The value of an RIA firm isn't just dependent on revenue and size, but is also influenced by subtler factors such as client demographics, Fidelity has outlined in a new report.

Only 38 per cent of RIAs recently polled by Fidelity said they have a strong grasp of how to augment the value of their firm, an issue compounded by the fact that many are simply not making this a priority. 

The findings, taken from Fidelity's 2015 RIA Benchmarking Study, suggest that a considerable number of RIAs have yet to realize their full potential from a value-creation standpoint, and may also be setting themselves up for disappointment in the event of a sale or merger, the firm said.

“A firm’s value is dependent on many factors – some of them, such as size and revenue, are widely known,” said David Canter, executive vice president of practice management and consulting at Fidelity Clearing & Custody Solutions.

“Other valuation drivers, such as client demographics, may not be so obvious, but firms still need to consider them in order to get a clear picture of their worth. The demographics of their clients – which can shed light on whether those accounts may grow or depreciate over time – can indicate a lot about a firm’s current stability and its ability to grow revenue in the future,” Canter said. Indeed, with an aging client base that is often more connected to individual team members than to the overall firm, the stability of many RIAs may be under threat if they fail to effectively target new clients, Fidelity warned.

There are eight key drivers of firm valuation, the firm said: Firm size (as it grows, the ability to scale wealth management without being highly dependent on any one associate, for example, increases); revenue growth and structure (potential buyers will want to know future revenue growth potential as well as whether its structure is fee- or commission-based, and if fee-based advisors charge for additional services); organization (primarily relating to human capital) and leadership strength; capabilities; client experience; cost structure (external buyers will want to know the elements of this they can build on after a sale while internal buyers will seek to gaugue where the cost structure is heading in the future); and, as previously mentioned, client demographics.

In light of its findings, Fidelity has highlighted four ways it believes RIA owners can boost the value of their firms.

Firstly, if an owner is considering taking actions that are related to its value, such as issuing equity, arranging a third-party valuation can offer meaningful insights from an outside perspective on the firm’s business value, it said. Secondly, the firm advises that RIAs use KPIs to help them understand and manage the fundamentals of their business, helping paint a clear picture of what it's worth (only 22 per cent of those polled strongly agreed that their firm uses KPIs in this capacity).

Fidelity also emphasized that the quality of a firm's talent pool can significantly influence its value. Identifying the skills individuals and teams need to develop, and providing a combination of professional experiences and training to help them reach their potential, are two ways of investing in staff, it highlighted. As a side note to this, the findings showed that while 59 per cent of firms said they would like to pursue an internal transition, only 27 per cent have made considerable headway with this endeavor. Underscoring how important these individuals can be, 38 per cent of new AuM for 2014 at firms with next-generation owners came from these individuals, according to the data.

Meanwhile, if an owner is planning to pursue an internal succession, they should seek to identify next-generation owners at least five to seven years before their planned exit, Fidelity said. The firm added that firms may also want to develop equity compensation plans to retain key employees and consider providing them with opportunities to buy equity at a discount to fair market value.

Lastly, Fidelity said owners should position their firms to capitalize on business opportunities from inter-generational wealth transfer. Strategies for this include identifying client relationships that have the potential to expand to younger generations and building engagement strategies that not only deepen these relationships, but also involves these clients’ adult children, and potentially grandchildren. Additionally, when pursuing new clients, firms should cultivate relationships with younger investors who meet the firm’s account minimum, or who have a combination of high income and strong saving habits that may eventually result in them meeting the account minimum.

“The biggest takeaway here for RIAs is that knowledge is power,” according to Canter. “In order to realize the full potential value of your firm, you need to know what can drive that value first.”

Around 600 firms participated in Fidelity's survey, of which 441 completed it, forming the basis for the findings of its report.