"Even if you are doing a good job for your clients and making a large income for yourself, you may not be building equity in your business or realizing the quality of life you want."

Sweat Equity

By John Bowen

If you're like most advisors, you got into the personal financial services industry for some specific reasons. The most common ones are to have the freedom to build your wealth by creating equity in your businesses, to earn an unlimited income, to be your own boss, to have the flexibility to take time off, and finally, to enjoy the satisfaction that comes from helping clients achieve financial success.

Reprinted from:

When I ask advisors I know if they have achieved those goals during their careers, however, few say yes. Instead, they have created little or no equity, unlimited income is unrealized, being their own boss isn't what they thought it would be, and job flexibility has turned into working 12-hour days. The only promise most feel that they have realized over their careers is helping their clients—although there is often some disagreement there.

Perhaps while you have been helping your clients to reach their financial goals, you have been ignoring your own. Even if you are doing a good job for your clients and making a large income for yourself, you may not be building equity in your business or realizing the quality of life you want.

If you simply continue doing what you have been doing over the past few years, you won't continue to get the same results in the future. As competition increases, your results will dwindle unless you work harder or smarter. It's your choice to make.

The foundation of a successful advisory business—and the key to achieving your most important goals—is the ability to create real value in the business. While all advisors want to build substantial equity in their businesses, few actually succeed at doing this. Even when they have great revenues and satisfied clients, they miss the boat when it comes to creating equity.

The more that you learn about what drives value, the better position that you will be in to build your business around those drivers. There are four primary drivers of value in any financial advisory business today—cash flow, clients, company, and competitors.

Cash flow. To create equity in your advisory business, the most important thing that you can do is to maximize both your cash flow and your profit margins. In the best of all worlds, your cash flow continues to grow and your margins continue to expand in a straight, upward-sloping line. An up-and-down or bumpy line is a less desirable outcome.

Here's an important point to remember: As you consider cash flow, don't mistake it for good revenues. While you cannot have a lot of cash flow and good margins without great revenues, cash flow is still the by-product of good margins. Revenues, on the other hand, are the by-product of good growth.

Clients. You want your clients to be loyal, satisfied, willing to make multiple referrals, and not tied to a single person at your firm. Having systematic, high-quality client management systems in place will make your client base much easier to transfer to a buyer.

Company. You should be able to retain your satisfied employees, both in terms of work environment and their compensation. In addition, be prepared to show turnover patterns and to point to recent success stories of employees who have moved up through the ranks of your firm, taken on additional responsibility, and grown their compensation along the way.

You also need to show evidence that your financial advisory business is well managed. Important markers of your overall progress can be found within four main areas of your business: client management and process, financial management and process, employee management and process, and operations management and process.

Competitors. Create a unique business model that competitors can't figure out or that is difficult for them to replicate. Competitors should be in awe of your model's profitability and growth. But don't make the common mistake of thinking that this means you must have some sort of complicated trade secret or strategy driving your success. In fact, what competitors are most often in awe of is an extremely simple business that works extremely well day in and day out.

Finally, you would like there to be some visible signs that your competitors have essentially capitulated and even said to themselves, "If I can't beat them, I should join them instead." For example, it would be quite powerful if you could demonstrate to potential buyers that your competitors have called you to ask to join your firm.

The four Cs of creating value only form the foundation of your business value. The following features are also important to create equity in your advisory firm:

Business model. It's obvious that your business needs to produce a substantial profit and to be able to increase those profits as it grows. You want to be able to paint a picture of how, over time, the company has gotten bigger, its margins have improved, clients have gotten more satisfied, and its employees have become happier. Any potential buyers will want to see a clear, virtuous loop between your business model and the results that it generates.

Client profile. Among the spectrum of clients, high-net-worth clients are the most valuable. So to the extent that you can have a client profile composed primarily of affluent clients, you have an important value driver. A short list of 20 to 50 clients who each have over $10 million to manage, for example, would be a nice client profile.

Revenue structure. A telling factor in the price a financial advisory practice commands is the manner in which it generates revenue. One good rule of thumb to value commission-based practices is 0.5 times revenues. For advisory firms that derive most of their revenues from fees, the rule of thumb is 1.5 to 2.5 times revenues.

Strategic alliances. You want to cultivate strategic alliances with other professional advisors who are excellent referral sources. The best alliances are firm-to-firm relationships (not advisor-to-advisor ones), where the relationship is formalized with some kind of partnership agreement.

Technology. It's important to have technology that works well, not just in connecting each area of your company internally but also in connecting you with every other firm or individual that you work with. These parties should include investment management firms, wholesalers, custodians, and of course, your clients.

Operational systems. Efficient and effective operational systems and excellent documentation of these systems are crucial drivers of value. It's also important to have strong financial documentation that is regularly updated.

Depth of existing client relationships. By focusing on wealth management and managing existing relationships with clients, you will be able to increase the value of your financial advisory firm. This approach will set you clearly apart from other financial advisors who focus on investment strategies and products—most often at the expense of their existing client relationships.

Pricing. When you can demonstrate that your contracts with various service providers are low-cost relative to other parties or that you have the volume or the buying power to drive even lower the prices you pay, you have a big value driver. On the other side of the pricing equation, when you can prove to potential buyers that you command higher prices because you offer a higher level of service, have an outstanding reputation, and provide high-quality client relationship management, you have another big driver of equity.

Market niche. When you have fully established yourself within your chosen target market niche, you have created a defensible market position for yourself. Such a market position is something that any potential buyer or partner will find attractive. Brand equity. You want your firm to stand out; it should have a reputation for being able to provide the expertise its affluent clients need. Your marketing efforts will come into play in driving value in this area.

Network of contacts. It's important, of course, to have an extensive and comprehensive network of contacts with the media, lawyers, accountants, and various other referral sources. But it's even more important to be able to hand that network off cleanly to a buyer.

Location. Buyers are driven by the location of the business, so if you have chosen a good place to live and establish your practice, you will realize greater value. In addition, most buyers wish to acquire a business that is located within 60 miles of their own, according to new research by Tiburon Strategic Advisors. Relatively few are willing to relocate. Practice size. The size of your practice is also an important factor. Most buyers are interested in firms of 10 or fewer employees.

As you can see, the value that you create to increase your current income is the same as the value you create to make your advisory business worth buying. Again, it's critical for you to manage your business now as if you were going to sell it, even if you have no immediate plans to do so. Not only will you realize more equity when you do sell, but you'll have a more profitable and more enjoyable business throughout the years that you do own it.

Never forget that you are in business to have more life, not in life to have more business. Recognize the outcome you want from your business.

Most of us want to have a good cash flow, to develop something that makes us proud because we're making a difference in the world, and ultimately to realize substantial value in order to fund our dreams for the rest of our lives. We are blessed in this industry because we can achieve these things by doing well by our clients, but we must be able to focus and execute well.