How to Maximize Your Firm's Long-Term Value

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In the day-to-day work of being a financial advisor, you're busy, and it's easy to lose sight of how well your firm is performing beyond the headline numbers of revenue and your personal income. But taking a close look at your financials can pay huge dividends down the road. Hi everyone, I'm business coach Steve Sandusky for Barron's Advisor, and welcome to Actionable Intelligence. My guest today is Alan Darby. Alan is the CEO of Alaris Acquisitions, and earlier in his career, he was a financial advisor and he was a buyer advisor for United Capital where he sourced and closed 32 acquisitions. In today's conversation, we dig deep into the P&L statement of advisory firms and discuss how you can effectively manage the financial side of your business to maximize your firm's long-term value. So let's get started with Alan Darby. Having worked with and coached financial advisors for more than 25 years, one area, Alan, that I don't think gets as much attention as it should is the monitoring of the financial performance of an advisor's business. Now, yes, you know, all advisors are looking at their gross revenue, they're looking at their personal income, but I think there's great benefit as a business owner to dig deeper into the firm's financial performance and use the firm's income statements and related metrics as a tool to increase profitability and cash flow. And you, you're one of the most successful dealmakers in the advisory space, as well as having been an advisor yourself. So you really understand the numbers from both sides of the table. So I think you're a perfect one here to have on the show today to really dig into the numbers. So, Alan, welcome.

Yeah, well, thank you very much. I appreciate it. I'm looking forward to it.

So let's just start with the basics. When you're evaluating an advisor's financial statements, what's your preferred level layout?

We would start by evaluating the sources of revenue. And one thing that we encourage— let's just call them sellers or advisors in this case— to be really clear on is the nature of the revenue that they're booking into their P&L. And often we just see like a top-line number. They may have different sources of revenue, whether it's recurring revenue from like fee-based assets under management. They may have financial planning fees that are billed annually. They could have some— if they have a— if it's a hybrid firm, they may have some legacy like trail commissions or even non-recurring commissions if they're in risk management. So we want to start with very clear and well-classified sources of revenue. You know, don't just lump all your revenue into one top line. So once we have a clear understanding of the sources of revenue, Then we're going to get into the expense line items. And we try to separate the various expenses that are associated with revenue, you know, cost of goods sold. So these would be like typical expenses that are variable in nature with the number of client accounts. You know, they could be custodial fees that are only, you know, existent if there's assets there. So we want to understand of the expense category, how much of those expenses are truly variable. And then Then we'll get into the, the basic fixed expenses, typical categories that you would see. So the biggest one would be like staffing. That's probably the most significant part of the P&L and understanding. Then you have your basic operating expenses, which are normally costs associated with the office, you know, utilities, various vendor costs, etc. Then we actually like to see a very specific category broken out in the tech stack. That's often a major part. You know, we're in M&A, so when an acquirer is purchasing them, they're going to be layering in their technology. So we need to understand that expense category in great detail. That's the basic layout, just a real clear, broken out description of the sources of revenue, variable expenses or cost of goods sold, and then your regular way operating expenses.

So a couple other terms that we hear thrown around a lot. One is EBOC, E-B-O-C, and then a second is EBITDA, E-B-I-T-D-A. E-B-O-C-K and E-B-O-C-K-I-T-D-A. So tell me what those two are and how should an advisor be thinking about those two ways of looking at your financial performance?

