Financial Planning firms have multiple sources of income including their annual recurring revenue from the fees charged to clients. This is different to any upfront fees they may charge for particular statements of advice relating to investment options or the set-up of Self-Managed Superannuation Funds.
As a result of the recurring revenue within the business, many banks are willing to finance financial planning ‘books’ for the purpose of organic expansion or the purchase of other financial planning businesses.
As with any lending on an ‘unsecured’ (no property security) basis, there are a number of tests the business needs to meet prior to a loan being approved.
Aside from experience of the operator, a well recognised deal group membership and a lack of complaints against the business, the following boundaries should be examined.
The proposed debt for the business:
- Should not be more than 1.75 times the annual operating revenue
- EBITAPR must cover at least 2.5 times interest cost
- The total loan should not be more than 3.5 times the EBITAPR
In a similar fashion to Accounting Practices, the EBITAPR is calculated as follows
“EBITAPR = Earnings Before Interest and Tax After Partner(s) Remuneration. i.e. Net profit before tax + interest + depreciation + amortisation + salaries and fees paid to partners – LESS standard professional remuneration”
How does this work in a practical sense?
Lets say that the recurring revenue is $500,000 and there is one financial planner in the business. The profit for the business is $150,000 and the planner takes $160,000 as a salary.
EBITA is $150,000 Profit plus $160,000 salary equals $310,000. Revenue is $500,000.
A financial planning salary may be deemed at $110,000 by the bank. And so the EBITAPR is $310,000 less $110,000 leaving $200,000.
Using the A), B), C) tests:
- $500,000 x 1.75 = $875,000
- Interest Cost must be a maximum of EBITAPR divided by 2.5 = $200,000 / 2.5 = $80,000
- Total Loan Not more than $200,000 (EBITAPR) x 3.5 = $700,000
At an interest rate of say 5%, if this business borrowed $700,000 then it’s interest cost would be $35,000. The loan is less than A) ($875,000) and equal to C) ($700,000) and it’s interest cost is less than B) ($80,000).
On the basic numbers, this firm could be financed up to $700,000.
Of course, there are other factors such as the demographics of the clientele, the business strategy and the types of products sold that will still need to be investigated.