How to Value a Wealth Management Firm? Wealth management firms provide assistance to individuals and corporations for the purpose of managing their financial assets. However, If your plan includes investing into, buying or selling a wealth management firm, it is equally important to learn how the firm can be valued. In this article, we’ll walkthrough the important aspects methods and most importantly how to value a wealth management firm, in simple and understandable language.
Wealth Management Firms Overview
Wealth management firms also help people in financing services like investment management, retirement planning, estate planning, and achieving other financial objective. This class of firms is usually in charge of servicing high net worth individuals and corporates. Most of their earnings comes from charging clients a fee depending on the designated percentage of assets under custody and managed by the firm (AUM).
Before assessing the valuation aspect of such firms, it is essential to appreciate the outer looks of such firms’ earnings:
-Mangement Fees: This is the principal revenue earning source, normally taking the form of a proportion of the firm total managed assets.
-Performance Fees: Certain companies take up this additional charge for upscaling the level of investor ‘s portfolio.
-Other Services: These are also the incorporation of additional charges, tax advice or wealth management best practices like estate planning and retirement planning.
Principal Considerations When Carrying Out a Valuation of a Wealth Management Business
Certain critical aspects are evaluated in the process of estimating the value of a wealth management business and these include, but are not limited to, the following areas of concern:
- Assets Under Management (AUM)
One of the more important aspects of capitalizing on a wealth management firms is the total amount of assets which are managed by the firm. As the AUM increases, the chances of earning affirmative fees also increases.
- AUM and Revenue: Other factors remaining constant, a $1 billion asset manager will make more revenue in management fees than a $100 million asset manager in a similar period of time.
- Client Retention: Equally important in assessing AUM is the factor of client retention. Because of the possibility of loss of revenue, firms that have seen the growth of their clients over many years are worth more.
- Revenue and Profitability
Revenue and profitability are other significant factors another financial services business that can be empirically assessed. Examine the annual figures regarding the firm’s authorization to conduct its business, profit, and regularity of the income earning pattern.
- Revenue Stability: Is the revenue on an upward trend or on a downward trend? Increasing revenue and profit firms are given more valuation compared to the erratic and decreasing revenue and profit yet no consistent improvement.
- Profit Margins: High margins relative to cost are considered as a sign of higher efficiency hence higher worth of the company compared to a company with lower margins relative to costs. This can be attributed to low operating costs and effective fees charged.
- Client Base
The nature of clients portrayed by the wealth management firm can also prove own impact on its valuation. In most cases, companies with affluent individuals and corporate clients are appraised at a higher valuation than the ones with small clients.
- Client Demographics: Any pool of clients with financial means such as assets will prompt a higher management fee for the institution. Also, higher margin clients can generate additional referrals which enhances the growth prospects.
- Client’s age bias: In addition, clients’ age dispersion is also a factor. It is more lucrative to have young clients whose investment needs are long-term as opposed to older clients who are in or near retirement age or depleting their investment portfolios.
Methods of Appraising the Value of Wealth Management Companies
When it comes to the valuation of a wealth management company, one may use different techniques. Below are presented the most widely used three methods:
- Market Valuation Approach
This technique assesses the value of the target wealth management company by referring to the values of other wealth management businesses already engaged in the transactions in the market. One would consider the firm in question alongside other firms with similar scale, assets under management (AUM) or profitability.
- Equity Multiples: For example, if an investment firm such as the one being analyzed, can be bought for a certain multiple of revenues of 2%, so should the firm in question. It is however, necessary to factor the variations in the nature of clients, the stages of development and the regions involved.
- Drawbacks: Market value may sometimes prove a challenge especially in instances where there are no comparable firms or the transactions being benchmarked are far dated.
- Income Valuation Approach
The income approach to valuation examines the potential future revenues that the company may generate. A specific formula that is extensively applied is the Discounted Cash Flow (DCF) analysis, where cash flows are estimated for the company and discounted to arrive at their present worth.
- DCF Analysis: In doing a DCF analysis, you project the cash flows of the firm given the expected increase in AUM, changes in the fee structure, and the projected retention of clients. Those cash flows are then discounted using a target RRR to obtain a present value.
- Applicable to Growth Firms: This technique is employed in case, the firm has a stable or increasing stream of revenue and the profit is properly anticipated.
- Asset-Based Valuation
This method measures the equity of a firm in relation to its physical as well as financial assets held less any obligations. However, this approach is not prevalent in wealth management because for the most part, management does not have a lot of tangible assets. Most of what they are worth is in their intangible assets such as, clients and AUM.
- When to Use: Asset-based valuation is more relevant when the enterprises are winding up or where the physical structure like real estate or plant and machinery is of considerable value.
The Contribution of Intangibles
Apart from the primary resources such as the physical location, staff and investments, intangible resources also play a great role in estimating a value of a wealth management company. Some of these include the firm’s standing in the industry, the quality of its client network, and the equity of its brand. Although they are immaterial, they have a great contribution on the worth of the firm.
- Client Relationships: Having durable and healthy relationships with the customers, increase the value of the firm, as these customers are loyal and will remain even in the event the ownership of the firm changes.
- Brand and Reputation: Companies that manage to build a positive image of themselves as an ethical instant service and performing investments will normally have higher valuations. And, if building a strong brand does indeed take time, then it will definitely pay off, as outlining its geographic presence will be far easier with an already established brand.
Other Elements That Should Be Considered In the Valuation of Wealth Management Company
There are a number of additional points that you need to consider in the process of valuating a wealth management company.
- Regulatory Environment: Wealth management firms are subject to a large number of regulations. The changing regulations or active compliance can have an effect on firm’s profits and thus its worth.
- Growth Potential: In case the firm is likely to grow further in the future and has high growth potential – that is getting more clients or provides services in additional geographies or offers other forms of services – the firm is worth more.
- Management Team: In some cases the value of the firm is influenced by how strong and how experienced is the management team. A well education and experienced team can bring performance, client retention and even growth.
How to Accurately Value a Wealth Management Firm.
Assessing the worth of a wealth management company assessments entails a dive into financial metrics, demographic composition, growth potential, and soft assets. Understanding the firm’s AUM, revenue, profitability, client numbers and other factors provides for a rough idea of the firm’s value.
Further, appropriate valuation methods such as market-based valuation, income-based valuation and assets based valuation will facilitate the valuation of the firm on an appropriate basis. When acquiring, disposing of or investing in a wealth management company, understanding its valuation trends, or rather, performing due diligence is of utmost importance.
