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Investing in the Advisor

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Fraunces’ Tavern is so steeped in history, it has a museum attached to it. Founded in 1762, it played an important role in the Revolution and the Revolutionary War. Actually, the number you call to make a reservation ends in 1776.

It may be an appropriate place to visit just ahead of the Fourth of July, but is it a good choice to interview the CEO and president of Private Wealth Management, one of the newest companies on the block? Mark Goldberg certainly thinks so: “I’m actually deeply steeped in tradition,” he says.

Indeed, Goldberg is no novice in the industry; in his previous job he headed Royal Alliance, the biggest of four broker-dealers in the AIG network. He started at the firm in 1987 as a due diligence analyst, eventually making his way all the way to the top.

However, though a consummate insider, he promises nothing short of a revolution in the financial advisory field. PWM, which has been in operation since February, may not be bringing about this revolution single-handedly, but Goldberg expects it to play a prominent role in — and benefit from — the coming changes.

Who: Mark M. Goldberg, CEO and President, Private Wealth Management

Where: Fraunces’ Tavern, 54 Pearl St. New York, July 3, 2007

On the Menu: Fish and chips, mixed berry cobbler a la mode and the Spirit of ’76.

The change starts with the fundamentals.

“When I look at the valuations the market assigns to investment management companies, custodians and, ultimately, broker-dealers, I realize that these are proxies. The real, intrinsic value in this industry lies in the relationship between the financial advisor and the client.”

While the services provided by a custodian or a BD are becoming commodities, and accounts can be shifted from one to another in a matter of hours without much change in the quality of service, the relationship between the FA and the client remains the crux of the industry. It is an extremely stable relationship, lasting in some cases for decades, and the quality of earnings at the level of the FA is extremely high. While BDs operate on a 5 percent to 10 percent margin, at the advisor level earnings can be as high as 25 percent to 50 percent.

PWM’s mission as a private banking institution is to unlock the market value of this relationship, by valuing and capitalizing private wealth management firms. It will provide capital solutions for a wide range of uses — expansion, M&A, purchase of new office space, succession management, etc. — but ultimately it will shift the financial muscle to where Goldberg has always felt it belongs, i.e., at the advisor level.

Rewarding the WarriorsGoldberg recounts something he heard from a financial advisor, a former Marine. Among Marines, there are warriors and there are staffers. Warriors do all the fighting, but over the long haul, as far as promotions and metals are concerned, staffers tend to do better.

He observes a similar analogy in the financial advisory industry. When a broker-dealer is sold, its owners and managers get rewarded, but not the FAs who, essentially, add 99 percent of the value in the industry.

“What we’re trying to do,” says Goldberg, “is reward the warriors. We are doing so by introducing market pricing into wealth management and by allowing wealth managers to take capital stakes in their own businesses.”

Private Wealth Management is not the only firm doing this. Wealth management firms are highly investable businesses that have achieved average growth rates of around 20 percent a year by financing themselves, without the use of outside capital.

“Imagine what such entrepreneurs could do if you put real money into their hands?” says Goldberg.

Others in the market have noticed this as well, and now there is no going back. Goldberg likens what is now happening in the financial advisory industry to the introduction of free agency, which forever changed the pay structure in baseball.

In the wealth management industry, Goldberg sees a natural progression from a wirehouse to the independent channel, where financial advisors attain independence not just as business owners but as managers of their clients’ assets as they see fit. The fee-based business model has also introduced a new element of independence. And now, with wealth management businesses attaining market valuation, the process will be complete.

This doesn’t mean that wirehouses and BDs will take it lying down. “These companies are run by seasoned professionals, and they are certain to respond.”

The only firms that are in danger are the ones that refuse to recognize the change and do not adapt in time. The process of adaptation has already begun at many BDs, with some of the top names being sold at the peak of their earning power.

Change is driven by the fact that it clearly benefits FAs. Just as the bulk of their clients are now facing choices ahead of retirement, many first-generation wealth management firm owners are starting to look at succession. They want to take out equity they have built in their business, and they want the business to carry on after they retire. Capitalizing the business is clearly the way to go and, Goldberg asserts, more and more FAs will realize this. After all, independent wealth managers are among the most adaptable entrepreneurs there are, he says.

It is a sign of respect for these entrepreneurs that PWM doesn’t plan to alter the way wealth management companies do business.

“Of course, as a responsible minority shareholder we will always be willing to offer advice on how to improve business,” he says. “We see many companies out there, and we can spot inefficiencies, overpricing and poor execution.”

One service PWM does provide as an integral part of the transaction is setting up ownership structure. In particular, it provides help with employee stock option plans, answering the need to create multiple stakeholders and to broaden the shareholder base.

Revolution in ValuationsThere is a rule of thumb in the industry, says Goldberg, which suggests that a wealth management practice is worth about twice its gross annual revenue. This came about because the value of a practice to a BD is in its annual production.

“But as an investor,” asks Goldberg, “which company would you rather invest in — one that clears $600,000 on revenue of $6 million, or the one that has revenues of $3 million and has profits of $1.5 million?”

It’s an easy question to answer. PWM won’t go near the former company, for all its high revenues.

Valuation is only one of the criteria on which PWM will base its investment decisions. It will look at businesses providing a range of wealth management services, which do not depend disproportionately on a single producer or client. Goldberg says there is a universe of about 1,100 companies out there that fit this description.

PWM has four of them closing imminently, and eight additional deals are pending at various stages. Overall, it plans to take stakes in some 40 firms, spending $150 million to $160 million. PWM should become self-financed thereafter, generating funds from previous investments for further growth.

For Goldberg, running PWM is a dream come true. “Throughout my career, I have been telling people that the value in this business lies with the financial advisor. At PWM, I finally have an opportunity to practice what I’ve been preaching.”

Alexei Bayer runs KAFAN FX Information Services, an economic consulting firm in New York; reach him at [email protected]. His monthly “Global Economy” column in Research has received an excellence award from the New York State Society of Certified Public Accountants for the past four years, 2004-2007.


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