deliverer of bad news and dealing with the stress imposed on clients, staff and themselves.
• Sellers over the 12 months have been predominately in their 40’s and their reason for sale is debt consolidation or lifestyle, as take home remuneration has not reached pre 2008 levels.
• Retirements have been delayed, health allowing, as mature age principles have seen the diminution of their superannuation as well as business values with the fall of recurring revenue linked to FUM.
• If we have a sustained recovery in financial markets we will see an increase in supply due to this deferral and the potential market overhang which may have price implications in the future.
The best thing that can be said for 2011 is its over but the general consensus is we are likely to have another year as difficult or even more difficult, with the known challenges posed by European sovereign debt, credit ratings, geo political machinations and global recessionary concerns likely to dominate.
• With regards to practice valuations we hope to see the deferral of the FOFA start dates from July 1 2012 to 2013 and as above they will remain a contributing factor to buyer considerations. The key determinate to value is still supply and demand and we expect the historical equilibrium to be maintained.
• There is an expectation of further interest rates cuts as the Reserve bank sees the slowing of the non mining economy and this will assist buyers.
• Overall what we are seeing are better businesses as all principles have been forced to review their business models.
• Growing focus on profit or use of EBIT valuations for full business sales.
• A FOFA concern is that any grand fathering of opt in will cease if there is a licensee change. This may have valuation impacts as buyers will look to acquire within their dealerships and therefore a reduced market for vendors to sell rather than going to the whole market. Additionally if the business is taken to open market a discount maybe applied to inactive clients.
• Financial Planning businesses have been consideration recession proof as they are beneficiaries of ETP’s requiring advise, but if this stagnation of business activity continues we will continue to see demand be maintained due to the lack of organic growth and the need for scale.
• As all market participants know it is inherently difficult to market time and the time to sell is before you have mentally walked away from the business. If principles are “hanging in there” waiting for improvement it is more than likely they will experience value lose due to client and/or staff defection or compliance failure as a principle must be continually vigilant. Forte recommends principles do a personal inventory and assess if they have the energy to grow the business and if so stay, but if the aspiration is to maintain the status quo and wait it out it is probable best to sell and go now.
Business Valuation in a FOFA Regime :
FOFA AND BUSINESS VALUE
Whilst the debate rages regarding the final form of the FOFA changes and the timing of implementation may have to move from July 2012 the political agenda is set and if you do not adjust your business to comply with the new environment you will find your practice less competitive and of lesser current or future value.
The proposed changes for advice related licensees can be summarised as follows:
• the adviser must give priority to a client’s interests where a conflict arises
• the adviser is required to act in the best interest of the client – with minimum steps that must be taken
• a general ban on commissions paid to licensees
• commissions on insurance through superannuation banned
• volume based benefits paid to a licensee are banned
• volume based payments to advisers by a licensee are banned
• a product provider must not provide conflicted remuneration to a licensee or representative
• a general ban on licensees & representatives receiving soft dollar benefits
• a ban on licensees charging asset based fees on borrowed amounts
• licensees will be required to provide annual statements to clients showing fees and services with a biennial requirement for the client to “opt in” to continue with the services
• advice can be scaled for retail clients
Note : there are exceptions to a number of the changes shown above that are not relevant for the purposes of this article.
Disregarding the politics involved and the “grey” nature of the final form of the current proposals, there are 10 recommendations that you should consider for your practice in order to improve and maintain its value.
BANNING OF COMMISSIONS
One of the key tenants of the legislation is the removal of commissions and the relationship between the manufacturer and the adviser.
The first recommendation for maintaining or improving business value is to move your business to a fee based model at your earliest opportunity. . In almost all cases this has lead to enhanced revenue and client engagement.
VOLUME BASED PAYMENTS
The second recommendation is that whether volume based payments are deemed to be conflicted revenue or not and whether they will be able to be received in the future directly by the practice or not, they must be considered at risk. There is some grandfathering of existing volume payments, however as they are capped they are likely to diminish over time. There is also the question as to whether a capped volume payment will continue to be paid if a business or client base is sold to another licensee.
