Key Levers That Impact Your Business Value

Many factors can influence a firm’s EV, including size, human capital growth prospects, profitability, and EBTDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) growth, market conditions, and more.

Whatever the stage of the owner’s career or goals for the business, using Enterprise Value as a North Star can help prioritize the areas of the business to focus on as a management team. Growing the value of an advisory firm can:

• Ensure long-term sustainability and growth
• Sustain or enhance competitive positioning in a changing market
• Improve financial performance and profitability
• Attract potential buyers and increase your leverage position

RIAs, wealth management firms, and retirement planning businesses have a variety of growth levers to pull, but strategic planning (pulling the right levers at the right times) will significantly impact terminal value and their ability to achieve business objectives and goals. In addition to, and as components of strategic planning, other growth levers that can impact the value of a business include,

• Broadening the ownership group
• Minimizing key person dependency
• Strategically driving profit and revenue

Before we examine these growth levers, however, let’s consider how the value of your business is determined.

Internal vs. External Valuations: Understanding the Difference and When to Use Them

A common misconception is that business valuations are only necessary when selling, merging, or seeking investments. In fact, according to M&T Bank, 98% of small businesses surveyed over two years didn’t know their company’s value.¹ It’s exceedingly rare for business owners, even those looking to exit, to be able to quickly articulate the value of their business. If you are one who can, you’re in the minority in the wealth management world. Beyond solely determining business value, valuations are powerful business tools and should be used in strategic planning, equity distribution strategy, internal perpetuation planning, acquisition planning, and ultimately, exit planning. There are two types of value to use when managing your business: internal and external. The two can differ significantly, so let’s break it down.

Internal Valuation

Internal value reflects the value “internal to the business” of your shares and can be used in line with your operating agreement, in determining how to buy out exiting advisors or shareholders, or in setting a value for second- and third-generation ownership to buy out existing owners.

Compared to external value, the delta can be significant and often ends up between 40% and 60% below market value in a transaction. The reasons for this are numerous, ranging from the standard LOC/LOM applications to this value, hard-coded operating agreements set years in advance, internal buyer’s inability to finance large amounts of a purchase, and more.

As such, it’s necessary to have two key components to ensure success in implementing an equity distribution strategy:

1. Time: Successful programs are often implemented 7-10 years in advance of any internal transition.
2. Management Mindset: Internal transitions of equity will not yield the highest short-term monetary value to shareholders.

External Valuation

External value, or strategic value, is a market-based assessment reflective of the business’s value in the market today. With the influx of capital over the last 7+ years and a large, motivated group of potential acquirers, external values have found themselves steadily rising. The most common application for a strategic valuation is for the external sale of the business, though this is also a key component of acquisition strategy planning for firms.

Applications for Business Values in Strategic Planning

The combination of these two values—whether performed by an outside party or internally by your own management—should be a tool to help drive your business forward. By pairing the internal (to support critical aspects and internal planning) and external (as a real-time indicator of market value and whether your firm is following market best practices), your team will be poised to continue growth long-term.

Key Growth Levers to Maximize Business Value

Broadening Your Ownership Group

One of the biggest mistakes owners often make is having an unwillingness to expand their ownership group. While it’s true that you’ll own a smaller portion of a highly valuable business, ultimately, a broader ownership pool can increase growth and the value of the business overall. Think of it this way: Would you rather own 100 percent of a grape or a smaller percentage of a watermelon? This strategy can drive long-term stability for a business while, driving growth in EV.

A Strategic Approach to Equity Expansion

Ninety-five percent of HR leaders and 80% of employees agree that equity compensation is a powerful driver of motivation and engagement.² Expanding ownership among key employees fosters growth by incentivizing them to think and act like owners. The result is often a collective commitment—a culture where everyone is rowing the same boat in the same direction. In that same vein, this strategy can also minimize the risks of losing key employees. Being part owners, key employees and top performers are more likely to stay, help grow the business, and become comfortable with the risk inherent with owing a business – a key to any internal perpetuation plans.

