“Where Have All The Entrepreneurs Gone” was the title of one of many panels at the MarketCounsel Summit last week in Las Vegas, but the theme resonated throughout the three-day event.
The broad thesis, reflected in the rotating panelists and speakers on the stage, as well as executives in the hallways and social events outside the meeting rooms, is simple: The trailblazers and personalities that opened the independent wealth management space are giving way to professional operators and business managers who are turning the companies into viable, sustainable businesses.
Independent wealth management is clearly winning in the marketplace, given the rapid growth of the RIA channel over more traditional advisors "captured" inside banks and brokerages. Yet with that maturity comes a danger of losing the innovative and client-centric culture that motivated many of those early pioneers, and remains ingrained in many of the firms.
“Professionalization may be a good thing,” said Brian Hamburger, founder of MarketCounsel. “But it’s a warning. The people, passion and vision of the founders ideally is freed up to inspire the next generation.”
Like Walmart Coming to Town
The theme crystallized in a conversation between Hamburger and Mark Hurley, founder Fiduciary Network and now CEO of a cybersecurity firm.
In an almost 100-page polemic released during the conference, Hurley argues independent wealth management firms have been riding high on cheap money, ever-higher equity markets and a highly fragmented space that made for easy acquisitions and low-effort growth.
But now, with higher rates and tighter economic conditions, the party is over. Several dozen large, national RIAs will emerge over the next decade, but they won't be unique; they will begin to resemble more integrated financial services firms, bringing in their own brokerages and being all things to all clients. Useful, but “it’s like Walmart coming to town,” he said.
The theme was picked up again in the first public interview of Jim Dickson, the founder and former CEO of Sanctuary Wealth, whose abrupt departure from that firm earlier this year surprised many. Dickson admitted to losing his compass, and control of the company, as the pressure was on to quickly raise more money from outside investors to fund an aggressive acquisition strategy. The tension between raising capital and buying firms, while at the same time balancing the obligation to employees and clients, is “a really hard balancing act for a young, growing company,” he said.
Valuations Are Business Tools, Not Price Tags
The tension is there even when valuing a firm. RIA principals, and potential investors, want to know what a firm is worth. It’s a foundational number that can guide a decision to buy, sell or invest.
One potential trip up: A professional valuation rarely matches the price a firm will get in an actual transaction, said David DeVoe, head of RIA investment bank DeVoe & Co., during a panel on firm valuations. Why? Firms vary in their attractiveness, and value, depending on the acquirer. Larger firms will often be able to pay premiums over the “established” valuation.
“Valuations are different for different purposes,” agreed John Furey, managing director at consultancy Advisor Growth Strategies. Both DeVoe and Furey said valuations can better serve as a diagnostic tool, uncovering a firm’s areas of strength, and weakness, and giving the principals a roadmap for improving the business—and by extension, its value to buyers and investors.
Yet there is a contradiction in that, Furey noted. He warned that if firm managers focus too much on maximizing the “almighty dollar” of the business, there is a danger of taking the focus off maximizing the business for the clients. “Two years later, you see the degradation,” he said.
“You can become overwhelmed optimizing the factors,” said DeVoe, and principals need to understand who they are optimizing for.
Still, no principal wants to leave money on the table. And while there are many valuation drivers, they largely fall into three camps—growth, profits and risk. “Optimize the first two, minimize the last” will broadly be the path toward highest value in the marketplace, he said.
If a firm can create a “growth machine” and sustain a growth rate of even 1% a year, outside of market appreciation and acquisitions, it will see its value increase by 6% to 7%. Up that growth rate to 3%, and the value increases 20%, he said. Showing a sustainable ability to grow profits can have an even larger impact on value.
Several panelists agreed that as independent firms become more valuable, and managed more professionally, the notion of advisors looking to an internal successor to take over the ownership—usually junior advisors—is now more of a myth than a reality. Firms are getting too expensive to manage a wholly internal equity buyout.
“Selling internally is harder to do than open market,” DeVoe said. “There are things you can do, but the money is a tough nut to solve.”
It was hard to do when firms were getting five to seven times earnings, he said. “It’s even tougher to do when it’s twice that. The valuation of firms exceeds internal employees’ grasp.”
Private Equity's Bad Rap, and Public Market's False Promises
For the past several years, large private equity investors have taken significant stakes in independent wealth management firms, fueling consolidation. Some RIA executives are concerned about the investors’ short-term time horizons, adding leverage and slashing costs with a singular eye to extract as much value from a company as possible.
But so far, there have been no Barbarians at the Gate-type reckoning for wealth management firms, argued a group of executives in a panel discussion on the future of private equity in the industry.
“If you’re a private equity investor, wealth management is a great place to be,” said Jim Cahn, chief investment and business development officer with Wealth Enhancement Group, the $68 billion RIA and serial acquirer, itself owned by private equity firms TA Associates and Onex Group.
Far from seeing RIAs as inefficient, asset-heavy industries to be stripped apart and sucked dry, the private equity investors in wealth management like the consistent cash flows and relative ease with which companies can improve profits. “It’s here to stay,” he said. “PE has woken up to the fact they can’t obliterate a firm. You can’t rip out the guts and push the maximizations.”
“You hear horror stories about PE. I don’t think you see that in our space. We’re not making widgets,” agreed Jeff Alpert, head of growth at Miracle Mile Advisors, a $4.7 billion RIA backed by private equity form Corsair Capital.
Private equity sees an RIA as an annuity, said Jessica Polito, the founder of Turkey Hill Management, an M&A consultant to wealth management firms. “You only need to do small things to grow. You don’t have to do much to the business,” she said.
But the arrival of professional investors and managers has changed what was once a more familiar industry. “This was an industry of large personalities, now you would be hard pressed to name the CEOs of top 20 firms,” said Alpert.
All agreed investors are favoring firms that acquire and integrate as opposed to the roll-ups that could mop up succession-hungry RIAs for relatively low multiples while letting them remain largely independent.
“The Focus [Financial Partners] model has been discredited,” said Cahn, referring to Focus Financial buying several RIAs with minimal integration. Focus was one of the first RIAs to go public, where it struggled to sell investors on the story even as the market changed around them. Earlier this year they went private again.
“You can’t just buy and walk away,” he said. "The financial-only model will go by the wayside.”
“Integration will drive value and the ones that aren’t fully integrated won’t get to that point,” agreed Alpert.
That said, the harsh scrutiny of public market investors looking for quarterly progress may be a step too far for even the largest integrators trying to balance obligations to owners and clients.
“I fail to see why IPOs are a carrot dangling in this industry,” said Polito. “My personal opinion, getting big enough to IPO goes against putting clients first. IPOs do not seem like the future of the industry.”