What’s More Lucrative: Wirehouse Package or Selling Your RIA?

While limited industry data has made it clear that the pace of wirehouse recruiting, and the size of typical deals, has increased in recent years, there has been remarkably little information about the terms and details of the 'typical' deal. For the most part, this is because broker-dealers have not been very public about the deals that they're offering, likely because too much knowledge limits their ability to negotiate on an advisor-specific basis for a more favorable deal. At the same time, brokers themselves are usually not very open about the deals they complete. In part, this is because many broker-dealers require them to sign non-disclosure deals to keep the terms secret, but in some cases the reality is simply that the broker doesn't want other advisors or his/her clients to know what was paid to entice a change in firms (an area that FINRA is now scrutinizing).

The end result of this environment is a highly inefficient marketplace for advisors looking to transition from one wirehouse to another. Notwithstanding all this confusion, a new firm is looking to bring an end to the opacity of brokerage firm recruiting deals. Called "AdvisorHUB", for $9.99 advisors will be able to download a current report detailing the recruiting deal terms of dozens of broker-dealers, private banks and wirehouses in today's marketplace via an Apple or Android app, based on the intelligence that the AdvisorHUB team is able to gather from its available connections and networks.

An early glimpse at the data reveals a startling reality: in a world where the 'typical' RIA deal is approximately 2X revenue, the typical wirehouse recruiting package is as much as 350% (3.5X) trailing revenue. This suggests that the trickle of breakaway brokers (rather than a flood) may have less to do with the captive confines of the broker-dealer world and more to do with the fact that a broker can actually monetize their practice for as much or more than many RIAs. On the other hand, the reality is that the amounts that wirehouses are paying may well be unsustainable, especially if AdvisorHUB brings so much transparency to deal terms that every broker demands such treatment.

Nonetheless, for the time being, having built a practice in a wirehouse—and staying there—may have been far more lucrative than the independent community ever realized, and that the decision to break away is far more nuanced than just the concept of "having equity [to someday sell] in the advisory practice."

The Typical Broker Recruiting Deal

So based on the AdvisorHUB data, what does the typical broker recruiting deal look like?

The starting point is to look at what the broker generated in revenue over the preceding 12 months. Let's say the advisor had roughly $200M of AUM and was generating $2M of revenue (and likely receiving compensation of approximately $900,000 at a 45% payout rate). In today's market, AdvisorHUB indicates that a "typical" deal, based on what Merrill Lynch is currently offering, would be recruiting compensation of approximately 325% to 350% of this trailing 12-month revenue (with a few wirehouses or large banks paying slightly more, and a number paying a bit less).

In dollar amounts, at a 325% recruiting deal, the payment to the advisor would be a total of $6.5M, paid out over a series of years. For instance, the terms might stipulate that the first 150%-of-trailing-12 is paid up front, with another 25%-of-trailing paid in six months assuming at least 65% of client assets have transferred, and another 50%-of-trailing paid after a year as long as the advisor has brought over at least 75% of the AUM and has generated at least 75% of prior revenue. At this point, the advisor has already received 150% + 25% + 50% = approximately 225% of the trailing 12-month revenue that he/she was earning at the prior broker-dealer (in addition to being paid under the usual payout rules for the actual revenue now being generated at the new firm).

To receive the remaining ~100%-of-trailing-12-month payments that would remain (to get from 225% to the "full" 325% amount), the advisor might have additional revenue growth benchmarks to meet in subsequent years; for instance, the end-of-year-two payment requires the advisor to be back to 95% of assets and 95% of revenue, and by the end of five years to reach 150% of prior assets and 150% of prior revenue to receive the last, full payment. To the extent these payment benchmarks are not achieved, the prior amounts already paid are not forfeited, it's just that the new amount isn't earned. Thus, for instance, an advisor who transfers with a recruiting package but fails to hit the benchmarks beyond year two may still have earned 265%-of-prior-revenue in payments, but won't reach the full 325% target.