Any practice receiving volume based payments need to reduce their dependency on this revenue stream and if your clients are not aware of the subsidization of your service offer because of the existence of the volume override they need to be. The client needs to understand and accept that if volume based payments are removed then they may be asked to pay more for the same service.
This brings into question the perceived value for service that you currently present to your clients and what that value proposition should look like in the future.
Apart from the change from commission based to fee based charges, the “opt-in” requirement will require licensees to firstly think through their approach to providing advice and then look at documenting that in a way that clearly articulates their service offering to the client.
Those licensees that do not have a clearly defined service offering which all clients participate in will receive a lower valuation.
The government appears determined to force through this wonderful example of over engineering. The initial suggestions that the cost of satisfying the opt-in requirements would be $11 per client are laughable. Almost all the cost analysis thus far have been generated by the product providers, which is of course limited to their product.
Bear in mind that the licensee is required to advise the client of the services that they received during the previous 12 months – this may include such things as assistance with any or all of the following;
• formulating a budget
• a centrelink application
• chasing lost super
• hand holding in a market downturn
• acting as a sounding board for discussion of general finance issues
• submitting an insurance claim
• estate planning
• legislative changes that might affect clients
and many other intangible services – but it is the intangible services such as those above that clients tend to value the most.
Unfortunately details of these services are not recorded on a system, at best they are contained in individual file notes within the client file.
Clearly each licensee will need to develop a process for extracting this information so that the client can be reminded of the range of valuable services provided.
Any business with strong processes, particularly for retaining clients, will be valued more highly.
ADD VALUE TO THE SERVICE OFFERING
High value practices in the current environment, with little new investment other than cash are focusing on alternative areas to add value, such as ensuring a current last will and testament and estate planning
Additionally after the fire and flood disasters experienced across Australia many are offering full document archiving and storage e.g. SMSF Trust Deed, life insurance policies, all investment plans and tax information plus family photo’s in secure online electronic storage facilities. An audit against a checklist can be done of what should be stored and what is missing and needs to be addressed and created. Additionally full reviews are being done with many clients reassessing previous risk profiles and requiring new portfolio adjustment.
We have seen the movement of many practices and Dealer Groups for greater participation along the value chain. This is moving from purely advice to administration, portfolio creation and research. This is being enabled by the new technology of IMA’s, MDA’s and SMA’s and the ability to outsource to specialists whilst still reducing costs to the client but increasing revenue participation.
RE EVALUATE PERSONAL RISK BUSINESS
One area that has seen a repricing upwards is Personal Risk. Risk practices demand a premium of 3.5 times or greater. There are a number of reasons for this, the robust nature of the revenue stream, it is not subject to market movements and appears at least for the moment to be free of legislative risk, the exception being corporate superannuation.
RE EVALUATE CORPORATE SUPERANNUATION
Corporate Superannuation revenue has collapsed since FOFA announcements and there is little seller or buyer interest. The last offer on a corporate superannuation book received was at 1.5 times and the disappointed vendor felt that the revenue would continue beyond 18 months and therefore decided to hold it as an annuity stream.
However there has been significant work done in this area and those practices that specialised in this area have moved from commission to fee for service on a member basis and in most cases have experienced enhanced revenue streams and it is felt confidence will return to this part of the market once legislation is known and it is discovered that the world of corporate superannuation has not ceased.
The real positive is that now members are being serviced, relationships are being built through service delivery, the competitive pressure of industry funds addressed and the revenue stream is not only not at risk but promises cross selling opportunities.
For any practice who has not addressed their corporate superannuation remuneration model they need to do so immediately and as a result a practice is likely to experience a 100% increase in valuations on this revenue stream by moving to a fee for service. However there needs to be the delivery of service and this requires in many cases product change and in some cases additional resourcing.
