Regardless of whether you’re thinking about buying a wealth management practice, selling a firm, or just trying to get a handle on the competitive landscape, knowing how to value a wealth management firm is a vital aspect of making informed financial decisions. The wealth management sector has seen rapid growth and consolidation in recent years, making it much more imperative to be correctly valuing a firm.
Wealth management firms have unique models and business practices, which largely differ from other financial services companies. Their value is driven largely by recurring revenue, relationships with clients, compliance with regulations, and the expertise of its advisor team. Learning these particulars is fundamental towards getting to an absolute value.
Key Drivers of Wealth Management Firm Value
Assets Under Management (AUM)
The most basic statistic used in the valuation of wealth management is the firm’s assets under management. AUM measures the total market value of all investments that the firm manages on behalf of its clients. AUM is an important factor in estimating a firm’s revenue, as most wealth management firms earn their revenue in the form of fees that are a percentage of AUM.
When considering AUM, assess both the dollar amount and growth. A firm with growing AUM is typically valued higher than a firm with no growth or declining AUM. Also important to consider the structure of the AUM. Discretionary assets (where the firm has investment authority) are likely to be worth more than advisory (non-discretionary) assets.
Revenue Quality and Predictability
Revenue quality is arguably the most important consideration in determining how to value a wealth management firm. Recurring fee-based revenues are immensely more valuable than transaction-based revenues. Most well-established wealth management firms generate 80 to 95% of their revenues from ongoing management fees, offering predictable cash flows and revenue that institutional buyers appreciate.
The fee structures throughout the industry vary considerably, but the better firms typically charge 0.75% to 1.25% as an annual fee on AUM. Higher fee rates may reflect premium service or specialization, while lower fee rates may reflect competition or more institutional clients.
Client Demographics and Retention
The client base is the most critical aspect of the value of a wealth management firm. Important metrics include client concentration risk, average age of clients, client tenure, and retention. Firms with decentralized client bases (no single client representing greater than 5-10% of AUM) and high annual retention rates (greater than 95% annually) will command premium valuations.
Younger-age client demographics can be particularly valuable, as they represent revenue potential in the longer term. Older-age clients may have larger account balances and market participant rates; they might be at their peak wealth accumulation years. The optimum client demographic balances current profitability with future growth opportunities.
Operational Efficiency and Profitability
Profitability margins vary widely across wealth management firms, generally in the range of 15% to 40% EBITDA margins. Firms with efficient operational processes, good technology infrastructure, and appropriate staffing levels tend to have better margins and valuations.
Key operational metrics include revenue per client, revenue per employee, and overhead ratios. Firms that have invested in technology to automate basic tasks and provide better service to clients generally have better operational efficiency and valuations.
Common Valuation Techniques for Wealth Management Firms
Multiple of Revenue
The most common method for valuing wealth management firms is using a multiple of annual recurring revenue. Typical industry multiples vary from 1.5x to 4.0x annual revenue, based on a number of factors, such as the size of the firm, the growth rate of the firm, the firm’s profitability, and overall market conditions.
Large firms with more than $1 billion AUM often trade at the higher end of this multiple range, while smaller firms and practices typically trade at lower revenue multiples. Firms with strong growth rates, high client retention rates, and large bases of high-net-worth clients typically trade at premium multiples.
Discounted Cash Flow Analysis
Discounted cash flow (DCF) analysis is a rigorous valuation methodology that can be useful when dealing with larger transactions or more complex buyers. DCFs estimate future cash flows. and are based on expected growth of assets under management (AUM), fee schedules, and operating costs. After estimating future revenues and costs, the DCF analysis determines the present value of the cash flow using an appropriate discount rate.
Because DCF analysis allows for the greatest number of different assumptions regarding market conditions, competitive dynamics, and firm-specific circumstances or drivers influencing longer-term impacts, it is regarded as the most robust valuation methodology. However, DCF analyses rely on both a detailed set of financial projections and assumptions that are subject to being incorrect over time.
Comparable Transaction Analysis
In addition to DCFs analyzing the most recent transactions of comparable wealth management businesses also provides market-based valuation standards for the potential acquirer. Comparative transaction analysis focuses on the multiples offered for firms with similar AUM levels, client demographics, geographic markets, and service offerings.
The downside to surveying similar transactions in wealth management is that a large number of transactions are privately negotiated and leave very little public disclosure of the terms or price paid. Industry databases and professional networks can be useful in gathering additional information on similar transactions.
Due Diligence Considerations
Regulatory Compliance
Wealth management firms function under a highly regulated practice area; therefore, compliance history and current regulatory status can be a key part of overall valuation. Buyers should review FINRA records, SEC examinations, customer complaints, and any regulatory issues or fines.
Firms with clean regulatory records, a robust compliance environment, and history with regulators will enjoy higher valuations while firms with regulatory issues may be discounted or present difficulties in the deal process.
Technology Infrastructure
Sophisticated technology platforms manage portfolios, client reporting, compliance monitoring, and customer relationship management in today’s wealth management environment. Acquisition of a wealth management firm with obsolete systems may require significant investment of funds or time as part of an overall transition after an acquisition will have an effect on valuation.
Cloud-based platforms, integrated solutions, and modern client portals all convey some form of value to the acquiring firm because they improve operational efficiencies and enhance the client experience. Technology infrastructure is also very important because client expectations are shifting as well.
Key Person Risk
Many wealth management businesses rely on one or a handful of key people for client relationships and business development. This creates “key person risk,” which can severely impact valuation.
Acquirers of wealth management businesses generally want firms with distributed client relationships, documented client engagement processes, and succession planning that makes the firm less reliant on one or a few key people. Firms that have been able to institutionalize client relationships tend to receive higher valuations.
Market and Demographic Trends Impacting Valuation
The wealth management industry is undergoing consolidation as larger firms purchase smaller practices to add scalability and expand geographically. This trend has generally driven higher valuation levels, especially for firms positioned well in the segement.
Demographic trends such as the aging of baby boomers and the upcoming generational transfer of wealth to younger generations, present both challenges and opportunities for wealth management firms. Successful adaptation to the changing client needs and preferences are supporting growing valuation levels.
Valuation factors are increasingly tied to technology adoption and digital transformation. Firms that embrace technology but still provide high-touch client service tend to produce higher valuation outcomes.
Conclusion
Understanding the elements of the wealth management industry, from recurring revenue streams and the nature of client relationships to regulatory aspects, is vital to a proper valuation of a wealth management firm. While there are a variety of approaches to valuing a firm, the best valuations will weigh quantitative assessments and qualitative characteristics that are unique to each firm.
Diligence, sound assumptions concerning future annual cash flows, and awareness of market conditions will determine the success of your valuations; whether you are purchasing or selling, it is important to enlist the support of specialists in wealth management, your valuation success could hinge on their recommendations.
As long as the industry contemplates innovation across technology, regulatory frameworks and client expectations investment valuations will be subject to evolution, thus, remaining perceptive to market trends and best practices will always be critical in performing firm valuations within the industry.