At 52 years old, Mike Leonetti has hardly reached traditional retirement age.
In fact, he's about the average age for a financial advisor these days. But last year, after twenty-six years in the business, Leonetti, the owner of Leonetti & Associates, a Chicago-based fee-only RIA, decided he wanted to “take some value off the table” and test the market. So, he sold a portion of his business. Despite the bloodletting on Wall Street, his business proved to be quite attractive to suitors: It has long-term relationships with about 450 fee-only clients, approximately $400 million in assets under management, upward trending profitability and established junior partners. Leonetti received several offers just months after he began asking around. He just had to decide which one best fit his requirements.
It's not that Leonetti wanted to cash out. On the contrary, he doesn't plan on retiring for at least another eight years. Instead, he was looking for a deal that would allow him to retain management control and ensure job security and succession opportunities for his handpicked staff. Not least of all, he wanted his firm to continue growing. “I want to reach $500 million, but eventually $1 billion, and I think I can do that in eight years,” Leonetti says.
He found a partner in Sanders Morris Harris, a Houston-based financial services holding company with $17 billion in client assets — and a reputation for being a hands-off facilitator of growth. He sold SMH a 50.1-percent stake of the firm in February, retaining the rest of the business to eventually sell to his junior partners. The two parties agreed on a valuation of eight times the net profits, which were determined to be $1.4 million — a calculation that subtracted all expenses excluding Leonetti's compensation from gross revenues. To compensate for the stock market's volatility at the time of the valuation, both sides agreed to the creation of a composite index that reflected the average holdings of a Leonetti client.
As for the terms of the deal, he signed an eight-year employment agreement that, with growth incentives, could boost the valuation to nine times the net profits for a total sale price of somewhere between $5.5 million and $6 million. Not too shabby. Now SMH is helping Leonetti develop a succession plan for his staff, including setting up a way to help the junior partners finance the purchase of the remaining 49.1 percent of his ownership down the road. Leonetti says he couldn't be more pleased with the way it turned out. “The valuation was attractive, the timing was right and it was the kind of transaction I wanted to do.”
A GOOD DEAL, AND A GOOD DEAL MORE
Whether you're looking to buy or sell, the way the deal is priced will, of course, be determined by the book of business changing hands. But one thing is for certain: The market for financial advisors is hot, so deals are getting done — even in this credit-starved environment.
Indeed, with the global equity markets falling for the past 10 months, reducing fee income and dampening earnings, many practices — especially smaller ones — are putting up for sale signs. For FAs looking to buy and with a good eye for value, there are some great opportunities are out there. “Before the market really began to fall, it was two buyers for every one seller, but it's closer to one to one now,” says Sal Zambito, senior vice president of business development at LPL Financial.
In the independent RIA channel, mergers and acquisitions continue apace, adding to a streak that started years ago. Between 2005 and 2007, some 80 deals were consummated, with the average firm managing $1.5 billion in client assets, according to research from Schwab Institutional. “The first quarter of this year was slow, but year-to-date [mid-June] there have been 28 deals, so it's still nearly the same rate,” says David Devoe, strategic director of M&A at Schwab Institutional. And while 2007 was fueled by holding company buyers, including Focus Financial, Boston Private, Sanders Morris Harris and others, says Devoe, this year the M&A market has been dominated by individual RIAs buying other RIAs.
The deal-making takes a slightly different form inside the wirehouses. The personal net worths of most wirehouse FAs are hurting — and hurting big (with the firms' stock prices hitting new lows). And yet, while investment banks are tottering, individual retail financial advisors' businesses are thriving. To keep the most talented advisors — and their clients — in house, wirehouse firms are offering a number of perks, including enhancements to their succession planning offerings, which allow retiring advisors to keep making money on their books of business while they transfer clients to team members. (See related story, “The Top 100 Wirehouse Advisors In America,” page 30.) But the economics aren't quite as attractive as they are when you sell your book outright. Occasionally, a wirehouse advisor will take his book independent so that he can do just that.
“A lot of what's driving interest in deals is demographics, certainly,” says Dan Inveen, a consultant with Moss Adams. “Owners are getting older; they haven't given much — if any — thought to succession. And these are profitable businesses. There's a lot of interest from different types of buyers.”
PRICE PERFECT
The question on every financial advisor's mind is, “What is my practice worth?” It's a good question without an easy answer: It's impossible to apply blanket multiples when the industry is full of so many different business models. There are many variables that go into the calculation, including practice size, services offered and compensation (fee or commission), among other things, says Inveen's colleague, Owen Dahl.
The calculations are simplest when you are dealing with smaller practices. For instance, those with assets of less than $100 million, and a book of business that is split evenly between fees and commissions, typically command multiples of between 1.8 and 2.6 times revenues, says Dahl. For larger practices with steadier income, like Leonetti's, the multiple can go much higher.
