Many financial advisors dream of the day when they can sit back, kick up their feet, relax and enjoy the rewards of their hard work. They may be thinking they’ll just slow down and work less, or they may think they want to retire completely.
Either way, they typically have only one of two options in mind for their business when that day comes:
- Create a business that runs on its own and provides its owner with consistent cash flow — one with very little dependence on owners being present to accomplish growth.
- Sell the business to an outside investor for a nice valuation, based on a multiple of the practice’s revenue or earnings.
Whether it’s the automated cash flow machine you want or a sell out, both of these strategies would be a great option for a successful advisor to have in order to live the retirement years they’ve always dreamed of.
But nine times out of 10, these businesspeople either end up with a practice that is much more dependent on them than they expected, forcing them to work and not retire at all. Or the valuation they get on their business and what they thought it would be worth, are miles apart.
I spoke with a successful financial advisor recently — let’s refer to him as “Mike” — who was at this point in his life. He was reaching retirement age and was very proud of the business he had built over the last 30 years. He knew all of the blood, sweat and tears it took to build his business. He was sure the business would be very attractive to buyers, and expected to get a high valuation for it. Besides, he had heard, the bigger the business, the higher the multiple he would get… right?
Unfortunately, outside investors had another opinion on what his company was worth.
An earn-out vs. a sale
I asked Mike two simple questions: “If you left your business for two months, would it run by itself? Would it be able to grow on its own?”
His answer? “No.”
This highlights one of the biggest fallacies regarding the time when an advisor tries to sell his or her business. Most believe they can sell their business for cash and sail off into the sunset. Many advisor practices, however, are reliant on the business owner, making it very hard to sell.
Rather than a sellout, in almost every one of these situations, the purchase comes in the form of an ‘earn-out.’ An earn-out, on the surface, is much like a sale. An investor gives you a cash multiple on your business. However, since it’s an earn-out, the deal requires you to stay on as an employee for a minimum of two years or more. This effectively takes you from owning a business that you built, to working as an employee in the business you built but no longer own, which is far different from being retired.