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Hosted by Financial Advisor Coach, Ray Sclafani, "Building The Billion Dollar Business" is the ultimate podcast for financial advisors seeking to elevate their practice. Each episode features deep dives into actionable advice and exclusive interviews with top professionals in the financial services industry. Tune in to unlock your potential and build a successful, enduring financial advisory practice.
Ray Sclafani (00:00.366)
Welcome to Building the Billion Dollar Business, the podcast where we dive deep into the strategies, insights, and stories behind the world's most successful financial advisors and introduce content and actionable ideas to fuel your growth. Together, we'll unlock the methods, tactics, and mindset shifts that set the top 1 % apart from the rest. I'm Ray Sclafani, and I'll be your host.
Today's episode is about the valuation trap, why market-based multiples alone miss the mark. So here's the setup. I'm checking into a conference recently, and as I'm wrapping up at the hotel front desk, an advisor recognizes me and asks if he can have a word, confidentially. Well, of course I say yes, asking for a quick moment to finish checking in, and then I walk over to him. He's standing there as if the house is on fire.
clearly holding onto a burning question, something urgent. And then he asks, Ray, I've been offered seven times for my business. Is that a good number? Will I pause and ask, well, seven times what? He blinks and says, what do you mean? And I respond gently so as not to embarrass him. Seven times revenue, seven times EBITDA, seven times EBAC. He shrugs. He looks at me and says, well, I don't know.
Now that response may seem surprising, but it's far more common in our industry than we'd like to admit. Today's episode aims to clarify that confusion because comparables, those flashy multiples we hear thrown around can actually do more harm than good when misunderstood or misapplied. We at ClientWise are rethinking comparables. Why they're not as reliable as they seem, where they go wrong,
and how to ground your valuation in reality, not rumor. If you've ever been curious or confused about what your firm is really worth, then I think you'll enjoy today's episode. One of the most common methods for establishing an advisory firm's value is using market-based multiples, metrics derived from comparable businesses within the industry. While this approach is simple and easy to apply, it frequently fails to account
Ray Sclafani (02:25.08)
for several unique firm characteristics and the reliability of the data used to determine these multiples, well, that often presents big challenges. As a result, we believe that a far more nuanced approach is essential to ensure valuation accuracy. Market-based multiples or valuation ratios derived from metrics such as earnings before interest, taxes, depreciation, and amortization, that's EBITDA, revenue,
Assets under management AUM. If you're following along and all of this information sounds well, I kind of know that already. Bear with me for just another moment. These multiples allow investors and analysts to evaluate the relative value of firms deemed comparable due to shared operational, structural and strategic characteristics. While analysts often disagree on what constitutes comparability,
Generally speaking, firms of similar size operating within the same industry serve as a starting point for defining a relevant set of comparable transactions. Suppose the XYZ advisory firm has revenues of 5 million and is valued at a multiple of 10 X EBITDA. In that case, it stands to reason that firms with similar revenues would also be ascribed a valuation of 10 X EBITDA. Well, there are three challenges to data reliability. Number one,
Limited comparability. Advisory firms often differ significantly in their scope of operations, their client demographics, compensation models, and geographic focus. Comparing the value of a boutique wealth manager serving ultra high net worth families in Silicon Valley with a money manager catering to mass affluent retirees in Florida, it's nearly impossible due to these vast differences. If you're on the acquisition side and you're a serial acquirer,
I bet you've bumped into firms that sort of think their value is inflated based upon what a friend down the street might have recently gotten for evaluation or what they've been quoted or what a valuation firm placed multiple of EBITDA. If you are shopping your firm, if you are thinking about selling to the next generation, if you are considering getting evaluation, it's important to consider how you're comparing your firm to others.
Ray Sclafani (04:49.964)
The second key challenge to data reliability is variability in reporting. Two similar advisory firms may differ significantly in how they report earnings and revenue data, and that leads to major inconsistencies when calculating multiples. One firm might include non-recurring revenues while another excludes certain costs, and different operating models treat revenue and expense reimbursement differently, and that skews their comparative multiples.