E-B-O-C-K is an acronym for earnings before owner's compensation. It's essentially gross profits of the business. So once you look at your revenue sources and you back out operating expenses— so then the operating expenses in this definition would be those variable expenses and the fixed costs, essentially all costs associated with the business with the exception of the owners. So when we're calculating an EBOC number, you would take the gross revenue from all sources, you would back out all expenses associated with the business with the exception of the owner. That's EBOC, earnings before owner's compensation. EBOC number does not take into account owner replacement costs, and that's a very specific term that we use in evaluation. Once you've determined what gross profits are, that's essentially all the revenue that would go to the owners in whatever form they're taking it, whether it's a, a salary or some type of draw payment. Plus any distributions, contributions to qualified plans, things like that. So EBAC captures all of that to get to EBITDA, which is the most important number, particularly in terms of valuing a practice. You're essentially taking EBAC or gross profits and you're layering into that retained owner's compensation. It is a market value for what it would take to hire that replacement to replace that advisor. So EBAC less a retained owner's comp equals EBITDA or net income. And that's something that we don't see a lot of advisors, or they're not familiar with that concept. They treat their— it's like a checking account, you know, whatever's there, they're going to distribute it. And they really should think about what in their market, based on their client service model, whatever their practice is delivering for clients, what would it cost to hire their replacement? Particularly when you're thinking about how to value your practice, It's not only service the clients, what would it cost to hire someone to service the business and move the business forward? So it truly does have to be, and it is somewhat geographic, you know, dependent replacement cost in Manhattan is different than what it would be in like Omaha, you know, but that's the basic math. EBAC less owner's comp equals EBITDA.

So if we take the EBAC and we subtract out the owner replacement cost and the leftover is a positive number, would that be considered the true quote profit of the business.

Yes.

And then from a valuation standpoint, we're going to put some kind of multiple on either the EBITDA number. Is it more common when we're valuing, are we going to put a multiple on the EBITDA, the EBOC, a combination, other factors?

I guess it depends on the buyer, but the, the vast majority of transactions that we deal in, it's a multiple of EBITDA. The reason is simple, you know, if a buyer is going to place a multiple on EBAC and they're not holding in the P&L any dollar amount that would go to this, we'll call it the servicing advisor for that business. If something catastrophic happened to that buyer, there's no available cash flow to pay them. In an acquisition, we require the owner to retain a market number because if something were catastrophic to happen to that person post-transaction, We've got to have the dollars to go hire someone to step into that role and keep the business moving forward. We've seen it where advisors, they've done well in their life, they've taken their own medicine, so to speak, and they've developed a large net worth and they get to the valuation process and they want to monetize 100% of their EBAC number and a buyer just won't do it because one, the next day they're not incented to come to work. They're literally not taking any cash flow from the business. And then there's no replacement dollars in the event of a catastrophic event. So EBITDA is, is the vast majority of valuations where the multiples apply.

Okay. So key thing here then is as you're putting together your P&L is to make sure that you're calculating your EBITDA number because that's a key figure that potential buyers down the road would be keying in on. Okay. Right now. So let's say we got the P&L statement. Now I want to talk about some of the profitability ratios or some of the metrics that we might be able to develop from looking at our P&L. So I'd love for you to share some of the common ratios or metrics that you look at. And then I think we're also, we want to compare those against some industry benchmarks. I know Barron's has some great data, which we can touch on here in a moment too, but what are some of the key ratios and metrics that you're looking at?

What I'm going to talk to you about is in relation to gross revenue. So we look at the various items that we just talked about you know, what percentage of gross revenue would be a regular— what we would consider a healthy business. So if you're looking at operating expenses, for example, and again, this is operating expenses without the owner being factored in, I would tell you a normal number that we would see would be somewhere between 35% and 40% of gross revenue would be a fairly standard type of operating expense budget. If we see that number less than that, that can be indicative of a few things. One, you may be just really good at running an efficient practice, that is possible. More commonly, it's a firm that doesn't have the infrastructure in place necessary to continue a robust go-forward growth pattern. So, but 35 to 40% operating expense would be normal. I would say from owner's compensation, that retained owner comp number, typically you're going to see 20 to 25% of gross revenue would be a standard number that we would expect, which would leave EBITDA to be somewhere between 35 and 40, you know, normally. If I saw that P&L and it had those ratios, my immediate thought would be, yeah, this is a standard healthy practice. When you start deviating from those numbers, that's when ears start to perk up and we take really deep dives into it. Another quick rule of thumb kind of ratio that we look at is, uh, revenue per employee. So if I didn't know anything about a business, an RIA let's say, then I wanted to guess their revenue, I would just go to their website, count up the number of pictures of staff and multiply it times 300, and usually that gets me in the ballpark of what their revenue is. The assets can be misleading in terms of trying to predict what revenue is because everyone's fee schedule is so different, but revenue per employee of $300,000 is fairly standard in the industry. So those would be like my baseline metrics that we would look to see, and then anytime we have a deviation from that, we want to understand why, you know, what's the reason.

