You may not have noticed yet, but Mark Hurley has come out with another white paper. As lead author of several controversial reports on the future of the advisory profession, Hurley impressed me with two skills: his ability to grab the profession's attention and his marvelous gift for overstatement. He's also a charmer; when he sent me a preliminary copy of his 116-page report, he recommended that I actually read it before I comment.

These days, Hurley is CEO of Fiduciary Network (FN), a firm that lends money to facilitate the transfer of ownership from the founders of advisory firms to successor generations. The lender, Emigrant Bank, takes interest and equity back in return, under some of the most complicated deal structures I have ever seen. When I unraveled FN's arrangements for RegentAtlantic in Morristown and Chatham, N.J., and Evensky & Katz in Coral Gables, Fla. for my newsletter, the resulting article proved an excellent cure for insomnia.

Hurley's white paper, called Creating, Measuring and Unlocking Enterprise Value in a Wealth Manager," focuses narrowly on enterprise value: how to create and sell it. Since planning firms aren't loaded with tangible assets (chances are, you don't have factory equipment, aircraft or cargo containers) this value is measured by projecting future profits and revenues out 30 years and applying a discount rate.

Here's the catch. The paper asserts that fewer than 400 advisory firms "have or possess the potential to build material enterprise value. The remaining 18,000 to 19,000 firms," it maintains, "currently have no enterprise value and are very unlikely to build any."

REVENUES FOR SALE

If yours is not one of these roughly 400 elite firms, you might be wondering why Hurley thinks you have nothing to sell. His report says that if you're following a "fee-based" model, with revenues from both fees and commissions, you're probably transferring substantial profits and enterprise value to your broker-dealer-but none is accruing to you. To a prospective buyer, your commissions have front-end loaded what a client pays for advice-and the buyer, of course, wants future revenues.

Fee-only firms are treated a little more gently. On average, their 1% to 3% annual client turnover implies 30-year client relationships. You can spreadsheet what follows yourself: Suppose your annual fee is $20,000 (implying a $2 million portfolio), and the markets plus client accumulation add 6.5% a year to the portfolio for the first 20 years of the relationship. At that point, the client retires, and fees decline by 5% a year for the final 10 years. Add it up, and you will have collected more than $1.28 million in advisory fees from that one client. Using a discount rate of 15%, the present value of that client relationship is $200,999.

My conclusion is that if you have a few dozen of these relationships, you probably have something to sell. But Hurley disagrees. If you deduct operating costs and a fair salary for the owner, he says, virtually all fee-only firms are unprofitable. That is, they don't pay their owners market-level salaries or produce sufficient free cash flow for internal reinvestment.

The report says you already know this: Deep down, you realize that your firm is not a mature, sustainable business. Moreover, you may not be convinced that your client relationships are transferable.

BUILDING VALUE

In the end, the report offers two kinds of advice: how to build enterprise value in your firm, and how to evaluate deal structures when you eventually decide to transfer ownership. When building enterprise value, your chief obstacles are limited scalability (one advisor can manage only so many client relationships) and a shortage of quality wealth management professionals to hire. Chances are, you'll also need to get bigger. The paper places the threshold of enterprise value between $3 million and $4 million in annual revenues.

Whether you believe these dramatic conclusions (I don't), the paper offers seven good recommendations for morphing your practice into a business: Recruit and retain the next generation of professionals; institutionalize your client relationships; and weed out unprofitable legacy relationships and wealthy clients who demand more than their fair share of your time and energy. Institutionalize your firm's marketing efforts and brand; evolve the company's management and governance structure from an absolute monarchy to an oligarchy that values input from all shareholders, has written policies and procedures, and repeatable business processes; create a robust culture of compliance; and reinvest in the business.

DECONSTRUCTING DEALS

The paper's best value comes when Hurley deconstructs the deal terms and selling arrangements now being offered by a variety of buyers. In general, negotiations start with some kind of valuation of future revenue streams. Then you manipulate the rate at which those revenues should be discounted, based on the risk different parties are taking. If the seller demands all cash up front, the buyer shoulders the risk of losing some client relationships; therefore, the discount rate will be higher, in the 30% to 40% range. If the seller is willing to share the risk by entering into an earnout arrangement, the discount rate will come down, and the overall purchase price (the other end of the see-saw) will rise accordingly.