Creating Value through M&A in Financial Services
Key Takeaways
Valuation Metric: EBITDA multiples are the primary valuation tool, with smaller firms typically valued at a 30% discount to listed companies.
Market Trend: The wealth management sector is consolidating rapidly, creating numerous opportunities for value creation through strategic sales.
Value Drivers: Post-acquisition synergies, cultural fit and client retention are crucial factors influencing deal valuation and success.
Due Diligence: Thorough financial modelling and due diligence are essential to demonstrate value and validate synergy assumptions to potential buyers.
The first point to make is that “creating value” through acquisition or merger does not mean simply that you “add profits” to your business—in fact, if you overpay for profits you destroy value. This is the case in Financial Services and in any other industry. There are many approaches that a buyer may adopt in measuring value creation through an acquisition of a wealth management or financial services business, but this article focuses on a very simple way to avoid the risk of overpaying. It is based on the principles applied by larger acquirers, but which apply equally to all transactions.
What do we mean by “creating value”?
The simplest way to think about adding value is to work out how much you could sell your business for pre and post-potential acquisition. We will work through this in more detail later in the article, but it is an important principle that you should only go through with a transaction if you have thought through in advance how you measure pre and post-acquisition value AND you stick to your guns—emotion always plays a part in the M&A process—it’s easy to fall in love with a potential acquisition for a whole variety of reasons, but at the end of the day, you are undertaking a financial transaction and adding value is the only measure of success that really matters.
Valuing a Financial Services business—where do I start?
We go into this entire topic in more detail in other articles available on our site. However, we focus here on the measure that we believe is most relevant to businesses looking to grow to a reasonable size through a number of acquisitions—multiples of profit. In this case, we define profit as earnings before interest, tax, depreciation and amortisation (“EBITDA”)—this metric defines the extent to which operating profits generate cash. It is the most frequently used measure used by large buyers to determine the price they are prepared to pay for an acquisition.
There are two obvious places to start to establish a sensible EBITDA multiple to be applied in valuing any business—quoted company multiples and completed transaction multiples. The former is available in the public domain, but the latter is usually only available if one of the parties to the transaction is itself a listed business. We, obviously, have access to confidential data on deals on which we advise, and this insight is especially important for smaller deals, the relevance of which is explained later.
Here are some examples of EBITDA multiples of listed financial services businesses in the wealth management sectors as well as EBITDA multiples for smaller transactions in the wealth management/IFA industry:
Valuations of Wealth Management Transactions in the UK, n=37
Source: Dyer Baade & Company (2020)
To bring this to life, let’s assume that a listed financial adviser trades at a multiple of 12x historic EBITDA. Would it be appropriate to value your business on this multiple? The answer is almost certainly no. Larger businesses trade at a premium—they are usually more resilient to market uncertainties and have greater growth potential, both organically and through acquisition. So, a “discount factor” should be applied to listed multiples, the extent of which will depend on the size and profitability of your business. However, as a benchmark, a business with a £4 million turnover should have a “normalised” (i.e. taking into account principal remuneration taken as dividends and other exceptional and non-recurring expenses) EBITDA of around £800,000-£1 million. Our view is that it would be reasonable to apply a discount factor of 30% to a business with this profile i.e. a multiple of 8.4x based on our “listed multiple” of 12x.
In this admittedly simplified example, the business would be valued in the range £6.7 million to £8.4 million, a mid-point of £7.6 million. This may seem quite low at first sight—a business with a turnover of £4 million would normally have recurring income of around £3 million or more, which implies a recurring income multiple of only 2.5x. The reason is that, in practise, if you are selling your business the buyer would base a price on EBITDA after synergies.
How much should I pay for an acquisition of a financial services business?
If you establish an EBITDA multiple for your business at 8.4x, you should be seeking to acquire businesses at a discount to this level. The extent of the discount will depend on a number of factors, but of particular importance is the extent to which you can achieve post-sale cost and revenue synergies. This is where due diligence plays a big part in the acquisition process—it should provide firm evidence that synergies are real. If they aren’t and you end up paying above our theoretical level of 8.4x, you have effectively destroyed value through acquisition.
Another key factor in your assessment of an acquisition in the financial services sector is the extent to which there is sufficient cultural and proposition fit between the buying and selling business and the extent to which advisers (and clients) stay post-acquisition. Significant “attrition” has a material effect on ongoing EBITDA, hence value creation.
How can we help you to create value?
Dyer Baade & Company act as an adviser to some of the leading acquirers in the financial advice arena. As a result, we have access to a significant amount of price data, which will be directly relevant to a wide range of transactions. This means that we are in a great position to provide buyers with clear guidance on appropriate multiples.
It is vitally important that an acquirer has a firm understanding of the impact of an acquisition on its EBITDA. Here, we provide financial modelling expertise that shows exactly how value will be created (or destroyed!), including a “what if?” analysis that shows what would happen if assumptions don’t work out in practice. Our independent viewpoint should provide comfort that assumptions are reasonable and deliverable.
Due diligence exercises must be designed to not only discover issues of concern but also that synergy assumptions are soundly based. Our role here is to ensure that the right analysis is performed and that it is properly coordinated.
And in summary…
Our strong belief is that the wealth management sector will continue to consolidate and, if anything, the pace at which it happens will increase. So, this means that there will be massive opportunities to increase value through properly managed acquisition programmes.
We are here to help you create that value.