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Written by: Micah Shilanski
I’m pretty sure my practice is worth $1 billion. Why? Because I like it and it’s mine.
Unfortunately, we can’t base the worth of our practice on how much we love it, although the numbers we see thrown around sure look that way.
Knowing your practice’s actual worth, not the emotional worth, can help you make better business decisions and give you measurable success metrics.
While you might not be in the market to sell your practice, practice valuation is something that we all need to be aware of for several reasons:
- You should know the value of your estate for tax planning.
- Practice valuation helps you know how much life insurance you need in contingency planning.
- Maybe, someday down the road, you may want to sell your practice.
Ultimately, knowing how to value your practice boils down to giving you a benchmark so you can measure your growth. And I hate to break it to you, but your practice isn’t worth a billion dollars simply because you’ve banked your entire retirement on a massive payout after selling.
Here are a few essential things to consider when evaluating your firm.
Actual numbers don’t lie
One of the first things I always want to consider is whether this business pays for itself.
Where’s the value I’m getting from this business? And If I can’t find it on the P&L, is there any value there?
See, this is where folks get sucked into timeshare presentations, vacation rentals, and, yes, even buying and selling IRAs. The people selling will always claim they make money, and potential buyers find themselves drawn into the allure of the dollar signs.
When I’ve asked the realtor for tax returns on that hotspot vacation rental, I get ghosted because the actual numbers don’t lie—the rental isn’t doing as well as they claimed.
The same thing can happen in evaluating practices.
We hear from somebody who heard from somebody else that they know a guy who sold for absurd multiples of their practice’s worth. And yet there’s not much to show for these so-called “deals”—probably because it didn’t actually happen.
To understand how much a practice valuation is, you’ll need to study real deals, not theoretical ones.
Practice valuations are 100% made up
Practice valuations seem entirely made up because actual data never backs these numbers.
Often, I’ve found that when an advisor is selling for retirement, the value of his practice is precisely the amount he wants to retire on, which seems horribly convenient.
If you want an accurate bead on how much a practice is worth, ask a lender what they lend on. The lenders are the ones who stick around for the deal long after the consultants take their checks and leave. You see, the lenders have to see the agreement all the way through.
The lenders won’t tell you how much a practice is worth but can provide a formula for lending that you can use to do a valuation. I can take that formula, plug in the numbers and see if this practice pays for itself.
Study real deals
We’ve all heard numbers thrown around about how much our practices are worth. But if you want to learn about the value of actual practices, study what existing practices are being bought and sold for. As you walk down this path, you’ll learn much about the changes you can make in your practice.
You’ll start looking at these deals and asking yourself: What would I do if I were to sell?
This will force you to start looking into the deep corners of your practice for things to clean up. We all have junk kicked under the couch or cobwebs that must be swept. I’m not talking about compliance issues, just little things we haven’t refined yet. Stuff you keep putting off for later must be fixed if you sell.
It’s a good idea to clean up these inefficiencies now to make your practice smoother.
But I’m not selling
Okay, so you may have no interest in selling. That’s fair, but you must know what to measure in your practice to mark your progress.
Of course, you can look at your ADV and get a general idea from your AUM, but there are other metrics you can use.
- Are you counting your days off this year?
- Do you know your revenue for last year—down to the last penny?
- How many households do you serve?
Sure, you probably know an “ish” value off the top of your head, but I can’t stress the value of digging into your actual numbers enough.
Third-party verification
When it’s time to review your real numbers, have someone else pull up your Quickbooks, client books, tax returns, and other documents you use to track these things. We’re too biased to deal with our financials.
I don’t know about you, but I’m way more inclined to pick apart someone else’s numbers than I am with my own. By having someone else gather these metrics, I can evaluate them impartially.
For example, I know advisors who will argue all day that their fee is 1.75%; however, when we took a fine-toothed comb to their tax returns, we found they were making closer to 0.6%.
Unfortunately, it’s too easy to get caught up in the story you’re telling yourself, and it’s painful to realize that the story you’ve been telling is far removed from reality. Intentionally or not, these advisors have been lying to themselves, their spouse, and their team.
Track your numbers not only to help you stay out of your own Kool-Aid but also to have an honest gauge of your progress and worth.
Action Items
- Create a system to gather your vital metrics from a third party, such as an employee or your bookkeeper.
- Register today for our TPR Nation 5 Symptoms of the ONE BIG Mistake That Is Holding You Back Power Session on March 29, 2023, at 9 am PST.
Related: Advisors: Don't Overlook This Part of the Prospect Process