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Practice Management > Building Your Business

Is Your Practice Big Enough?

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Is bigger really ­better? As demand for merger ­partners ticks ­definitively upward, growth-oriented advisory businesses are giving each other the once-over on a scale not seen in years. But the trend has some industry observers worried that many small enterprises—the so-called lifestyle practices—may be headed into the abyss.

As Deena Katz, associate professor at Texas Tech and chair of Evensky & Katz in Coral Gables, Fla., frames it: “Many of these are little boutique firms built around the personality of the owner. They haven’t hired well, if at all. A lot have older clients that they’re not replacing. That’s like buying an oil well that’s drying up. And most don’t even look at their practice in terms of profitability. The bottom line is they have an overblown estimation of what their practice is worth and they have no idea how to manage for what’s coming.”

A provocative report released in April from industry prognosticator Mark Hurley suggests that about 150 large independent RIA firms will ultimately dominate the lucrative wealth management space while thousands of low-revenue producing “books of business” fall through the cracks. The report, “Brave New World of Wealth Management,” was two years in the making. (To download a free copy, visit In the white paper, Hurley counts roughly 19,000 small firms whose value will dissipate, if not disappear.

“The easy money has been made,” says Hurley, who heads Dallas-based Fiduciary Network, which invests in wealth management firms. “It used to be a land grab, a pie eating contest—no longer. Everybody I know in the industry, and I know hundreds of guys, all know someone who is an idiot who’s been successful. Due to the long bull market, there was an environment where even idiot advisors could become millionaires. Going forward, you’re going to have to be a much better business person. Strategy matters.”

 Not everyone agrees with Hurley’s dire forecast but most do acknowledge the marketplace conditions that are reshaping the industry: aging clients that in many cases are not being replaced; aging advisors headed toward retirement; a far more competitive landscape; the well documented talent shortage; and the failure of many advisors to plan for their own succession.

Harman “Jet” Wales, managing director of Moss Adams Capital in Seattle, believes advisors are beginning to wake up to the fact that a smaller number of large advisory firms will one day lead the wealth management sector. Additionally, he thinks clients will come to expect a full breadth of resources and services that only a big firm can deliver.

“It’s a realization that is taking hold right now. There’s a range of new technology solutions, new investment solutions and with social media, client expectations are changing faster. A small firm with $200 million to $300 million in assets under management can have a nice business and serve clients pretty well, but you are going to find it’s the bigger firms growing into the billions of dollars that will shift client expectations and create a client experience that becomes the new norm,” adds Wales. “If you’re a smaller firm relying on your own resources, you’re anticipating this. You’re looking for a partner.”

Interest Piqued

At a recent Financial Planning Association conference, presenter Greg Friedman, founder and CEO of Private Ocean in San Rafael, Calif., posed a series of questions to the 150 or so advisors in attendance.

“I asked, ‘How many people in the room are open to a merger?’ A bunch of hands went up,” recounts Friedman, whose firm, the product of a 2009 merger, manages $750 million in assets. “‘How many are actively pursuing a merger?’ A bunch of hands went up. ‘How many have been approached by somebody for an acquisition?’ A bunch more hands went up. Finally, I asked: ‘How many people in the room are not at all open to a merger?’ Not a single hand went up.”

The anecdote demonstrates the deep level of interest in merger talks at the moment. Hurley calls it an “explosion of demand for acquisitions” that he expects to have a three to five year run.

Gabriel Garcia, director of relationship management for Jersey City, N.J.-based Pershing Advisor Solutions, agrees that conversations around mergers, acquisitions and inorganic growth have intensified recently—in part due to the projected exodus of 12,000 to 15,000 retirement-bound advisors over each of the next 10 years. “There’s renewed interest and more dialogue,” he adds. “We anticipate an impending wave of activity.”

Philip Palaveev, CEO of The Ensemble Practice in Seattle, says he has observed a “silent current” of mergers under way. “Every other call I get has something to do with mergers or the desire to have partners to achieve growth,” he adds. “We all have scars from the financial crisis. It reminded us all that our businesses are just a small boat in a big ocean. There’s a desire to have a bigger boat. It’s more secure. Mergers are a great way of growing bigger.”

Palaveev, however, does not believe, as the Hurley report predicts, that small practices will necessarily fade or fail.

“I think Mark has some very legitimate concerns but we’re not helpless in this situation,” he says. “We’re not some sort of Greek tragedy heroes that are the recipients of fate. I think there are businesses out there that have heard Mark and they are acting on it. They are recruiting and retaining young people who will be their successors, they are more competitive and they are putting a variety of structures in place to make sure the founders can transfer ownership to the next generation.”