According to Moss Adams' research, the sweet spot for RIAs is encouragingly wide: Those practices with assets of $100 million to $1 billion are in high demand. If your book is bigger than $1 billion, though, selling can get downright complicated, as the ranks of buyers thin out and financing becomes more difficult. At those asset levels, it is hard for junior partners to afford a buy-in.
THE SMELL OF OPPORTUNITY
Derrick Andrews, an LPL FA with $57 million in assets under management, was sniffing around for a practice to buy this year — and he bit when he found a good match. The 47-year old advisor in Auburn, Calif., had built his book on shoe leather prospecting and referrals, but this year he decided to put his marketing efforts on hold and make a purchase instead. With the aid of LPL's matchmaking list, he found a woman who was interested in selling her book. Because of health issues, she wanted to ease into retirement while helping the buyer with the transition. She had fewer assets than Andrews ($49 million), but fewer clients too (only 140), with most of the assets concentrated among the top half — a good sign. While Andrews' book was 80 percent fees, the seller's book was closer to one-third in fees — a fact that lowered the valuation, but not Andrews' confidence in the purchase. “The non-recurring assets were long-term relationships, so we felt strongly that revenue would continue,” he says. “The bottom line is that we felt we'd be able to grow the book.”
Andrews bought the practice in May for 1.8 times trailing 12-months production, or roughly $950,000. He put down 40 percent of the asking price (she had asked for 30), and the remaining 60 percent of the purchase price will be paid out over five years, which comes to roughly 19.5 percent of annual revenue per year. The seller retains a consulting role during that time period to help with the transition of the business. In the end, the only obstacle to the union was geographic distance — his office is in Auburn, 120 miles from the seller in Carson, Nevada. But Andrews considers that a minor obstacle that he intends to deal with by keeping her office open for now, and spending half the week there; he will also keep one staffer in her office permanently until other arrangements are made.
WHAT'S A WIREHOUSE FA TO DO?
Most wirehouse advisors do not opt to go independent to sell their books outright (but we'll see whether the ARS scandals and the CDO embarrassments change that fact). Instead, many advisors are choosing to jump to another wirehouse for a large upfront pay package, work for the seven- or eight-year term of the employment agreement, and then retire gradually, receiving a trail from a younger colleague who slowly takes over their book — a double payday, of sorts. It's a strategy that has gained popularity in the past 18 months, say recruiters, since the wirehouse firms' share prices continue to plummet, inflicting severe damage on the net worths of their FAs. In other words, many wirehouse advisors are switching firms and taking upfront recruiting bonuses in lieu of selling their businesses.
Again, to combat the merry-go-round of switching and poaching, wirehouse firms including UBS, Morgan Stanley and Smith Barney have improved their retirement and succession planning offerings. For wirehouse FAs, the deal structure involves a revenue split arrangement between the retiring advisor and the advisor who is taking over, with the former taking a declining cut of revenues over a period of five years. The payout rate on the revenue split maxes out at 70 percent to 80 percent at all the firms, and is typically determined by a combination of factors, including: length of service, production, proportion of fee-based business and whether the FA is part of a team. A retiring FA on a team with high numbers in all those categories could receive as much as 200 percent of his trailing 12-months production over the five year period. And that's assuming production stays flat — if the new FA improves production, both advisors make even more.
UBS rolled out its new program in April. Previously, the retirement payout consisted of 70 percent of a rep's trailing 12 with only a little bump up or down based on the mix of business and length of service. Now, if an advisor has been in a team for at least a year before the handoff, the deal can amount to as much as 180 percent of trailing 12-months production over a five-year transition period, according to the firm. At Morgan Stanley, the payout rate for top producers just increased as well, according to a firm spokesman. For $1 million producers with 25 years at the firm, at least one year in a team and a “substantial percentage of fee-based business,” a retiring FA may receive as much as 200 percent of his production over a five-year period.
At all the firms, the size of your retirement payday depends largely on how long you stick around, and whether or not you're on a team for at least one year. Under Smith Barney's 2008 Comp Plan, a retiring FA who is not on a team gets a paltry 50 percent, regardless of all other factors. Here's the impact: A $1-million retiring producer who gets a 50-percent payout on a declining portion of that $1 million (70, 60, 50, 40, 30) each year for five years will earn — assuming production stays the same — $1.25 million, or 125 percent over the five years. Another $1 million producer who has been on a team and has length of service of 25 years will get an 80-percent payout on the same revenue split over those five years, or $2 million.
B/d executives are said to favor teams for many reasons: They allow for a smoother transition of assets from one advisor to another, which makes it more likely the assets stay with the firm. An advisor with a junior partner who knows the business and the clients has a better chance of retaining the assets than the FA in search of the perfect partner in his own branch or elsewhere. One top Wachovia Securities producer in his early 50s (acquired in the A.G. Edwards purchase) says he'll have to take on a junior partner soon, or risk that potentially disappointing search. “It's why so many FAs want to bring their kids into this business. There just isn't anyone in my branch of 10 FAs that I really want to hand my book to.”