How much of these numbers vary based on the size of the firm? So I know a lot of the industry benchmark data that gets published, there are different peer groups. So maybe up to $250 million in assets might be one peer group, $250 to, to maybe $500 or $750 might be another, $750 to a billion, and so on and so forth. Do these numbers vary widely or not widely depending on the size of the firm?

They don't vary widely based on the size of the firm. They vary widely based on the service model, the client service model. So I mean, As the firm gets larger, certain economies of scale are just going to kick in. Your vendor costs are going to start to go down compared to smaller firms. There's just some scale that kicks in, but not to where we would see those ratios that I just went through deviate widely. The client service model does have a big impact on us. So for example, if it's a wealth management firm that has a really robust financial planning, you know, a deep planning infrastructure, versus a firm that is purely an asset manager that doesn't really have a planning service model or offer to their clients. That could really alter these numbers quite a bit. But the size of the practice, not so much, I've found anyway.

Okay. I really like to key on this revenue per employee number. And I know in coaching, we like to talk about $350,000 to $400,000 in revenue per employee. You mentioned $300,000 here. I'm looking at the Barron's benchmark data. And this is based on the top independent advisors, and they're showing $484,000 revenue per employee. Now, granted, these are the top of the top, and these are firms that are averaging, the data I'm looking at, $11.3 million in revenue, $1.9 billion in assets under management. So these are definitely very good-sized, extremely well-run firms. But you also mentioned if a firm is doing a lot of financial planning versus another firm that might be more focused on investment management, Do you see these revenue per employee numbers varying significantly depending on if I'm a financial planning firm? Maybe it's smaller, but maybe not because maybe I'm charging more planning fees.

That was going to be my counter.

Okay.

You know, we're focused right now on essentially like expenses, but also the revenue is also a big part of this profitability equation. And while a firm that had deep infrastructure to support a different client experience They also may be charging an average fee that's higher than a pure asset management firm. So you're absolutely correct.

Yeah. Yeah. The Barron's data is very fascinating here. Another piece here that I'm looking at is the average fee charged is approximately 60 basis points, but then the average account size is $2.7 million.

Yeah. So this goes back over, you know, tons of transactions. But I would say, like, if I were— you just asked me, what is an average basis point charge in the industry, I would put it right at 70 to 72 basis points, but that's on probably an average client account that's roughly around a million. Some of the larger firms, you know, they're, they're getting there by moving up market in terms of their client, and therefore their average account size goes up, their average fee, their blended fee correspondingly goes down, you know. So 70 to 72 basis points, I would say, is a pretty standard, uh, blended fee rate today.

Let's talk about some of the levers that you can pull here to increase profitability. So we put together the P&L, we've done some of these ratios, and we've identified that, well, it looks like our profitability ratios here, or our revenue per employee, is a little bit less than these averages that you had just mentioned here, or less than the Barron's Top Advisors. So what are some things as a business owner you would advise someone to take a look at and say, hey, if you need to get your profitability up, here's 2 or 3 or 4 or 5 different areas of the business where you have an opportunity to make an impact.

