Like any plugged-in entrepreneur, an RIA owner needs a firm grasp of the financing options available for underwriting growth. However, the advantages and drawbacks of these methods can be hard to see. To shed light, we’ll focus on the financing strategies most RIA principals use to align capital with business objectives, lifecycle stages and market conditions.
Highlighting the significant capital needs within a growing industry, the Investment Adviser Association found in 2021 that over 60% of RIAs manage more than $1 billion in assets. Meanwhile, Cerulli Associates reports a 14.5% increase in the number of RIAs between 2015 to 2021, reflecting the trend of new firms entering the market in need of financing.
For most independent RIA owners, raising capital involves one of three main instruments: equity financing, debt financing and convertible securities. Each carries significant implications for ownership, control, and financial health.
- Equity financing
This method involves selling ownership stakes in exchange for capital. Early-stage RIAs often rely on this to fuel expansion without the immediate pressure of debt repayments.
- Debt financing
Borrowing funds with a promise to repay over time, along with interest, preserves ownership but imposes regular financial obligations. Established RIAs with steady cash flows might prefer this route to leverage their assets while retaining control.
- Convertible instruments
These hybrid options can transition from debt to equity under certain conditions, offering flexibility to RIAs owners unsure of their long-term capital structure needs. This can be handy for startups looking to raise capital repayable either in terms like bonds or—post conversion—as equity.
As suggested, each of these strategies offers advantages and challenges that can impact the firm's ownership structure and development. By probing into the pros and cons of equity financing, debt financing and convertible instruments, RIA owners can make decisions that align more closely with their business goals.
A Deeper Dive
On the plus side, equity financing provides capital without the burden of direct repayment, allowing businesses to focus on growth rather than debt servicing. But it reduces the founder’s share and potential profits. For RIAs, equity financing calls for balancing the need for immediate funds against the long-term value of maintaining a greater share of ownership. Prematurely giving away equity can restrict future flexibility, especially when it comes time to recruit top talent.
Debt financing lets owners retain ownership, but it calls for incremental repayments, including interest, on a strict schedule. This can stifle cash flow. For mature RIAs with liquidity reserves, it can make sense to leverage existing assets to fund growth without diluting control or ownership. Take warning though: repayments can become onerous where market conditions or business outcomes worsen.
Convertible instruments hold the middle ground between equity and debt financing by offering initial debt with the possibility of converting the obligation to equity issued to convertible note holders. This can be helpful to RIAs looking for flexibility in terms of repayment, but these instruments can be complex. As a result, the terms of conversion must be carefully scrutinized to avoid outcomes unfavorable to the firm.
Strategic Alignment with Business Goals
Aligning financing choices with business goals and market conditions is critical. Early-stage RIAs might prioritize equity financing to accelerate debt-free growth while more established firms might use debt to fund expansion while preserving ownership. The prospect of market volatility, which may call for flexibility when it comes to funding structures, can also influence these decisions.
Understanding the motivations of capital providers is equally important. Funding from family or friends might offer more lenient terms, but can complicate relationships if the business falters or misunderstandings creep in. In contrast, private equity firms expect returns within specific timeframes—offset, in theory, by the experience and discipline they bring to the table. Clarity around the objectives—whether market expansion, product distribution, or leveraging talent—of “strategic” financiers in the same or adjacent industries is crucial. This can help ensure that expectations are marked to concrete results and managed effectively over time.
Avoiding Common Pitfalls
Due diligence is paramount. Not vetting would-be investors or lenders leads to unfavorable terms and strained relationships. Asking potential partners about unsuccessful past deals can provide valuable insights into how they handle adversity. This approach reveals more about their character and operational style than success stories alone. In sum, rushing into agreements without a thorough understanding of likely outcomes is never wise.
RIAs should also consider alternative capital sources such as crowdfunding and grants, and maintain a balanced capital structure with a mix of debt, equity, and other instruments to avoid overreliance on one type of funding.
Building and Maintaining Investor Relationships
Investors require regular, transparent communication and mutual respect. Properly maintained, these relationships can provide strategic guidance that can contribute to an RIA’s long-term success.
When it comes to fundraising for independent RIAs, informed decision-making is everything. By understanding the pros and cons of each type of capital, aligning financing strategies with business goals, and remaining adaptable to market realities, RIAs can make financing a tool for adding depth as well as growth. Building strong investor relationships, meanwhile, bolsters the potential for sustainable growth against a backdrop of financial stability.
Shirl Penney is CEO of Dynasty Financial Partners
