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Valuing An Oddball Advisory Business

A sole proprietor of an RIA who caters to an unusual niche—law enforcement professionals—is toying with the idea of selling his business. But he’s flummoxed about just how to value his idiosyncratic practice and the best way to find a buyer. We asked our panel of experts for their advice: Chip Roame, Hellen Davis, and Philip Palaveev.

A sole proprietor of an RIA who caters to an unusual niche—law enforcement professionals—is toying with the idea of selling his business. But he’s flummoxed about just how to value his idiosyncratic practice and the best way to find a buyer. We asked our panel of experts for their advice: Chip Roame, Hellen Davis, and Philip Palaveev.

The situation:

Howard Kapper started his career in the 70’s as a commercial and industrial real estate broker in Milwaukee. But that was a time of sky-high interest rates and Kapper decided after a year or two to seek greener pastures. His next move was to join an insurance company where his father worked. For several years they worked together; then, Kapper ventured out on his own, eventually concentrating on high net worth and small business customers. He mostly sold insurance, with about 20 percent of his business coming from mutual funds.

That changed in the late 90’s, when Kapper got to thinking it was time for a change. He was tired, he realized, of trying to sell something “people didn’t really want,” he says. “I wanted to be on the other side of the equation.” The answer, he figured, was to transform his practice into a financial planning firm focused on investments, not insurance.

That’s easier said than done, of course. What type of clients should he target? And how to market the recast practice? For help, Kapper took a course on marketing run by a local expert. In the process, he zeroed in on an unusual niche: firefighters, police and other law enforcement professionals. Back in the early 90’s, he’d taken up competitive pistol shooting, practicing a couple of hours a week. Gradually, he got to know many of the guys who also hung out at the range; most of them worked in the area of law enforcement. And, as he worked to identify his ideal clients, “It dawned on me that this was a very underserved market,” he says. Indeed, despite the fact that his pals had solid pension plans, they were still very concerned about their retirement. In 2000, the federal government passed a law allowing public service employees to invest their retirement plans as they wished. Kapper realized the time was right to make his move.

To reach prospective clients, Kapper started exhibiting at trade shows and conferences and holding classes. Prospects were wary, at first. “These people are very careful,” he says. “I learned they really checked me out.” But, gradually, his practice grew into a firm with what Kapper describes as a “fiercely loyal” clientele who appreciate his understanding of their concerns and who, he says, “abhor debt and are terrific savers.”

Still, the business is mostly transaction based, because the average account size is too small to charge a fee in many cases. The “average ticket size” is $100,000, says Kapper. Assets are around $12 million.

After several decades in the workforce, Kapper is thinking of selling his practice and hopes to do so over the next three to four years. But, thanks to the idiosyncratic nature of his business, he’s unsure of his next step. For one thing, he doesn’t know how to come up with a realistic value for the firm. How to account for a firm with a small book of business, but a highly loyal clientele often overlooked by competitors? “How do you put a number on client loyalty?” he says.

What’s more, there’s the matter of how to find the right buyer. To that end, Kapper recently contacted his b/d, letting them know he wanted to cultivate a working relationship with a younger advisor. But he’s unsure what his next step should be.

The advice:

Chip Roame:
I’m a big fan of niche marketing as long as you’re doing it right. You can tell whether that is the case in a few ways. Is he getting a lot more referrals than the typical advisor from policeman and other people in his niche? Does he have a better chance of closing than the usual advisor? If he’s really an expert, then he should close every policeman who walks in to his office. And, are his costs to serve them lower relative to those of another advisor? If you serve 30 people from the same police force, what is it you don’t know about the 31rst?

If he can answer “yes” to these questions, then his niche business should be worth a lot more than a regular business.

He has a few ways to go about finding a buyer. The best and easiest is to transition within his b/d. The next is to transition within his clearing broker, so he doesn’t have to pay to transfer accounts. The worst case is to sell to an advisor at a different b/d using a different clearing firm because then they’d have to write to every single client and get their approval.

He’s not going to just get a big check from a buyer and walk out the door. What he might find is a younger rep who gives him a chunk of money every year for three to five to ten years. He’d stick around for that time and slowly phase himself out, making sure his clients are still there when he departs. In that case, the value will be in the discounted cash flow of his future business.

He also has two choices for the kind of buyer he selects. He can find a failed broker with potential on the street. If I’m a guy who tried to make it at Merrill Lynch and someone tells me you can take over my business, I’m likely to be interested. Or he can find a younger broker who preferably is affiliated with his b/d and is looking for a way to expand.

Hellen Davis:
If clients really are so loyal and they’re slow to trust, he’s going to have a hard time. He has to bring someone in as soon as possible to take over the business incrementally and he’s going to have to stay there for three to five years. He may have to stay forever as a figure head, popping in once or twice a month. I really worry he’s starting this too late.

Because of his niche, the fact that the practice is largely transaction–based and because he provides a lot of service, it’s going to be hard to find a buyer. What he may have to do is hire someone at around $40,000 a year to conduct the transactions and let the practice die a slow death. He’ll meet with clients once a year, set up his annual review maybe in January, April and October. He won’t take on any new clients. Eventually, people will retire or leave him. In five years the business will wind down.

Or he can merge his practice with another one. Find an accounting firm in that marketplace or a small boutique financial planning firm and merge with it, instead of trying to find a younger person to come in, which I think would be just about impossible. He’d look for like-minded people, perhaps advisors who deal with public service employees, teachers or ministers and so on.

Philip Palaveev:
Generally, you value a practice based on a few considerations: profitability, cash flow and whether it’s transferable. That is, can the business owner pass it on to someone who will enjoy the practice as much as he has and can absorb the cash flow? Also important is what the potential is beyond current cash flow. Is the practice going to grow? Are clients going to go away? Can you attract more clients from that niche?

Of course, we can’t answer the profitability question without a look at the financials. You need a detailed analysis of revenue, the expense structure and cash flow. Perhaps the biggest question is transferability. How do you transfer a practice in which clients are so loyal? The buyer needs to be someone with a similar profile to the proprietor. Somebody who is not necessarily a gun enthusiast, but fits the culture of that niche. That might make it harder to find the right advisor.

The logical avenue for finding someone is through his b/d. Perhaps his b/d can help him market the practice. Also, if the buyer has to move accounts from one b/d to another, it’s not a tremendous complication, but it is a complication

Aside from working with his b/d, I would recommend he start asking around. Are there other financial advisors in his community who would fit? He needs to network. And it’s not unheard of to send out a letter using an intermediary saying we have a practice for sale.

But, this business is transaction-based. Generally speaking, transaction-based practices are valued less than fee-based practices, on a dollar for dollar basis. Also, it seems the average client size is smaller than that of the average practice. Smaller practices with smaller clients receive lower valuations than practices with larger clients, dollar for dollar.

Still, the fact that the practice is transactional could be as much a strength as a weakness, providing it with strong potential growth. A good practice will always find a buyer.

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