We'll start with the easy stuff, I suppose, which is like vendor contracts and things like that. That tends to be, you know, where people focus on, you know, comparing one technology to another, one custodial charge to another. I don't find that's overall as impactful as some of the bigger items, which like number one would be staffing. We routinely see firms that are overstaffed., you know, due to poor process or poor technology or both. And that plays out in that revenue per employee number. When we see it, you know, $300,000, if it's a baseline average, anything below that, which we do see a lot, that tells me like almost instantly they're probably overstaffed. So I would take a really hard look at our staffing model and evaluate if the personnel that we have are necessary first to support the client experience that we're delivering. And then secondly is, you know, what's the comp package that we're offering those employees? One thing that we see frequently with smaller practices, their staff is like a family. And while that's, on one sense, it's quite admirable and you want to treat your family well and reward them for the good work that they do, but on the other hand, we see their compensation just start to creep out of what a normative range would be for that respective role. So it becomes like this tenure-based compensation package not tied to the actual service they're delivering. And so they have these bloated staff P&L, bloated staff expenses compared to what they could go hire another equivalent position for. So paying attention to the staff infrastructure, you know, it's interesting, you look at firms that come from warehouse environments or banking environments to go independent, their staffing infrastructure is significantly less than what the standalone RIA that we see is. And you ask yourself, how are they able to do that when the other firm has twice the employees to service the same number of clients, similar client service model, etc.? So absolutely, number one would be staff. You should have a staffing model to support your respective client experience. And then make sure that you're not overpaying for the positions that you have. If you have a tenure-based person, been there a long time with you and you just have to make the decision, are you going to continue to add more and more comp to them that exceeds what they could get in an open market? Or if push comes to shove, are you willing to part ways and go rehire that position at a better economic outcome for you? So that would be number one. And then secondly would be, How are we charging? I am of the opinion that fee compression is largely a myth. I think there's value compression that's taking place out there. And so perhaps you, you take a hard look at your fee schedule and make sure that you're charging appropriately for the service that you're delivering. You know, we see a lot of firms out there that frankly they just underbill. In a lot of the transactions we do, when the acquirer is looking at that practice, one of the things that they intend to do, whether it's stated or not stated, is over time they want to bring that fee schedule up to match theirs. You know, of course, that may come with delivering new services, etc., that justify the additional fee, but that's easily a way to increase your profitability that has nothing to do with, you know, cutting expenses.

So let's go back to the staffing piece here for a minute. And you said oftentimes you see firms that are overstaffed. So let's say a firm is growing 20, 30, 40% per year. So they're perpetually in the mode of adding new staff, and that new staff is not operationally efficient yet because they're still in a learning mode. Do you cut those firms any slack for the fact that they may be growing fast and we've got extra staff because we're, we're constantly in hiring mode? How do you evaluate that and maybe strike the balance between we know we're overstaffed, but that's because we're growing fast and it's okay as long as we continue to grow fast? Is that how you sort of look at it?

We look at their income statement going back 5 years, basically. We're looking at variances in either their profitability or their growth in trying to paint this story. So when someone tells us, and we get told this a lot, whenever someone is below $300,000 revenue per employee and we've raised this question, the most common response that we get is, "We're making investments into our infrastructure for growth." Okay, well, when did you first make these investments in the infrastructure? Well, we added these positions 2 years ago, 3 years ago. All right. Well, then you would normally expect to see an incremental increase in growth attributed to those investments that they made. Overwhelmingly, the growth never materializes. And so in that scenario, the owner is going to be faced with a decision when it comes time to have a valuation, if they're going to look at a transaction, is do we bring these employees forward in this new model where in theory there's going to be additional resources and support that make those roles redundant, or do we retain them knowing that if we retain them, it's depressing our EBITDA, so our valuation is going to be impaired? So in those cases, we would not give the seller any credit for the investments that they've made. We would try to normalize it to see what the regular way business would look like without those investments, and that's where we would try to move the valuation to. Now, if they have significant growth. We, uh, for example, one comes to mind that we're working with right now where they made in the last few years, probably close to $1 million in infrastructure investments and tech, adding some younger staff, specifically client-facing advisors that didn't have a book of business with them. So they paid them a base salary and they're grooming them in their respective organic growth channels, et cetera. They made real bona fide investments, which we can just break out and see, But then they've also had phenomenal growth. So not just 20, 25%, but they've doubled their business in 2 years. So you can look at that investment and you can see the immediate return. In that case, we would be fine with normalizing those investments out of the P&L, giving them the valuation on that normalized EBITDA, not being impacted by the investments. But I wish that were the norm. That's not the norm. Normally we see they've made the investments, but the growth hasn't materialized. I would back one thing you said, 20, 25% net new asset growth. I assume that's what you meant, that would be a phenomenal number to see. We just don't see those numbers, not in a consistent fashion. Maybe you're one year to the next, but I would consider 8% net new asset growth a year to be a very healthy— If you could show me a 5-year consistent growth rate of 8% or north a year, I would say you're a strong growing firm. 3% to 5% net new asset growth is normal. Below 3%, below 5%, something is wrong. We're not growing as we should.

