Growth begets patience in race for advice business capital

By Natalie Dolan

There is no clearer sign of an industry’s appeal and future outlook than its ability to attract capital and talent.

Despite Australia’s complex tax, superannuation and social security system underpinning demand for professional advice, the financial planning industry has struggled to secure the backing of serious long-term investors. This has curbed the formation of large, sophisticated professional advisory businesses.

What capital investors are looking for can be summed up by growth opportunities and margin opportunities.

Unfortunately, a couple of major headwinds continue to impact the industry’s ability to deliver them, namely an overly tight regulatory regime and reputational issues. Both issues must be addressed to lure the kind of capital needed to take this budding profession forward.

Treasury’s Quality of Advice Review promises a more principles-based approach to regulation and, if efforts to raise barriers to entry for advisers and licensees are successful, a stronger reputation will ensue.

Assuming those two things happen, capital will flow back into the industry. It will then be up to business owners to demonstrate their capability and capacity to deliver growth opportunities and margin opportunities.

One of my earlier columns described the attributes of the ideal capital partner.

To briefly recap, there are basically two types of capital: patient and impatient.

Patient shareholders are focused on long-term value and, therefore, offer stability throughout the business cycle. This is a major advantage because it enables management to focus on building great businesses.

Impatient shareholders, such as traditional lenders and private equity, are focused on high, short-term returns. Their motives run counter to the motives of most small-to-medium enterprises.

This column focuses on what financial advisers need to do to build a world class business that can attract the ideal capital partner.

We believe the firm of the future will possess five key elements: a compelling shareholder value proposition, client value proposition, employee value proposition, a defined enterprise architecture and a strong culture, evidenced by clearly articulated values and behaviours that are monitored and measured.

This column – the first in a series on the firm of the future – focuses on the shareholder value proposition.

The table below provides a snapshot of a compelling shareholder value proposition.

Table: What good looks like: Shareholder value proposition.

Target state Measure
Mergers One every three years
Acquisitions One every three years
Client retention 96%
Client revenue growth 6.5%
Earnings before interest, tax and amortisation (EBITA) 30%
Net profit after tax (NPAT) 21+%
Dividend payout ratio 80%
Surplus cash At least one month’s operating costs including wages
Employee cost ratio 45%
Occupancy cost ratio 7%
Marketing cost ratio 4%
Debt to gearing ratio Not >3
Interest coverage Not <3
Average revenue per partner / senior adviser $1m-$1.5m accounting

$750k-$1m financial planning

M-A-O-inspired growth

Very few, if any, advisory firms possess all 14 characteristics but firms of the future will tick many of these boxes. Importantly, they will have a plan and will be focused on achieving that plan.

At the top, above all else, they must have a clear growth strategy.

There are only three ways to grow: mergers, acquisitions and organically.

Every firm, regardless of size, should have some idea and preferably a formal plan for all three areas. For some, that plan may be to focus on one or two areas and do nothing in the third.

Traditionally, mergers and acquisitions have been lumped together, hence the abbreviation M&A, but mergers can be vastly different to acquisitions. A merger can be a non-cash transaction. The most successful mergers are ones where both entities know each other well and share common values and motives.

Acquisitions, on the other hands, are almost always funded by debt and subject to a competitive tender process.

Both strategies are important and entwined. Mergers expand a company’s balance sheet, which enables acquisitions. Firms of the future understand the power of mergers and acquisitions to turbo charge growth.

They also understand the importance of organic growth.

Strong, consistent organic growth is an indication of a firm’s capability and capacity. It tells potential capital investors that the market wants to buy what a business is offering. It is the ultimate show of strength.

EBITA is another key metric that capital partners will look at. Firms of the future will have an EBITA target of 30% or higher.

Often investors will look beyond a company’s EBITA margin to the performance of each frontline resource. They may go one step deeper to look at the profitability of each underlying client.

An experienced capital partner can help businesses extract this kind of data to truly understand the profitability of their business.

From now until 2030, when the bulk of baby boomers will retire, many advice businesses will face major challenges such as succession planning and generational transitions, alongside growth.

Addressing these challenges will require capital.

In a bid to secure the necessary capital, business owners will need a compelling shareholder value proposition to turn the head of investors, especially patient ones.

Read more of Paul Barrett’s articles in Professional Planner.

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