Perspective. Perspective. Perspective. To paraphrase the old real estate saw, the older I get, the more I realize that truth is more often than not a function of one’s perspective. Case in point: Fiduciary Network president and CEO Mark Hurley’s June white paper entitled “Creating, Measuring, and Unlocking Enterprise Value in a Wealth Manager.”
To set the record straight, I like Mark Hurley. I’ve met him a couple of times and talked to him on the phone a few more times than that. I found him to be intelligent and engaging, and I’ve always learned something from our encounters.
With that said, I’ve also consistently found that some of his conclusions stem from what seems to me a rather skewed view of the independent advisory world—first, from the perspective of a former Goldman Sachs investment banker, and lately, as a financier of the largest of independent firms. To be sure, “large independent advisory firm” is right up there with “army intelligence” and “jumbo shrimp,” as oxymorons go. The biggest wealth management firms in our little world have a couple of billion client dollars under management, and generate maybe $5 million to $10 million in annual revenues: That doesn’t even qualify as a “mid-sized” small business by B-school standards. Still, from the advisory industry’s perspective, the difference between a firm with $100 million under management and one with $1 billion in AUM is like comparing apples to bowling balls.
The Value of Small Advisory Firms
In both his writings and in conversations, it quickly becomes apparent that Hurley’s exposure to the independent advisory world has largely revolved around firms falling on the largest end of this spectrum. By itself, that’s no crime: Mark probably knows as much about the business end of those large firms as anyone. More problematic, though, is his insistence on making pronouncements about the independent advisory world as a whole.
The result has been a constant theme in Hurley’s work questioning the value of smaller advisory practices. This notion culminates in his latest tome, which under the guise of informing advisors about the economics of their businesses, boldly suggests that for most firms, there aren’t any: “A careful analysis of the [advisory] industry suggests that only about 200 to 400 of its participants either have or possess the potential to build material enterprise value. The remaining 18,000 to 19,000 firms currently have no enterprise value and are very unlikely to build any in the future … the overwhelming majority of [the non-large firms] are unprofitable ‘lifestyle practices.’”
Not a conclusion intended to give a warm fuzzy to most independent advisors. But the good news is that he’s only half right, at best. We can see the skewing of Hurley’s thinking by how he frames the question: “What is enterprise value and what are the steps necessary to create it?” He gives us the definition of this “enterprise value:” the economic value that an investor captures from owning the equity of a company. He is approaching the question of value in advisory practices solely from the perspective of an investor, which he was as an investment banker at Goldman and continues to be today.
The Investment Banker Perspective
From that viewpoint, there probably is considerable truth to his analysis. If you’re an “investor,” you’d most likely want to think twice about sinking your portfolio into a smaller advisory practice. This is probably why many so-called rollup firms have to resort to financial sleight of hand to make their deals work: proprietary products, restricted stock, and advisor pay cuts, to name a few.
Yet Hurley goes on to write this 124-page report as if “enterprise value” were the only kind of value. Just because independent advisory practices don’t have much value to would-be investors doesn’t mean they don’t have any value at all. You don’t see institutional investors buying up single family homes like they’re going out of style, even in this market. Why? After debt service, upkeep, real estate taxes, income taxes, and the cost of keeping it rented, most houses just aren’t economically viable; that is, they don’t have any enterprise value.
Yet my house has considerable value. First, because I, like most folks, have to live somewhere. Second, it’s pretty comfortable here. Third, as long as interest rates stay reasonable, the mortgage payments aren’t that much more than renting a comparable house.
What does this have to do with the value of your advisory practice? Everything, at least from an advisor’s perspective. Like a homeowner, an independent advisor isn’t an investor. She or he is a business owner, and that’s an entirely different perspective. It never ceases to amaze me that the business-school-trained consulting gurus don’t seem to understand this.
In the case of value, a small business owner’s alternative isn’t to invest her or his capital elsewhere: it’s to get another job. One where you don’t have the same freedom, the control, the working environment, the staff or your own clients to take care of. Owning your own advisory practice is more than just a “lifestyle” choice, thank you very much, Mark.
By Hurley’s standards, practices with under $300 million in AUM don’t have much enterprise value. But let’s take a quick look at a firm only half that size, with $150 million under management. If the advisor charges clients 70 bps, she or he would be generating a touch over $1 million in annual revenues. Let’s say with three staffers, a junior advisor, a nice office, cutting-edge technology, travel to three or four conferences a year, a nice car, cell phones, etc., our firm is running at a pretty high 40% expense ratio. That means the owner/advisor is bringing home about $600,000 a year.
Could they have made more than that in another job or career? Maybe, but $600K for doing what you love to do isn’t too shabby, as we used to say. It’s also a far cry from Hurley’s overstatement: “[Most advisory firm] owners are paid less than they would be as employees of another wealth management ?rm.”
Advisors Value Other Advisors
What’s more, these firms may not have much value to “investors,” but they certainly do to other advisors. Contrary to Mark’s contention that “the relationships that the best ?rms have cultivated with their clients are extremely personal and may not be transferable to their successors,” FP Transitions in Portland, Ore., has data going back 10 years that shows if handled prudently, 95% or more of an independent advisor’s client base will transfer to a new, like-minded owner/advisor.
Hurley does correctly note that the vast majority of advisor-to-advisor practice sales involve “accretion,” or “the stripping away of as much of the seller’s overhead costs as possible.” But the only effect “accretion” has on a firm’s value is to drive it up. Thanks to nearly a decade of management gurus advising owner/advisors that they needed to leverage themselves by adding more staff, many of today’s firms can handle up to double their number of current clients without increasing overhead.
I’m not saying there isn’t value in Mark Hurley’s investment banker perspective. I have no doubt that $1 billion in AUM advisory firms which “retain next generation professionals” who are interested in continuing the business, “institutionalize client relationships, marketing, and brand,” “build a base of profitable, diverse clients,” and “create a culture of compliance” will be much more valuable than smaller firms that don’t do any of those things. That’s not to say, however, that smaller firms don’t have some value, or even substantial value.
Maybe a $300 million AUM firm doesn’t have much value to a bank, a brokerage firm or private equity investors. But bringing home mid- to high-six figures for 20 or 25 years, and then selling their firm for another $2 million or $3 million has considerable value for a majority of independent advisors.
It’s all about perspective, and in my experience, the investment-banker grow-your-business-into-a-small-institution-as-fast-as-possible perspective isn’t the only way to create value. It may not even be the best way.