“There has been a severe reduction in the profitability of clients at the lower end of the revenue range,” the report said.

“Our work indicates that it is very difficult to be profitable with a client with a fee under $3,000 per annum. Clients much below this level generally detract from value and have fallen to one to two times revenue, below $1,000 would be less than one times if they can be sold at all.”

Given rising regulatory costs across the industry, and the removal of grandfathered revenue, Centurion said practice buyers were factoring this in on valuation and applying a discount for low-value clients.

“The key acquirers in the market have a detailed understanding of their cost to serve and will price acquisitions accordingly, often applying a nil or negative value to small unprofitable clients,” the firm said.

Because of restrictions to business credit as a result of the royal commission, smaller practices were also more difficult to secure finance for, meaning they were less desirable for buyers, the report said.

“The royal commission has resulted in reduced access to credit for all small businesses as the banks rework their credit assessment and focus on cash flow and ability to repay,” Centurion said.

“Small financial planning practices have been caught in these outcomes, and as such, access to credit for ‘bolt-on transactions’ has reduced. Our experience has been that purchasers who are interested in small books have been unable to raise cash flow lending finance and have had to provide ‘bricks and mortar’ security for the lending.”

In addition, the increasing cost to serve had led to more pressure on practices to get to higher revenue levels before they were considered a scalable business, according to the report.

“The point of scale for any practice has materially increased. This means that the revenue point where a practice starts to get the benefits of scale has increased,” Centurion said.

“Anecdotally, this would be well above $1.5 million in revenue.”
While the COVID pandemic had not had a long-lasting effect on valuations, the short-term impact on practices that were more reliant on asset-based fees had spurred more firms to transition to a pure flat-fee model.

“Those practices with market-linked income saw a reduction in revenue [from COVID]. At the peak, this was around 12.5 per cent with a consequent reduction in profit and valuation,” the report said.

“In a long-term sense, we don’t see COVID as creating an enduring reduction in value. It will, however, speed [up] the transition to purer fee for service models and change operating models permanently.”