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Mutual Fund Business

Buying or selling a mutual fund business?

Buying or Selling a Mutual Fund Book, business, practice, dealer or company?

What all – the buyer and seller need to know, have to know and ought to know for a nice smooth transition that makes sense and leaves both parties feeling satisfied.

To put the right price on your business you need to know its true value and not just the perceived value; or what you think its worth.

Whether you are looking to grow your practice or considering how long you will stay in the industry, buying and selling a book of business is a topic you may face. Many of the questions I receive about the subject are about how to value your business. There is no magic formula for pricing a business, nor is it easy to compare the value of your practice to other practices since the details of the actual transactions are not made public. But below are some guidelines to keep in mind.

Is The Book Mine To Sell?

Before entering the buying and selling process, you have to determine if you even have the right to sell your client assets. Firms have different policies related to "who owns the clients." Some advisors have signed agreements that state the clients belong to the firm. Some firms may pay the retiring advisor a commission or retiring bonus for assisting with the transition of the client assets to another advisor within the firm. Other advisors have agreements that explicitly state that the advisor may only sell a book of business to someone within their own firm while others have no restrictions and are free to enter into a deal that is in their clients' best interests.

How Do I Value My Book Of Business?

Once you've determined your business is indeed yours to sell, you need to determine a price. The value of the business is tied specifically to the clients, the revenues they generate, profitability of the practice and the goodwill of the selling advisor. A buyer, for example, would generally pay less for a book that has an average account size of $25,000 than he would for a book with an average account size of $250,000. Here are five common formulas used to value a book of business, starting with the easiest to implement.

1. Assets Under Management (AUM)

Using the AUM method, the price is based on the market value of the client assets, as of the date of the sale transaction, times a factor that usually ranges from 1/2 to two times. Suppose a book of business has $50 million in AUM, and the buyer and seller agree to use a 1/2 factor (or 50 basis points). The selling price of the business would be set at $250,000. While the AUM method is used for some transactions, it has limited use for many financial advisors today.

2. Historical Commission And Fee Income (HCI)

Using the historical commission and fee income method, the purchase price is based on previous earned revenue times some factor. Depending on the earning and profit potential it should be simple in that the greater that the annual income is the higher the price should be. Some deals have used the historical commission and fee income earned over the preceding 12 months; others have used an average of the last three years. The factor used ranges from one to 1-1/2 times or more. Where a high percentage of income was earned from one-time commissions, a lower factor would be used. Like the AUM method, HCI establishes a purchase price that may bear no relation to the profits the business does not generate, nor does it factor in the retention of client assets, and the nature of those assets.

3. Historical Annual Recurring Revenues (HARR)

Under the HARR method, the purchase price is based on the service and trailer fees earned, as well as any other regular fee income the clients pay. Some buyers prefer this method because the price is determined upfront and it's easy to calculate and verify the numbers. However, things like profitability, attrition and the costs of running a business are not factored in.

4. Actual Revenues Earned On A Go-Forward Basis

Some buyers would prefer to base the value of the business on the actual revenues they are able to earn on a go-forward basis from the date of the transaction, and pay for the business as these revenues are earned. Basing the price on go-forward revenue also factors in the risk related to client retention and market performance. The multiple used for mutual fund assets ranges from two times or more of the actual revenues earned. When markets were hot, multiples of three times or more were not unheard of, paid over two and a half years or 10 quarters.

However, the very structure of these deals puts the seller at risk of not being adequately paid. The ultimate price paid is highly dependent on the effort the buyer puts into retaining the clients. While it has been suggested that sellers will be rewarded for building solid businesses with loyal clients, this method of valuation requires the seller to also focus on the quality and motivations of the prospective buyer.

Because the price depends on what the buyer actually does after they acquire the business, the seller does not have much influence once the deal is made. To ensure they receive value for selling their practice — and are not just handing the buyer an opportunity to market to the clients — some sellers require a minimum purchase price, or a non-refundable deposit.

5. Free Cash Flow

Using the free cash flow method, the value of the business is based on the profits the business generates, after all the costs of running the business, including expenses and professional salaries, are factored in. A multiple (related to a cap rate) is then applied to the free cash flow of between two and 10. It takes the most work to value the business based on the amount of free cash flow. While the other four methods use numbers based on third-party reports and statements, the free cash flow method also uses the businesses own reports that have to be reviewed, verified and adjusted.

However, this method does not work where a financial advisor is selling only part of his or her practice. It is also not effective for financial advisory practices that are run primarily as a professional service practice that generates a healthy personal income, rather than a business with sustainable profits.

How Do I Negotiate The Terms Of The Deal?

Once the buyer and seller have found each other and established a price, additional terms and conditions need to be ironed out before the deal is finalized. Some of the terms might push the price up or down. Terms and conditions include the following:

How long the seller will remain actively involved with the clients;

  • Whether or not the buyer will be assuming any of the seller's staff;
  • the transition plan;
  • The non-compete agreement, which prohibits the seller from competing with the buyer or soliciting for the business of the clients; and
  • financing details.

When negotiating, it sometimes helps to put a dollar value on what you would like to have happen or the cost to you if something does not happen. For example, if it's important to the buyer that the seller personally introduces him or her to all key clients as soon as possible, the buyer might want to tie a bonus payment to the completion of this activity.

The method used to value a book of business can be as complex or as simple as the buyer and seller want to make it. Take some time to determine what works the best for you. Ultimately, the price depends on what the buyer is willing to pay and what the seller will accept.

A CBV (Chartered Business Valuator) or Chartered Accountant knows and understands what to look out for, someone with good experience has done evaluations before and will likely be diligent verifying numbers and asking the right questions. Mutual Fund Experts in this field have an in- depth knowledge of books, businesses and practices for sale including work out arrangements.

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