Okay. Now, also on the staffing piece, you mentioned that oftentimes we'll see firms are overpaying longtime staff members because it's easy to just to say, we're going to give you a 2 or 3% increase per year just to account for inflation, and then we're going to give you a bonus here and there. And after 10 years, it's like, wow, you're really getting paid a lot. And I see that a lot when I'm working with advisors where they have longtime staff members who, if you were to replace that person, you could replace them at a lower rate. And so I know back from my corporate America days many, many years ago, they had very formalized compensation structures and ranges. So for every position, they'd say, here's the minimum and here's the maximum. And as long as you're in this job classification, this is the maximum that you can make. And if you want to make more than that, then you need to get promoted. Do you see any advisory firms being that formal with their compensation structures?

The good ones? Yeah, because they actually, you know, there's also a human side to this, you know. Again, smaller practices where it's, you know, 20 or fewer employees, these, because again, they become your family and sure becomes a very hard decision to make. But that's the difference. What you, you spoke to some of the banding that we see, the clustering of firms like at the $250 million asset size, the $500 million size. And then there's this no man's land between half a billion and a billion. Very few firms make that cross. And it's the ones who are running their business like a real business and they're making those tough decisions. They're making the infrastructure investments into their business. So very few— the larger acquirers have those type of staffing bands. Now, when they are acquiring the smaller practice's business, even if they have staff that are outside those normative bands, they're not going to like reduce that person's compensation. They're not going to, you know, that would, that would destroy the continuity of the business, which they have no interest in doing. So you're, if you have those types of situations in your business and you're transacting, you know, they're not going to have to take a step back. But going forward, I would not expect them to see very much in the way of comp increases if they're significantly outside of the band.

You also mentioned a second lever here that you can pull is the pricing. And I think you said that you're really not seeing much along the way of fee compression, but it's more value compression. So even though the fee may be staying the same, the amount of value that the advisor has to deliver for that fee keeps increasing. Is that what you mean when you say the value compression?

Yeah. And, and specifically firms The majority of the firms that we work with, I would describe as planning-centric, meaning they're not purely an asset management firm. If we see fee compression occurring anywhere, it's on the firms who are just delivering asset management as a service. And so the planning firms, and I'm talking about firms who are actually doing real planning, not saying they do planning and it's really just a ruse for asset management, they're delivering real value. And people pay for value. They have no pro— I don't— we don't see clients typically, you know, beating their advisor up when they're delivering real value, and typically on the planning side. So if you're looking to maintain your fees, if they're already priced properly, or if you're looking to perhaps adjust the fee schedule upward, really take a hard look at the value you're delivering. Perhaps consider new services that you can offer and then price properly for it. Don't be afraid to charge for what you're worth because If you're doing a good job in this industry, you're changing the lives of your clients and you should get paid for that.

As you look at the very best firms that you work with, how often do you see that they are actually reviewing their P&L? Is it monthly? Is it quarterly? How often do they look at that?

I would even say weekly, but certainly monthly. The best practice firms, one, you know, they typically have a a CEO or a CFO, that they view that as a very important part. They're not just entirely client-facing. In other words, you know, they're, they're focused on running the business. They establish annual budgets and, you know, 3-year forward-looking projections, and they're working on a plan, not just managing their business in the rearview window. So I, I would certainly say a monthly, uh, review is That's probably a best practice.

And then how much of that information have you seen firms share with the rest of their team members? So obviously the owners are going to see this, maybe the senior leadership team's going to see these financial results, but do you see any trends in terms of how much of that financial information is actually communicated to everyone else on the team, whether it's just the gross revenue or—

Very rarely, I would say, they share it with the broad team. Maybe again, the senior, certainly the owners in the practice, or maybe to some of the senior client-facing advisors. And if they do share, it'd be more on the revenue side. They're establishing revenue targets, net new asset targets, things like that, that they broadcast to the broader team. I have seen firms though that it's an open book within the entire— and that I think is fantastic to the extent that you don't feel like you're letting important information getting into the hands of people that you wouldn't otherwise want. I think it promotes overall transparency, and everyone understands the levers that are moving the practice forward economically speaking, and they can all work towards, you know, achieving those goals together. I think it's a good practice, but we don't see it often.

