Every so often the trade publications feature a rash of articles about the success of roll-up firms focused on consolidating financial advisory practices. Sometimes the hype is true; other times it’s wishful thinking on the part of the promoters. When consolidation strategies work, they can be extremely rewarding for the initial investors and the initial firms who participate because of the relatively low cost of equity at the beginning and the lift they get at the end. When these strategies fail they highlight the unpleasant risks of having passive investors in a personal service, owner-operated business.
Buyers that appear successful, for the most part, are HighTower, Focus Financial and United Capital. Others appear to have been wounded by the market meltdown or have drifted away. Boston Private, as an example, sold back their stakes in Coldstream Capital Management and Sand Hill Advisors, two West Coast wealth management firms. Another buyer that got hit hard, Western Bank, divested of most of its interest in this business as well. A number of other firms tried to consolidate the industry in the past 10 years, but only one made it all the way to a liquidity event: National Financial Partners, a firm geared more towards registered reps affiliated with broker-dealers and employee benefit practices. Early participants in that play had a wild ride with the stock reaching the mid-$50 range then tumbling down to single digits, though now it hovers in the mid-teens. This unpredictability exemplifies one of the risks and benefits of taking stock as part of an acquisition instead of all cash or terms to pay cash.
Some years ago when I was still a consultant at Moss Adams LLP, we analyzed successful roll-ups in all types of industries, from funeral homes to waste disposal companies. The common characteristics of success among consolidators: Those who were well-funded moved quickly to make acquisitions, and provided an exit for their early investors within a reasonable period of time. The other common denominator was a qualified and proven team of professional managers.
In the case of the financial advisory business, each buyer has a unique way of operating and investing in their business, but they all share two things in common: they unanimously reject the label of “roll-up firm,” and they all claim to be focused on growth-oriented practices. In this context, “growth-oriented” means that sellers cannot be looking for an easy exit. In fact, deal terms with a heavy emphasis on future performance tend to protect the consolidator against an early retirement by the advisors. In other words, if a seller doesn’t hit the targets, the economics of the deal are quite mediocre. This approach helps the consolidator keep all the practices together until they can negotiate or facilitate some collective exit.
Traditionally, consolidators are financial buyers, trading stock in their company for equity in the selling enterprise. Because the seller’s firm commands a relatively low multiple due to size, the consolidators argue that being part of their larger firm gives the small advisory firm owners an increase in their multiple by being part of a larger enterprise when the liquidity event occurs. Further, some argue, the smaller firm gains leverage from synergy, buying power, back office support and professional management. Venture backers and private investors expect that such firms will get their money back within five years so early momentum is key.
A hybrid consolidator keeps an eye on the financial benefits for their investors while also investing in infrastructure to help their advisors stay focused on their clients. HighTower and United Capital are probably the closest examples of this model. Further, both tend to lift out advisors from other platforms: in the case of HighTower, mostly from wirehouses, and in the case of United Capital, mostly from independent broker-dealers. Focus Financial, more of a classic financial buyer, operates differently. They intrude very little into how their advisors operate, focusing on a significant liquidity event such as an IPO or out-right sale. Whatever the label and intent, these distinct enterprises add a new dimension to the business of financial advice and reflect a growing maturation of the industry.