One reason for the emergence of advisory firm consolidators is that many in the next generation of professionals are either unwilling or unable to buy into the practices that employ them. If this is our reality, what does it forebode for the independent financial services profession? What will young advisors do if they remain employees and not principals? What will owners do without successors in place to purchase the firm?
While statistics from a variety of studies do not validate a massive trend toward firm sales to roll-ups, there is evidence that young advisors feel stymied in their efforts to acquire interests in their firms. The obstacles are not constructed by firm owners alone, however; many of the barriers are self-imposed by the young advisors. This scenario frustrates firm founders as well as the people they employ.
Why are young advisor’s reluctant buyers? There are four big reasons:
1. The high cost of purchasing an ownership interest
2. The desire to own 100% in a smaller firm over a minority stake in a larger firm
3.The perception that ownership means “more work”
4. A sense of entitlement that their labor has earned them equity in the enterprise
An obsession with the financial aspects of the business begins early in an advisor’s career. It starts with a feeling of being underpaid, proceeds to an illusion that his contributions have saved the business from ruin, and culminates in the belief that several years of toil add up to thousands of dollars in sweat equity that should be paid out in shares in the company. This combination of emotional and financial angst often creates great stress for both the current and prospective owners.
Cost to Purchase
It is generally true that sellers of advisory firms have an inflated perception of firm value which, for some reason, has not been tempered by the market disruption we’ve experienced of late. Many sellers calculate that their years of pain growing the business, plus their assets under management, plus their personal reputation, plus the sacrifices they made to hire the young advisor in the first place, add up to a valuation that will ensure their financial independence through their retirement years.
Further, they are certain that others in the industry have sold their practices for high multiples of revenue and cash on the barrelhead. This assertion is usually the opening volley in negotiations with younger prospective partners who challenge the asking price. When prospective buyers calculate the cost of purchase based on the current perception of value, they cannot make the numbers work.
Even when the valuations and terms are reasonable, young buyers still balk because they are uncomfortable with the risk of such a large outlay. To overcome this obstacle, both buyer and seller must approach the price in a more rational way, and structure the terms of purchase so that the seller receives fair value for the risk he is taking in self-financing the sale, and the purchaser may meet his obligations out of the cash flow from the business. But the young buyer should also frame their decision in the context of a personal financial plan, and make decisions based on his own risk tolerance and their immediate future needs for liquidity.
The Desire to Own It All