Okay, so we've got the P&L statement put together, we've talked about some of the ratios, we've talked about some of the levers that you can pull here to increase profitability. So let's look at the other side of the table here, which is what you're company does, which is the M&A piece. And so putting your M&A hat on here, let's go into a little detail here. What are some of the things that you're going to be looking at as you are valuing the business? For example, let's say we have two businesses that are generating the exact same amount of revenue over the previous 12 months. Those two businesses, I think, could have wildly different valuations based on different factors that's going on underneath the hood. So I'd love for you to explain what are some of the factors that could increase a firm's valuation? What are some that are going to decrease it?

Largely, the things that— so if you think about multiples of EBITDA in a range, so let's say we were talking about a range of 5 to 7 or 8x for the same business, two businesses, they each have that same range. Well, what would move move one of the businesses to the lower end of the range versus to the higher end of the range? Those typically are more qualitative in nature. So certainly if it's a strategically important market for the acquirer, do they have any organic growth driver that would be additive to the buyer, right? Or are they just like most firms, word of mouth, referral driven? What is the age of the seller? Right? You know, if they're, if they're 65 versus 50, 55, a buyer is looking at what's the, what's the runway of this advisor? Are they going to be additive to our team in that market, or do we have to go find a successor? I would say the growth of the practice, you know, if you're looking at their historic growth and you're looking at a firm that's stagnant versus a firm that's been hitting that, you know, north of 8% net new asset growth, that's going to move you into the higher end of the range. And then of course, are you articulating to the buyer a desire to be on the northbound train, you know, in their respective model? What are the things that they are telling you you have to align to, whatever that might be? Are you saying that, yes, those are, those are things that I would look to add or adopt in my practice? And so what determines the spectrum that you fall on, that with the range high or low, tends to be more qualitative, not necessarily economic. In fact, when it comes to valuation, when you run a really highly profitable practice— let's take my EBITDA average of 35 to 40%, but you are operating at 60% net income or EBITDA, right? So that's going to look weird to an acquirer. That will cause them probably more concern than if you were operating below 40% profitability because they're going to be asking this, what's wrong with this picture? This looks abnormal to us. Did they strip the P&L down to artificially inflate their net income for purposes of the valuation? Can they reasonably support growth given their lack of infrastructure and their high degree of profitability? So when we see firms from a financial perspective that are are, let's just say, less efficient than they would like, that's actually in many cases positive for the buyer because they're going to acquire that practice. The valuation would be lower because of their lack of profitability, and they're going to pretty them up and make them more efficient and get them back on a trajectory of profitability that's more in line with what you would expect, and they didn't have to pay for it.

Now, what about the average age of the clients? And then also, is concentration risk an issue?

So certainly the, um, concentration risk, if you have a revenue attributable to a client that's more than 10%, they would want to understand the nature of that relationship and feel really good about the longevity of those assets being there. For example, if it was an elderly family that represented that 10% client, do you have established relationships with the kids? What's the likelihood of that family, that relationship being around? So So client concentration risk is definitely something that we would look at. The age of the clients, we do request a demographic breakdown of all the households whenever we're doing an acquisition. And really, you're just looking for something that's just an obvious red flag. Like I had one firm, he told me at any point in time, like 30% of his client base was subject to a funeral. So that his average clients were probably 75 or north. That would be something that would definitely cause a buyer concern. But, you know, typically, you know, as long as you're, you're not above 70 in terms of the average age, I don't think that's going to be too big of a red flag for a buyer such that it would impair the valuation.

Yeah. And I like looking at this from a prospective buyer standpoint because ultimately, if an advisor is going to have a liquidity event at some point, they want to figure out how can I really maximize or optimize the value of my business? And so, you know, beauty is in the eye of the beholder here. And, you know, the buyer who has the checkbook here, what they say is valuable and what they're willing to pay for is for the most part what the advisor will likely want to be optimizing for. So I think it's helpful to look at this through the prospective buyer's lens.

