Most small business owners have no idea what their businesses are worth. Many turn to financial planners to determine the value of their most crucial asset. But if you ask a registered investment adviser about the value of his or her practice, you will often get very strongly held opinions about some multiple of revenue.
Unfortunately, this is usually no more sophisticated than back-of-the-envelope formulas. Worse still, RIA owners don’t truly understand how to get the right revenue multiple.
A generic revenue multiple does not define a practice’s value. Wouldn’t it make sense that two firms with the exact same revenue would be worth different amounts if, for example, the majority of one firm’s clients are in decumulation while the other firm had a robust growth rate and clients in their 40s?
Similarly, a firm that has made significant investment in next-generation resources, staff and clients is worth a different amount than one with no client website and antiquated back-office procedures, even if the revenues are identical.
Advisers often declare the worth of their business based on a revenue multiple “rule of thumb” they picked up from a breezy news article or half-remembered bits of wisdom heard at a conference. This leads many firm owners to vastly overestimate their value, but more importantly it causes them to misunderstand the actions they can take to improve their overall valuations and business quality.
I suspect the persistence of revenue multiples as a quick and dirty shortcut for