Is Your Practice Big Enough?

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 www.fiduciarynetwork.com.) 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.”