The number one thing that a buyer wants to hear is your desire to grow within their ecosystem. Most transactions, they're not looking for the— it's not an asset and revenue purchase, it's a talent acquisition. And so where buyers make their return, I mean, there's a return associated with the cash flow that they're buying, which often wouldn't be enough to cause them to do the transaction. There's a return associated with, particularly if you're taking equity in as a part of the currency stack, if you're rolling some of your equity into theirs, there's a return component associated with the delta of what they're being valued at versus what they're acquiring you at. So that's important. But where a buyer really makes their return is on seeing that practice grow in the future. And so now, but keep in mind, a lot of people, when I tell them that, they hear, oh my God, I'm gonna have to join this organization and become a salesperson, or I'm gonna have these quotas that we have to hit. That's not the case. When they say we want you to grow, they're talking about growing within their ecosystem, which typically has a great deal more of support and resources. They're removing a lot of the operational work that you or someone on your team is doing. So they're creating capacity for you. So they're not talking about having you add more hours to the week. There's nothing punitive if you don't hit growth targets. It's just they want you to articulate to them, yes, we would like to grow. You know, they don't mean ruining the quality of your life. So that would be like the number one thing other than, you know, the obvious personality conflicts that might arise in a dating process. They want to, they want to know that the asset that they're purchasing is going to grow. And so that would be the thing that I would tell a seller to the extent that they're comfortable saying such, that's what they need to articulate to a buyer.

I heard you say earlier that as a buyer, you're going to look at the previous 5 years' P&L statement.

Is that correct? Yes, 3 to 5 years.

3 to 5 years. So if you're thinking about selling your practice and you're trying to optimize it, you need to be thinking 3 to 5 years ahead of time. Yes. And making sure that you've got a really nice progression over time so that when you do get ready to sell and they look back at the previous years, you've got a great story to tell.

Yeah, I wish you could say that a thousand times because we see firms that they, they want to wait to the year that they plan on transacting, where they should be thinking about this 2, 3, 4 years ahead of time. So absolutely. And getting back to the qualitative things that might impact the valuation, if you wait till you're 60 or 65 to transact, that could impair the valuation a bit because the buyer is thinking, "Okay, we have to now add the P&L costs potentially for a successor." in this business if you don't already have one, or how, you know, how long is this practice going to be around if the person leaves? So I would tell you to transact earlier. Now, I will make one point. If you have P&L adjustments that you know you, you need to make, okay, often to increase your profitability, to maximize your EBITDA and drive the valuation higher, often a buyer will— if you come into the negotiation articulating that. Say, listen, we know that we're overstaffed, you know, we know our fee schedule is, is not adequate for the service we're delivering. These are the changes that we intend to make. Often a buyer will give you some runway to make those changes. So we will do what we call a recast of the P&L, and we'll take all these presumed changes that the seller is anticipating making So we'll normalize the P&L for those adjustments. That puts forth an EBITDA number, which is the valuation is based on, which is higher than their current EBITDA, right? Because they haven't made those changes yet. But we can give them the valuation assuming those changes are going to be made in that first year post-acquisition. Now, some of that valuation may be pushed to the end of that first year to allow you time to make those changes, but it's not necessary that you make all the changes up to hit the valuation you're looking for. A buyer in many cases will say, okay, let's talk it out. What changes are you anticipating? Here's our feedback on what we think you should do. And let's go ahead and base your valuation, assuming you're going to make those changes in the first year and you've got a year to do it. If you don't do it, the valuation would be reduced commensurately. But if you do hit the P&L adjustments, the valuation would be closed out at the end of that first year.

Let's say we have 100 independent advisory firms. Could you give me a breakdown of how many of those over time are actually going to be sold to more of a strategic buyer versus how many are just going to transition through an internal succession plan versus how many are just going to fade into the sunset and go away?