The Value of Equity Distribution for Owners Selling a Business

One detail that few owners consider is that not only can they increase value for employees and partners by expanding ownership. With acquisitions evaluated on a risk basis, an aligned organization can command a premium. This structure not only allows larger portions of the firm to benefit in a sale, but also allows for those key people to have access to the same tax-advantaged treatment of proceeds. These potential tax savings make the deal more lucrative, the process of transitioning your team to the right partner/acquirer more seamless, and alignment post-transaction more concrete, creating a valuation lift.

Minimizing Key Person Dependency

Business owners typically know the composition of their book of business — ages of clients, percentage of revenue per client, etc. — but it’s rare that they evaluate their advisors in the same way. Consider, for example, a firm with a client that comprises 10% of its revenue; this poses a significant risk. Likewise, when viewing a firm that’s overly reliant on a limited number of advisors for new client growth, business management or client service, buyers quickly identify this key person dependency. Consequently, the overall value of your business could be affected. For firms with this issue, it’s not uncommon to take a hit of 15%, 20% or more on the company’s valuation.³ This is often referred to as the “key person discount.”

Identifying Key Person Dependency

To help determine if your firm has a key person dependency issue, you can conduct a simple key person risk assessment. Consider the following questions.

1. Are there any key individuals for whom it would be difficult to quickly find a suitable replacement? (Consider top advisors or individuals that have specialized knowledge.)
2. To what extent would this individual’s absence disrupt business continuity, daily operations, client relations, etc.?

For wealth advisory and retirement planning firms, this key person is often a top advisor, and/or in many instances, the business owner themselves.

Strategies to Incorporate

Here are a few strategies to incorporate to help minimize any key person dependencies in your organization.

• Create leverage for the organization, not just 1 or 2 advisors.
  • Aim to strategically build layers of production. Develop future management with a healthy age distribution and build advisor teams with a structure intentionally designed to scale.
• (Actually) Develop your next-generation leaders/owners.
  • Don’t just hire younger people; constantly identify and train leadership and management. Succession is more than just a money equation — leadership must be cultivated.
• Build a growth engine.
  • Measure where new business comes from, and invest in the people, technologies, and marketing to reduce your business’s reliance on a single “producer,” market growth, or client referrals.

Identifying key person dependencies is an issue many firms overlook. However, proactively identifying and minimizing dependencies can enhance the stability and resilience—and, thus, the value—of an organization. 

Strategically Driving Profit and Revenue

In the active merger and acquisition (M&A) market that exists throughout the wealth management space, it’s worthwhile to identify what metrics really matter in today’s deals: Revenue or profit margin. Consider first a key distinction between the two.

• Revenue: A top-line metric reflecting total sales income before expenses. It can indicate business growth and market demand.
• Profit: A bottom-line metric showing the total financial gain after all expenses are deducted. It is an indicator for efficiency and business health.

Revenue Considerations

Revenue size is key. It is the primary driver of multiple expansion. The bigger the business, the greater the value, implied market position and assumed growth potential. For this reason, driving revenue is a better focus than trying to optimize for profit, which can create an artificially high margin.

Profit Considerations for Business Valuation

While revenue drives margin expansion in a deal, profit margin (expressed as pro forma EBITDA) is what’s being multiplied. It is possible to find deals expressed as a function of revenue, but there isn’t a professional acquirer in any industry that is not using EBITDA as the ultimate measure.

Balancing Revenue and Profit

If you’re looking to maximize the value of your business, there isn’t one measure more important than the other. Building the largest business that grows in the double digits annually, has capacity to continue to do so, and has a healthy margin that reflects reinvestment is preferable versus attempts to maximize cash flow and create an inflated profit margin.

Creating Leverage for Advisors

MarshBerry is uniquely positioned to help advisors understand the value of their business and the strategies they can employ to grow, retain independence, and maximize that value. If you need strategic guidance for achieving your business objectives, contact MarshBerry Vice President, Rob Madore today.

Investment banking services in the USA offered through MarshBerry Capital, LLC, Member FINRA and SIPC, and an affiliate of Marsh, Berry & Company, LLC, 28601 Chagrin Blvd, Suite 400, Woodmere, OH 44122 (440) 354-3230.
Marsh, Berry & Co., LLC and MarshBerry Capital, LLC do not provide tax or legal advice. Tax and legal professionals should be consulted separately before making any decisions that may have tax or legal ramifications. Any references to tax implications in this presentation should not be interpreted as the provision of tax advice.