Walkin' the Walk

You gotta respect a man who puts his money where is mouth is. Mark Hurley has received considerable publicity over the past ten years for a series of studies about the economic future of the independent advisory industry (most recently with JP Morgan Asset Management in 2005). I’ve taken exception in these pages to some of

Mark’s conclusions, most notably that because the financial markets value future cash flow more than advisors do themselves, eventually we’ll see the industry consolidate into 50 or so large, presumably public, advisory firms. I’ve felt that applying financial metrics to advisory practices where profits and even free cashflow can be easily understated leads to vastly underestimating the financial strength of many practices and, in my view, some pretty silly conclusions.

Much to his credit, Mark hasn’t been content to merely espouse his theories every few years: He’s recently launched a company designed to take advantage of the financial opportunities that he’s been talking about. Even more impressive, his new firm–Fiduciary Network, LLC in Dallas–isn’t structured to create one of the predicted mega-advisory firms that I and many others find so distasteful. Rather he’s offering an alternative to advisory firms that don’t want to be consolidated. Of course, as I’ve written before, in the sale of any advisory firm, the devil is in the deal terms. As one advisor put it to me: “Mark is a very smart guy and, shall we say, a real capitalist. There’s no doubt he and his partners will make money on these deals. The question is, where is that money coming from?”

That’s just what I’ve been trying to figure out. The problem for which Mark Hurley offers a solution comes from the immaturity of the independent advisory industry. Still less than 40 years old, independent advisors have yet to solve the succession issue. In established professions such as law or accounting, firms are structured so that junior professionals can gradually buy out the senior partners. By all accounts, the vast majority of advisors want to do this, too. The problem is that advisors have yet to come up with a structure in which younger professionals can afford to pay current owners anywhere near what their practices are worth. Consequently, most advisors who are ready to transition their practices end up selling to their employees for far less than market value, or selling to an outside advisor. That’s not the only option–a growing number of top firms sell out to banks or rollup firms.

According to Hurley, the problem stems as much from the high value of advisory firms as from the ironic failure of many planners to start thinking about succession until they are within five years of retirement. Unlike law or accounting firms, where the client relationships tend to be with specific professionals and are accordingly valued at around one times revenues, the steady stream of revenues from managed assets are worth much higher multiples to financial investors.

The caveat here, which Mark is quick to point out, is that those AUM revenues have to be generated by an advisory firm that is truly a business: with workable multigenerational systems to replace lost assets, work with clients’ children, capture trust assets, and attract, train, retain the next generation of advisors–and most importantly, grow those revenues in the future. For firms such as these (which undoubtedly number far fewer than 1,000), Mark says financial investors will pay substantially in excess of even the three or four times annual revenues that banks currently offer.

The Hurley-Milstein Approach

Who would pay that much? Enter Fiduciary Network, LLC–a partnership funded with a $600 million line of credit from Howard Milstein’s Emigrant Savings Bank in New York. Hurley’s strategy is to use Emigrant’s financing to enable junior advisors to buy out senior partners at some of the industry’s top firms: the senior partners sell shares at three specified future dates, for lump sums tied to future growth rates paid by the bank, and junior partners pay the loans back out of the future earnings of their ownership interests. Fiduciary Network participates in the growth of the firm though a minority stake of non-voting stock. “We want the junior advisors to buy as much of the stock as they can,” says Hurley. “That way, they have increased incentive to grow their firms. We just want to share in a small piece of that growth.”

Because the senior partners are selling their interest in the firm over time and that interest is valued at a multiple of earnings at the time of sale, they continue to have a stake in growing the firm. “It’s the future growth that’s financing the whole deal,” says Hurley. “If a firm has $2 million in cash flow that’s growing at 15% or 20% a year, what’s the present value of that 30-year income stream?”