“If someone takes success for granted and no steps whatsoever to ensure the continuity of the business, yes, 10 years down the road they may find themselves sitting on top of a book of business that is worth nothing. But we can take action,” Palaveev adds. “We don’t have to be the recipients of fate.”

And when talking about the “value” of a firm, he says it is important to first consider “value to whom” and “value under what circumstances.”

“Surveys tell us that the income of financial advisors is higher than it’s ever been. As long as the income of a business is high, the value of a business is high, assuming that income is sustainable. If you have an asset generating high income, even if it is finite in its life, it is still a valuable asset,” notes Palaveev. “If you have a business that’s going to pay you $1 million a year for the next 10 years, and then it is going to die, is that a bad business? I think not.”

Valuing Assets

For the past six years, valuation expert David Grau Sr. has watched one figure hold steady: 8–12% of advisory firms, no matter the size, will sell to an acquirer.

Even more interesting, the remainder of those practices below $1 million in value will wind down through attrition. “It’s unfortunate for them and for their clients and it’s bad for the industry,” says Grau, who heads FP Transitions in Portland, Ore. It’s a quite different story for those valued at above $1 million. Most advisors who don’t sell are working on internal succession plans with a move to protect and perpetuate their most valuable asset: their business.

“The amount of internal succession planning has accelerated through the roof,” he says. “We’re seeing a solid 20% increase every year in the number of advisors who actually value their practices.” The firm will do 1,300 valuations this year, measuring 100 data points across three indexes: cash flow quality, transition risk and marketplace demand.

“Until you put a number on that practice and what you spent a lifetime building, you can’t set up a continuity plan. This is your largest, most valuable asset. Take care of it,” cautions Grau. “Not only figure out what’s it worth but why it’s worth that.”

Do you want to put a number on your practice? Want to grow your business? Wondering how to make a merger work? Consider this advice from the experts:

Be realistic. There is an inherent quality in all of us to put a value on our creations that is greater than it should be. “It’s that pride of creation. My children are always the best looking. We have a bias, not a flaw necessarily,” says Palaveev. “It’s only a flaw if unreasonable expectations of the future are based on that bias.”

Network. Go to conferences, “shake some hands,” “drink some drinks” and reach out to other advisory firms and financial professionals in your region, adds Palaveev. “Start a conversation: How is your business doing and where do you see it going? How do you find new clients? You don’t have to walk around with a T-shirt that says ‘Looking for mergers.’ You network. You wave the flag.”

Hire smart. A more valuable practice—one that can be sold to an outside buyer—depends on people, according to consultant Angie Herbers, founder of Angie Herbers Inc. in Manhattan, Kan. “We know for a fact that with any service business, the most valuable asset is the people working in them. That plays right into your ability to sell your firm, to be acquired, or to be transferred internally. Nearly all of my [advisory] firms are looking to acquire or merge right now. I compare acquiring to the hiring process. You have to be an employer of choice. You need to prepare yourself to be bigger.”

Spend face time. With most deals, principals spend 80% of their time on the economics and 20% on the people part. Friedman says the equation should be flipped. “The deal structure is the easy part. The bigger issue is how do I get along with these people, their philosophy, their values? It’s important to really get to know each other. Grab beers, go to the movie, walk in the park,” he advises. In retrospect, Friedman says he would have from the beginning gotten mutual consent on things like roles and responsibilities—and documented it in detail. “Flesh it out. Dig in,” he says. “Even if it’s not binding, it’s helpful.”

Compare cultures. Firm owners should meet frequently, visit one another’s work spaces, learn about one another’s philosophy of advising, and fully understand what the client experience is like, according to Wales. “Part of the business that drives the greatest value is the client relationship and the ability to grow more. You need to understand what the effect would be on your clients going forward,” he adds. “You want a complementary culture and set of conditions. That takes a relatively long courtship.”

Do the math. Consider the economics that drive value in a business, yours and your prospective partner’s: cost structure, income mix and growth trajectories, as examples. Following that, says Garcia, take a look at the client base: the average age, tenure of clients, composition and retention rates. Next, consider the business opportunity. Is there a management team that’s managing day to day and professionally? Is this an organization that supports career paths? Is this a firm with a brand and solid reputation in the marketplace? “You’ve got to look at cash flow divided by risk minus growth,” he adds. “What you need to think about are all the things that drive those components.”


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