Predicting Cash-Out Value to Encourage Timely Succession Planning: The New Fortune TellingChia-Li Chien
Chia-Li Chien, PhD, CFP®, PMP® Jan. 20, 2018
When I was born, my maternal grandmother went to a well-known fortune teller and obtained a prediction of my life. The forecast of my life included predictions of what I would be as a professional, what my life would look like, when I would get married, and so forth. When I was in my mid-thirties, my mom revealed the prediction to me. I have to say that the prediction was generally accurate.
If there was a fortune teller to show financial planning practitioners what their retirement would look like, perhaps there would be an increase in willingness to plan for their succession. In the Nov. 2017 issue of the Journal of Financial Planning, PWC reported that “50% of business owners claim to have a succession plan” in place, but there are only “16% of business owners who actually have a documented succession plan in place.” In her April 2017 article, “Overcome succession planning paralysis” in Financial-Planning.com, Kelli Cruz concluded that the reason for the succession paralysis in financial planning practitioners is not about planning business itself, but about owners’ fear of diminishing their own social status upon exiting. What practitioners may not know is that there are planning tools to determine a business’s market value while there is still time to change the outcome.
Determining Market Value
There are different ways to obtain the market value of the financial planning practitioners’ business. In my March 2017 research “Selling a Planning Practice: The Relationship between Revenue Multiple and Revenue Size,” published in the Journal of Financial Planning, I identified several “rules of thumb” regarding selling multiples for the financial planning businesses. On average, the factor for selling multiples of recurring revenue was 2.21, and the factor for selling multiples of gross revenue was 2.23, even though, according to industry valuation expert Ryan Grau in his Nov 2017 article, “What Is My Practice Worth?” published in Journal of Financial Planning, the fair market value of the financial planning practitioners’ business is subjective based on the willing buyer and willing seller principle.
To demonstrate the selling multiples approach, let’s walk through one financial planning practitioners’ business value calculation with an assumed average annual GDC of $500,000 or (x) in Table 1. Table 1 is a profit and loss statement from my working paper in 2016. In column (b), I break down the assumed GDC into various types of revenue using the benchmarks from a survey conducted by FPA in 2013, shown in column (a). In column (d), I calculate the assumed GDC in column (b) using the benchmark rule of thumb multiples of column (c). I arrive at FMV_z1, the estimated fair market value of $886,650 representing use of various types of multiples of recurring revenue. FMV_z2 represents using multiples of the gross revenue of 2.33 times the average annual GDC to arrive at an estimated fair market value of $1,115,000.
This is no way near what Ryan Grau would describe in his research of valuation methods, but it demonstrates the point that the fair market value of a financial planning practitioners’ business can be projected. I don’t know about you, but if the time is right, I would certainly take the cash to exit the business and use that cash to fund my next venture. With proper succession planning, practitioners potentially can cash out in the range of $886,650 and $1,115,000 from their business of annual $500,000 GDC.
Timing is Everything
What are the three major factors impacting real estate value, marketability, and desirability? That’s right-location, location, and location. But what are the three major factors impacting exit from privately-held businesses? Logically enough-timing, timing, and timing. So, what’s the big deal about timing? According to private capital expert Rob Slee, author of the best-selling book Midas Managers (2007), there are truly three-timing factors that must be aligned when planning a successful business exit:
- Personal timing: The readiness of the owner to move on to something else more or less challenging.
- Business timing: There must be a substantial key management team able to operate with or without the owner or founder.
- Economic timing: Knowing where the economic cycle is and if your industry is trending up in the market M&A movement (not performance).
Table 1 might as well be your pseudo fortune teller, providing you some guidance about how to structure your business revenue to maximize the equity value for you, the owner of the financial planning practitioners’ business. Your current age is irrelevant, but your timing is critical. Take the time to plan your succession, because you have full control over your personal and business timing to get the most out of your business!