The third challenge to data reliability is market perceptions. The market sentiment can heavily influence advisory firm multiples. Historically, there has been a tendency toward pricing premiums that align with market peaks and pricing discounts corresponding to periods of market underperformance. The reason I'm publishing this at this point during the course of the year is we're noticing there's a fair differentiation.
with the current market uncertainty and volatility that we've seen. Unfortunately, the prevalence of these reporting discrepancies, well, that makes it difficult, extremely difficult for analysts and investors to obtain accurate valuations from standard financial databases. Okay, so in light of these challenges, analysts and investors need to adopt a more hands-on approach to valuation by utilizing the following tools to address transaction data shortcomings. First,
Custom data collection. Well, that involves gathering specific financial information directly from companies or negotiating access to more detailed data that includes adjustments for owner's comp. At ClientWise, we retain proprietary, animized data models specifically for this purpose. Then there's industry benchmarks. Establishing benchmarks for owner's comp within specific industry segments can help create a more standardized approach to adjustments.
However, make sure that you know whether the benchmark applies to adjusted or unadjusted raw data. And then the third is discounted cashflow. At our firm, we strongly advocate using this approach to establish current value as it avoids cross-contaminating observations about revenue, expenses, or income. Instead, it focuses on the company itself and allows for greater granularity and specificity in the assumptions needed for accurate reporting.
Ray Sclafani (07:12.31)
Establishing a clean baseline leads to a more effective and consistent measure of value moving forward. Pricing multiples such as EBITDA, revenue, and AUM become meaningful when placed within the context of the initial valuation. Of course, using discounted cash flow, the income approach, well, it's not a foolproof method as certain factors can be manipulated to influence valuation outcomes. For instance,
incorporating growth rates that are significantly above market expectations, well, that's going to lead to an inflated valuation compared to industry peers. Similarly, excessively optimistic expectations for profitability ratios can further distort valuations derived from this method. So reconciling valuations is critical, yet often overlooked by many parties involved. Understanding the core value drivers of a business is essential for accurately assessing its worth.
and avoiding misunderstandings or disputes later on. When valuations are conducted without a thorough examination of the underlying assumptions and inputs, it creates ambiguity, which can lead to conflicts during negotiations or when justifying the valuation in a market transaction. Advisors who are engaging in the valuation process can often become emotionally invested in a valuation outcome, especially if it aligns with their retirement goals. Once an inflated value,
Influenced by inaccurate market pricing multiples is published, it establishes a benchmark that sellers cling to. Supportable and meaningful valuations require genuine transparency. Stakeholders must understand the rationale behind the numbers, the methodologies, and the assumptions. This is where independent due diligence plays a crucial role, ensuring that all parties have a clear and justifiable basis
for the valuation, which in turn fosters greater trust among buyers and sellers. It's an intensive process that often serves as a major hurdle in deal making. According to the 2023 RIA report, fewer than half of all potential transactions survive the due diligence process. To avoid deal termination, both parties need to be proactive and honest about valuation inputs, potential red flags, and how these elements contribute
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to the overall business valuation. Between today and the deal signing day lies a minefield of data for due diligence to uncover. Therefore, there's no value in setting an unreasonable comparable or using inflated growth assumptions. They are merely low-hanging fruit for a due diligence team. Relying solely on market-based multiples to assess valuation in the financial services industry presents significant challenges and risks. Due to the inherent
unreliability of the data and the complexities of comparable firms, analysts must tread carefully. By implementing a more nuanced approach that combines various methodologies, well, that considers industry-specific metrics and enhances due diligence. Buyers, sellers, and investors all can strive for a more accurate and informed understanding of a firm's true value. In an industry where the stakes are high and conditions are changing rapidly,
This thorough analysis is essential for making sound valuation decisions. If you're an avid listener, by now you know, with each episode we provide a series of coaching questions to review with your team or the leaders that are helping to shape your firm. So the first question is, how are you educating your next generation of leaders and owners to better understand the assumptions driving your firm's valuation and the role in shaping those assumptions in the future? Second.
What valuation methodologies are you using today and how might they evolve as your business model, client base and strategic growth shifts over time? Number three, in what ways are you preparing your team to interpret and articulate your firm's value beyond just the financials, highlighting client impact, cultural strength and long-term sustainability? The better educated a team about valuation process,
the more likely you are to align on how to grow that value. Number four, what steps can you take over the next 12 to 24 months to ensure that your valuation inputs are clean, current, and fully supportable in a future transaction or transition event? And number five, how will your firm's valuation story change as you grow? And what narrative are you equipping your team to tell prospective partners, investors, or successors?
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Well, thanks for tuning in. And that's a wrap. Until next time, this is Ray Sclafani. Keep building, growing and striving for greatness. Together, we'll redefine what's possible in the world of wealth management. Be sure to check back for our latest episode and article.