If you're running a financial advisory business, one of your most important (and overlooked) goals should be creating equity. This is true whether you're nearing retirement or still decades away from leaving the workforce. It's also true whether you work for a wirehouse, are affiliated with an independent broker-dealer or own your own RIA firm. Regardless of your business model, you've got to think like a smart entrepreneur by continually enhancing the value of your practice and demonstrating it in ways that can lead to the right valuation for your firm or book of business.

Chuck Bowes, principal at Waypoint Wealth Partners in California, is a firm believer in this approach. In his mid-forties, he's nowhere near a liquidation event-but that doesn't stop him and his partners from focusing on value creation. "Every decision we make is designed around maximizing the value of the firm," Bowes says. "It's the big ground rule we all follow. In the event that we ever do sell, we know we're going to get the maximum value possible."

Bowes shows that it's never too early to take the steps necessary to build the maximum amount of equity in your practice. Indeed, as with investing for retirement, the sooner you start preparing and making an ongoing investment, the less you'll have to do later when the time comes to structure a deal.

So you should constantly focus on the aspects of your business that drive value and ultimately make an acquisition or sale more beneficial. You should always be in the market and inquisitive about potential deals, which will require you to develop relationships and gather information that often will lay the foundation for your eventual exit. And because the best deals are often done with people who already know and trust you, this exit will be much easier than if you were not prepared.

What's more, you never know when you might be inclined to sell or transfer a business. You might experience a rapid or unexpected change in health, receive an offer you can't refuse, inherit a large amount of money or simply become burnt out. Regardless of the situation, you attract buyers by preparing for them. In the process, you build a practice that has tremendous stability and supports quality of life for you and your team.

VALUING A PRACTICE

Advisors can get a grasp on what makes their practice attractive to someone else by understanding how it might be formally valued and how it should (and shouldn't) be valued.

Let's start with one of the most common approaches to valuation-an asset-based approach which, as the name implies, values the physical assets of a firm. This is a good way to value a business like, for instance, a wholesale distribution company, with a lot of hard assets such as trucks, heavy equipment and buildings. But it's not a relevant method for an advisory practice that has, say, $100,000 or less in physical assets.

Next, consider a revenue-based method that compares revenues across multiple firms to arrive at a valuation. Although commonly used, this model has one major flaw-the practices being compared must be virtually identical for the valuation to be accurate.

Most advisory firms aren't identical. There's a wide variety of business models, service models, pricing models, product offerings-the list goes on and on. What's more, there are regional and individual economic differences, profitability metrics and levels of competition in each market. Firms' unique characteristics are some of their greatest selling points in the marketplace.

The upshot: Most firms are just too dissimilar to use a comparables approach effectively. As a result, revenue multiples tend to oversimplify the complexity and diversity of practice models, leaving some practices grossly overvalued and others highly undervalued.

So where does that leave you? The best approach for most advisory firms is one that uses a discounted cash flow valuation, which examines an acquisition for what it really is: an investment. This method involves estimating your annual cash flows (essentially, in this industry, your profits) for the next five to seven years, determining a terminal value and applying a discount rate to come up with a present value. The buyer of an advisory practice essentially is investing in the expected value of the business' future cash flow. That cash flow-or net income-is what counts in any business.

Think about it this way: You don't take your revenue home at the end of the day. Take two practices, each with $1 million in gross revenue. One is well run and generates $300,000 in yearly cash flow, while the other is inefficient and generates just $10,000. Clearly, both firms aren't worth the same amount. Maximizing your cash flow and valuing your practice based on it will help ensure that you get top dollar when you eventually sell.