Advisors are inflating the value of their practices, according to new research by Cerulli Associates.

On average, advisors believe their practices are worth 2.8 times their total revenue, but for those advisors who actually purchased a practice within the past 12 months, the average revenue multiple paid was 2.2 times revenue, explains Kenton Shirk, associate director at Cerulli, in the Boston-based research firm's fourth quarter edition of The Cerulli Edge–Advisor Edition.

“With many buyers in the market, advisors’ expectations regarding the value of their practices are high,” Shirk says.

With the current imbalance of buyers to sellers in the market, Shirk continues, “advisors are overly optimistic about the enterprise value of their businesses. For every advisor who actually acquired a practice, there are nine who wanted to buy one.”

Cerulli explains that many factors can exert “downward pressure on multiples,” with demographics of both advisors and their clients having the most significant impact.

“As advisors begin to retire, a larger number of sellers will enter the market,” Shirk says. “Practices that are heavily weighted with older clients are less desirable because they have less potential to generate future cash flow. Retired clients are also inclined to deplete asset balances as they withdraw money for living expenses.”

Cerulli warns future sellers to work continuously to ensure an infusion of clients across various age ranges, and encourages them to build multi-generational relationships with their clients’ families to minimize a buyer’s concern about practice demographics.

For advisors who made an acquisition in the past 12 months, the most “challenging aspect of the deal,” Cerulli says, was transitioning clients from the seller. “While the percentage of targeted clients’ assets that were successfully transferred was high, averaging 88 percent, retention rates for practice acquisitions can vary widely. The majority (73.3 percent) of deals experienced retention rates of 90 percent or higher, but 16.7 percent experienced a retention rate of 75 percent or less.”

Cerulli says that nearly two-thirds of independent advisors (65 percent) wish to buy a practice. Of those, 47 percent are proactively searching for an acquisition opportunity, whereas 53 percent are not.

“Given that a relatively small percentage of advisors plan to retire in the next four years, acquisitions are highly opportunistic in today’s marketplace, and many deals are sourced informally via networking and word of mouth.”

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