How the Corona Virus Will Impact Valuations

As a nation, we are experiencing challenging circumstances as a result of the Coronavirus that is quickly spreading across the globe. As an industry, many advisors are grappling with working and managing staff remotely while keeping clients calm and engaged. Practice leaders are feeling the pull of many new demands, coupled with their own concerns about how this will impact their practice now and in the future. We can’t know everything that the future holds, but we can look to historical data for insights, as well as our own experience and expertise to provide some guidance on how the Coronavirus will impact advisor valuations and M&A activity in the coming year.

Impact of the Corona Virus on Financial Advisor Valuations

The first question many advisors are asking is how the Coronavirus will impact the value of their practice. For many advisors, their practice is one of the largest, if not the largest, personal asset they own. Therefore, their personal net worth is closely tied to the ebbs and flows that impact their practice and the client assets they manage. Unfortunately, the true impact of the Coronavirus can’t be measured until approximately 12 months after the market begin to decline. This is because valuations are based on the trailing 12-month production of the firm. It is also because on average, recurring revenue now accounts for 87% of a firm’s total revenue.

If a firm needs to secure a valuation for financing or for M&A transactions, the best approach is to use pre-Coronavirus data or to apply reasonable adjustments to the current data, in order to get the best representation of what the practice value will be once we move past the immediate impact of the crisis. As we move past the intense and immediate shocks the virus has sent through the market, the data will stabilize, and we will be able to arrive at even more accurate calculations of practice value.

Impact of the Corona Virus on Financial Advisor M&A Activity

For the past two years, the industry has been expecting and preparing for a mass exodus of retiring advisors. Many advisors have bucked trends, opting to stay in practice longer than projected. Some may continue this approach, opting instead to “wait it out” until the market recovers.

The Danger of Waiting for the Market to Recover Before Selling

Prior to this current market shift, analysts were already assuming that a disruption would be necessary to instigate the projected and hoped for, “age wave” of Baby Boomers selling their practices. Many older advisors remained in practice longer than expected because up to this point, they enjoyed low-maintenance clients and a record-breaking market. The pressure of the current market trends has many rethinking staying in practice, but still many are hoping to wait for the dust to settle before they actually make their move. Of those advisors considering waiting to sell, many are thinking of waiting for as long as 1 to 5 years.

The problem is that at that time, the surge of practices hitting the market will turn what has been a seller’s market into a buyer’s market. This will shift the leverage and bargaining power to the buyers. Additionally, many advisors are not aware of what goes into selling a practice and how long it can take. On average it will take a year to sell a practice. Advisors at or nearing retirement age can get ahead of the “age wave” by starting the process of preparing their practice to sell now.

What Buyers and Sellers Must Consider in Order to Do M&A Deals Today

In any transaction, each party has their own goals and priorities to meet. For a transaction to be fair to both parties, even during volatile markets, two considerations must be made.

Firstly, sellers should not accept a price or offer for their practice solely based on a temporary downturn (which would result in a permanent price adjustment). This is especially true when considering that the buyer may experience a temporary decline on those same assets and production but will likely return to normal once the market correction is over. Second, buyers also need to be protected from the downturn in assets and production and be able to achieve the appropriate net earnings pending recovery. With net earnings accounting for all expenses and acquisition debt service.

The best way to accomplish the above goals is through the deal terms and structures, as opposed to meaningful price adjustments. For example, if this disruption results in a 1-year decline followed by 2 years of recovery, we can then assume those three years are followed by a robust market, which is often how the market moves. In this scenario, the deal could be structured in the following way:

A Down Payment of 50%-60%, financed with a 10-Year Amortization Schedule Financed with a 10-Year Schedule at 6.5% Interest

The Remaining Balance of 40-50% Financed by the Seller for 36 Months at 4% Interest with a 10-Year Amortization and Balloon Payment

The Note Starts 6-12 Months After Closing and the Balloon Payment Can be Refinanced

This structure accounts for each of the buyer’s and seller’s positions as well as the long-term value of the practice.

Just as you would tell your client, the key thing for you to remember at this time is to make sound financial decisions and not let emotions or the turbulence in the market dictate your choices. Just as clients come to you for advice, you to need to lean on an experienced advisor to help you evaluate and make sound decisions about your practice. If you have any questions or concerns about the market and its impact on your business, please feel free to contact us. We are here to help.

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