(2 December, 2004) Common way to value planning businesses:
Multiple of recurring revenues
The most common valuation method where a multiple is applied to recurring revenue such as trailing brokerage, commission or ongoing fees and reflects the fact that the purchaser is actually buying the rights to the income generated by the client base.
Upfront commissions and non-recurrent service fees such as plan preparation fees and inflows from asset sales are excluded.
The qualitative judgment is what multiple to apply to recurrent income, with past history showing practices valued at two or three times.
The issue with this methodology is that it places a value on the recurring income stream with no regard for the cost of producing it. This method is only valid if a business is going to buy the client base and merge it into their cost structure.
Multiple of earnings
Under this method, normalised earnings are used as a proxy for future earnings and a capitalisation rate (or earnings multiple) is applied.
The method requires that some implicit assumptions be made about future earnings — that is, that current earnings can serve as a reliable indicator of future earnings — and about business risk, with increased risk implying a lower multiple.
The earnings being capitalised might variously be net income, earnings before income tax (EBIT), earnings before income tax, depreciation and amortisation (EBITDA) or some version of cash income or cash flow.
Multiple of revenues
The purchase of a planning practice can be the purchase of a book of business where the book’s revenue can be merged into an existing business.
This might not be an accurate reflection of the true cost impact of the acquisition, including management time, bringing forward of capacity constraints and so on, but it is sometimes thought more meaningful to understand and value revenues, rather than the profits of the existing business structure.
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