Only a very few firms are worth more than 10 times their earnings, so practices seeking extraordinarily high P/E ratios require breakthrough achievements.
James McGregor of Bridges in Sydney recently summed up the common challenge faced by business people building advisory practices:
“Whilst many people are currently distracted by a possible listing event that could get them into the 18 times or above price-earnings range, we’re really focused on getting into the middle ground of P/E ratios, about 12-14 times earnings. What do we have to do as a business to get into that range?”
McGregor’s challenge is an innovative one.
The prevailing logic is that the top end of P/E for small non-listed entities is 10 times profit or earnings. A 10 times P/E ratio by itself isn’t to be sniffed at. This is a damn good valuation usually only achieved by businesses that:
- have industrialised the back and front office;
- are not dependent on anyone’s personal exertion for delivery or rain-making;
- have a distinctive brand presence;
- constantly attract talented new resources; and
- have clients who are consistently thrilled with the services delivered by a team of experts.
There aren’t many firms like that in Australia today. Therefore, going into a 12 to 14 times P/E range of valuations requires some real breakthrough achievements. A 12 to 14 times P/E usually offers something unique.
Many advisers seeking extraordinary P/Es without listing are pursuing an aggregation road. They are aggregating either complementary businesses or complementary client bases.
Aggregating complementary businesses
Those aggregating complementary businesses believe that their valuation premium will be realised because they are building structures to encircle all the financial needs of ideal clients, to earn all the advice dollars spent throughout the lifetime of a client. Whether these dollars are for tax, cash flow, investment, superannuation, structural, leasing, insurance, management accounting, stocks, trading, business or family succession, they aim to capture them all.
Charterbridge was just one of the many firms that tried to pioneer this in the 1990s with little success. The incinerator of failed aggregations still contains some glowing embers, serving to remind us all that much more than good planning is required to prosper in this approach.
Aggregating complementary client bases
Those aggregating complementary client bases sidestep the inherent risks tied up in the long and potentially litigious history when a business is bought. These businesses believe their value premium will be attributed to the scale of product or renewal income they receive. This is the preferred model for value growth in Australia, due to the undisputed strength of trail commissions. With an extra $60 billion in funds every year, thanks to the super guarantee, and markets ticking along nicely, buyers are confident that a premium for scale is still achievable.
Bob Neill, MLC’s succession and acquisition services manager, and possibly one of the best authorities on this topic in Australia, would challenge the idea that only one in three aggregations results in an above-average value, with a third experiencing a drop in value and another third maintaining their value as a result of aggregation. (Defining “aggregation” clouds this analysis, as most business sales are really a client-base sale – i.e. an asset sale rather than a business sale.)
Another route for the attaining extraordinary P/Es is the alignment of business value with an ownership in the vehicle that holds your client’s funds. These businesses tend to be like messy tenants. Knowing that they own part of the building, they know that a 10 percent improvement in the building value is a hundredfold better than a 10 percent improvement in their little business which contributes to the overall value of the fund.
It always comes back to the client as they are the ones paying for our services. But these are peculiar times.
There are listed firms in our industry with P/Es of 18 and above, whose biggest revenue-paying clients are product manufacturers paying subsidies for access to distribution. This is like agriculture in America, where often the biggest payer for farm produce is the government. Neither model is very efficient for consumers.
People like James McGregor will crack the breakthroughs required to build private advice firms of extraordinary value. Once cracked, like all breakthroughs, it will become the norm, and our current thinking will be seen as old-fashioned.
That’s progress. Bring it on.