SERVICE & CLIENT SEGMENTATION
This value relationship is normally evident when service segmentation is in place, where multi service packages are offered and are clearly defined by offer and pricing.
Whilst industry practice has seen most fees as a percentage of FUM or FUA if you seek to improve your business value, set fees that attract a higher valuation. The reason is, if the fees are not held hostage to economic, market or product performance but solely on service delivery, the revenue is more secure and a known profitability or margin per client service segmentation is evident and ongoing.
Greater knowledge of client demographics- age, location and the ability to articulate the quality of the client base and the ability to “drill down” or “cut and dice” your electronic Client Management System the better. Any investment in this area will normally bring great dividends. Your CMS should be able provide you all contact dates, diary notes but also be able to supply birth dates, location, type of employment, remuneration, marital status, age of kids, professional relationships ( accountant, lawyer), hobbies, sport preferences, club affiliations etc it is with this level of transparency that your database becomes valuable. Any prospective purchaser can immediately see the quality of your clients but also your marketing and communication activities can now be specific and not just general in nature.
As will enhanced management tools – cash flow management and projection, business and marketing plans and the ability to segment FUM – by product, platform, superannuation, investment, risk, allocated pension etc. The need for this information will be critical in any assessment of a prospective buyer but will also assist management of a better business until the time for realisation.
FOCUS ON PROFITABILITY
Profitable businesses are being awarded higher multiples of recurring revenue and if or when there is the removal of volume overrides we may see greater use of EBIT valuations than ever before. There needs to be a focus on profitability and to maintain current recurring revenue valuations in the average business you need to be operating at above 35% EBIT to gross revenue to achieve pricing convergence ( 3 times Recurring revenue = 6 times adjusted EBIT).
An example may assist- a business with a Gross Revenue of $500k and a Recurring Revenue of $400k and an Adjusted EBIT of $200k ( 40% to Gross Revenue) on a Recurring Revenue multiple of 3 the value is $1.2m on an EBIT multiple of 6 times you achieve $1.2m and price convergence.
The issue with this example is the difficulty in achieving a 40% Adjusted EBIT without compromises service delivery. The adjustments to EBIT are the acceptance of a principles salary in capital cities of $120,000 and therefore if drawings have been $200k then $80k is added to EBIT. Additionally any one of expenses or personal expenditure such as travel, car leases, and insurance is also added back. The assumption is if the principle is not there then a senior adviser would need to be employed and what would the cost structure be.
GENERATE NEW BUSINESS
Premiums are being paid for practices that are generating new business, which are a minority in the current environment but some are actually growing against significant head winds. Those that are growing are doing so because of their value proposition gaining client and referral acceptance, especially from new accounting relationships.
The reason for greater acceptance from accountant’s is the limitations imposed on their own service offer, the acceptance of risk regarding product failure and impact to client relationships, the fundamental acceptance and alignment with fee for service and also the need for financial planning advice in the SMSF arena and the acknowledgement of cross over referral relationships. Practice Principles need to think of how they grew their business in the early days and get back to business development activities.
Compliance has and will always be the core of any businesses assessment and constant vigilance must be maintained. Good compliance is just good business as no one wants to buy your problems. Annual audits are essential and any recommendations made need to be enacted. Principles want good, clean businesses – it enables sleep but that is also what dealers, clients and purchasers want as well. Compliance has also moved into product selection with many closed or failed investments which could potentially lead to future claims and the more generic or main stream the advice and mangers selected the more comfort is achieved by purchasers.
All Licensees have had to review their business models and look especially at how to improve client engagement and by doing so they will improve business value. This introspection may have been born from FOFA proposals but if changes are made valuations will reflect this positively.
We currently have or will have better serviced and engaged clients, better business models and better managed and compliant businesses and with increased barriers to entry there is every reason to be confident on value maintenance or improvement in the FOFA regime and beyond.