The biggest "caveat" to these payments is that they are typically structured as an advance on a forgiveable loan, such that if the advisor actually quits/retires/is fired/leaves (exact details vary by recruiting contract), any outstanding payments must be repaid. Loan durations may be as short as five years or as long as 12, though AdvisorHUB indicates about nine years is typical. Thus, for instance, if the advisor has hit all the benchmarks and reached a total of $6.5M of recruiting payments over five years, but leaves after the seventh year of a nine-year contract, then only 7/9ths of the advances have actually been forgiven, which means the advisor would have to repay 2/9 x 6.5M = $1.44M. Once the end of the loan term is reached, the deal is closed for good. Again, though, failing to meet the growth benchmarks typically will not trigger a loan repayment, but simply fail to generate the next incremental amount of the recruiting compensation; the advisor usually must actually quite/retire/leave to trigger the loan payback provisions.

Wirehouse Recruiting Versus RIA Ownership

In a world where wirehouse brokers don't "own" their practices as independent entities and therefore generally cannot sell them, recruiting packages are important because they represent a way to "unlock" the accumulated equity value of the wirehouse advisor's business. And as the deal terms above reveal, the value can be quite significant indeed: wirehouses are paying 325% (or 3.25X) of revenue in a world where the standard 'rule of thumb' for independent RIAs is only 2X revenue! Obviously, not every wirehouse advisor will receive a 325%-of-trailing-revenue package (it may be a 'typical' deal, but recruiters only offer deals to the most successful practices in the first place), but the truth is that it's only the most successful RIAs that receive 2X revenue multiples on their practices as well; thus, it's still arguably a "fair" comparison, at least between the subset of the most successful advisory practices in the respective channels.

Of course, the reality is that forcing brokers to unlock the value of their practice by leaving their firm and changing broker-dealers is not exactly the most efficient way to monetize a practice. It's difficult and time consuming, not to mention rife with legal complications in navigating the various non-compete and non-solicitation agreements that brokers are typically required to sign. Nor, for that matter, is the process client-friendly, as it forces clients to go through a great deal of change that may or may not necessarily be in their interests, just so the advisor can be paid... thus the increasing amount of FINRA attention and the recent issuance of Regulatory Notice 13-02 that may require brokers to disclose recruiting compensation to clients. Of course, if the clients decide they don't want to go through the process and aren't retained, that's a loss for the advisor and the firm doing the recruiting in the long run.

On the other hand, the reality is that it's not only the wirehouse advisor who doesn't necessarily want to leave their company; the firm itself doesn't want to lose its advisors either (especially the ones that are the most profitable and therefore being enticed by competing broker-dealers). As a result, just as there has been a rise in the number of intra-brokerage-firm recruiting deals, so too has there been a recent—and equally opaque—rise in the number of retention deals that brokerage firms are negotiating.

While AdvisorHUB indicates that the typical retention deal is not quite as lucrative as the compensation for a typical recruiting offer (perhaps 160% of trailing 12-month revenue paid evenly over four years), it doesn't entail nearly as much work or inconvenience either, for the advisor or the client (and has less risk that clients won't be retained in the transition).

Either way, though, the potential for recruiting and retention deals for wirehouse brokers represents a unique form of monetizing a practice, with results that are remarkably similar to having actual equity ownership in the practice, and at what may be better revenue multiples than independent RIAs... an implicit acknowledgement that even while wirehouses nominally "own" the client, they clearly recognize that the true economic value of the client lies in the relationship with the advisor, who must be compensated accordingly. Yet it's notable that the "lack of equity ownership" is often cited as a primary reason for "breaking away" from a wirehouse in the first place, while the AdvisorHUB data suggests that in reality, the issue is much more nuanced; wirehouse advisors may in fact have opportunities to "monetize" their equity through recruiting and retention deals, though they will still be limited in how much control they have over the practice compared to a truly independent firm (yet on the other hand, wirehouses often give much wider latitude to their most successful advisory practices anyway).

Of course, a true comparison between the financial benefits of structuring under an RIA versus a wirehouse is more than just the sale-or-recruiting multiple; the portion of revenue an advisor takes home as compensation on an ongoing basis clearly matters, too. Yet while wirehouses are often criticized for their 40%-45%-of-revenue payouts, the reality is that the wirehouse structure also implicitly covers a lot of the overhead and expenses of the practice, and for large RIA firms the compensation of an advisor's salary-plus-profits where healthy advisor profit margins are "just" 20%-30% suggests that with large firms the gap may not be all that significant (though clearly the relative comparison of which is better varies depending on the size of the firm).

In part two of this blog series, we take a closer look at what these numbers suggest about the prospects for breakaway broekrs and for AdvisorHUB itself.

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