As the pace of advisory firm acquisitions slowly but steadily increases, more and more attention is being paid to the “going rate” valuations of advisory firms, with some recent mega-deals valued at upwards of 2.0X recurring AUM fee revenue.
Yet the caveat is that not all advisory firm acquisitions are treated the same for tax purposes. Earn-out arrangements result in the purchase price being taxed as ordinary income to the seller, while others deals that purchase the underlying business entity itself may be treated as a capital transaction eligible for long-term capital gains treatment. As a result, a deal that is reported at 2X revenue could actually be worth another 15% more (or quite a bit less) depending on the tax treatment.
The issue is further complicated by the fact that the treatment most favorable to the seller – taxation at long-term capital gains rates – is least favorable to the buyer, who will be compelled to spread the cost of the purchase for tax purposes over 15 years as “goodwill amortization” even though the cash flows for the purchase occur immediately. As a result, the tax treatment of the deal can be a significant factor in setting the price itself, as buyers may pay more for a deal with more favorable tax treatment for themselves, and sellers may accept less if they can receive more favorable tax treatment on their end.
In this guest post, advisor Daniel Zajac shares his perspective on how the valuation of an advisory firm can swing by 15% or more, based on both the tax treatment to buyers and sellers and the expected growth rate of the practice. Whether you’re considering the sale of your own practice, or are a prospective buyer of one (either as a way to start out as a financial advisor, or to make your existing advisory firm bigger), hopefully this information will help you gain a better understanding of the tax issues to consider that may influence the valuation of the firm involved!