Wow, that's a great question. I've never heard it positioned that way. I would say, um, and I'm biased to say this, I guess, but today I would say the vast majority are going to end up transacting with a third party. An external transaction for a couple reasons. One, there's just a plethora of buyers. The models are at an all-time high. You can basically structure what you want your life to look like on the other side of a transaction any way you want with a number of buyers, multiple cultures, deal structures, economic models, and all the rest. And then secondly, the internal succession, I get why that's generally thought of as the preferred route, because you're handing the firm over to someone that's presumably been on the team for a while. You're familiar with them, the clients know them, there's less change. But two things to consider. One is that person that's been on the team in an employee capacity, are they a business owner? You know what? You know, you're an entrepreneur. You started the business, you took risks. They didn't. If they were an entrepreneur, they were probably running their own RA somewhere. So do they have the business chops to move the business forward as an entrepreneur that you did. In theory, they could be better than you too, but I find that's often not the case. And then secondly, the valuation that you would receive through an external buyer versus an internal buyer is typically a lot more. The internal buyer just often doesn't have the financial capability to write the check that the external buyer does. And so So for those two reasons, I would say, I think it's going to trend towards external transactions. I mean, there's some really nice firms that are coming into this M&A landscape that I think are just a fantastic option. Now, putting a percentage at it, I would say greater than 50% would be external, but that's just a wild guess. It's funny, the ones that ride off into the sunset, those tend to be like solo practices. It's purely a lifestyle business. Some of them, they're working out of their home. I would put that at a fraction of the— they're gonna— those will likely be gobbled up by the, you know, local regional practices. But I think the external M&A is definitely going to dominate the landscape going forward.

So do you think 5, 10, 20 years from now we're just going to end up with a landscape where you've got the warehouses, and then of the independent firms you've got these some number of national RIA firms that have thousands of advisors with them and maybe a very small number of remaining independents? Or how do you see the landscape evolving over the next decade or two?

I would say definitely we see the emergence of dominant national firms in the independent kind of space. So, you know, you think about like a United Capital of the world or a Beacon Point, groups like that where they're, they're going to be $20, $50, $100 billion in size, which those firms don't exist today. So I think that is going to be the dominant trend. The effect of the wirehouse, I think it's been persisting for some time now, the migration of wirehouse advisors into the independent space. I think the rise of these nationally dominant regional firms are only going to accelerate that. Now, there always will be room for the boutique standalone smaller firm. I don't, I don't think that the rise of these practices are going to necessarily eliminate that opportunity for a firm just to say, you know what, we're gonna, we're gonna stay small and pursue internal succession and things like that. The challenge is going to be for those firms is just being able to keep up with the investment technology, you know, process that the larger firms are, are going to be rolling out. That's— you're going to have to truly be a boutique, have some kind of really small niche that allows you to, to be valuable within that niche without necessarily having to have access to all the neat tools and things that these larger firms are going to be— have available to them.

Well, Alan, what's the best way for folks to reach out and connect with you and learn more about what you guys are doing?

Sure. So I would send them to our website, which is alaris alarisacquisitions.com, and there's a bunch of videos and you can schedule a meeting with us, and that would probably be the best way. Or you can reach out to me at Allen, that's A-L-L-E-N, Darby, D-A-R-B-Y, at alarisacquisitions.com.

Okay, well, I can't let you go without asking, what does Alaris mean?

It means wingman. You know, I've always loved, you know, things that describe what we do in a really neat way. So we feel like we're, you know, wingmen to both sellers as well buyers in the industry. So I thought it was an appropriate name.

Well, Alan, this has been great. Appreciate you taking some time here to be on the show, and congratulations on all the great work you and the team are doing.

Thank you very much, Steve. It was a pleasure. Look forward to doing it again sometime.

My key takeaway from my conversation with Alan Darby is start now. There's no need to wait to optimize the performance of your firm from a financial standpoint. Point. Make sure you have a clean P&L statement, review it frequently, compare your results to industry benchmarks, and make the changes necessary to keep your firm at least at the midpoint of industry profitability. Alright, that's all for today. Make sure you like and share this podcast through your favorite social platforms. And for more great podcasts, visit us at barons.com/podcasts. Take care. Take care and be safe.

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