The leaders of the 2014 Broker-Dealers of the Year and the editors of Investment Advisor met in Chicago in August for the Broker-Dealer roundtable. (Photo: Tom McKenzie)

In the in-person roundtable featuring the leaders of the 24th annual Broker-Dealers of the Year, we asked them to respond to four common scenarios faced by independent BDs. Here’s how David Stringer of Prospera Financial, Doug Wright of The Investment Center, Kevin Bachmann of Questar Capital and Eric Schwartz of Cambridge Investment Research responded to the first scenario on how broker-dealers can, and should, grow their firms.

Scenario 1: Do Independent Broker-Dealers Need to Grow?

You’ve become aware that another independent brokerdealer can be acquired by your firm. This other brokerdealer has a similar culture to yours and you’ve always respected the leadership. This firm has also been struggling to keep its top producers, perhaps because it’s too small to offer a broad range of services. Assuming you have the financial backing to make a bid for this other BD, what are the factors you’re going to consider before you decide, or not, to make a bid?

David Stringer, Prospera Financial: We actually went through this last year. It was not a 1099 firm but was a W2 firm, a local firm. We had a sevenpage duediligence process that we went through, but I’m just going to hit the highlights of what we actually did.

The first thing that we had to do was make sure it was a good fit; that they aligned with our culture. Our vision is to be the gold standard of boutique firms, and we wanted to make sure that they met that qualification. The advisors met our standards of what we were looking to do and how we could serve them.

The second thing we were looking at is, “Could we add value to them?” In our case, we thought we could. We had a little bit of work to do on the economics to shift them from a W2 environment to a 1099 environment, but the approach was, first, “Let’s make sure the people are a good fit with our culture and our firm,” and then, second, we would follow with the economics. It’s been a great addition to our firm. We’re very proud to be serving those fine folks.

Jamie Green, Investment Advisor: How do you define “culture?” Is it written down?

Stringer:  It is. We recently just went through the RitzCarlton training process so we’ve defined our gold standard as we see it, and we have our employee promise, and our credo, that we’re financial professionals serving financial professionals. Our vision is to be the gold standard of boutique firms. We’re not going to be the bigscale players in this age of consolidation. We’re trying to stand in our spot and be an advocate for small firms.

Our core values are very important to us. It’s about, first, character of the people; [but also] that they’re competent, that they work to master their skills; and then third, and most important, is that they put their clients’ interests first, that they care for their people, that they serve a higher mission than just making the dollar.

Kevin Bachmann, Questar Capital Corp.: We would do many of the things that David [Stringer] was looking at. The culture: Is it the right fit? We also want to look at the rep: What’s the rep profile? Do they fit with who we are and what markets we’re in? What products do they sell? Then, technology, how painful is it going to be to really integrate the brokerdealer?

Do you run it separately or do you integrate it? We’d look at clearing platforms, CRM systems, making sure that they align with our systems if we’re going to integrate. What previous products were sold, what kind of due diligence was done? We want to make sure that we’re not buying something that could cause us issues down the road.

Green:  So it’s both on a personal basis of the reps, but also how the two firms would merge, even technologywise. If you shared the same clearing firm, would be a plus in terms of your interest?

Bachmann:  It’s a huge plus, but I see a lot of the firms right now that are being acquired, they’re being left to run independently. That’s an option, but I don’t know if you’re going to get the scale and the value—the synergies—out of that [leaving a firm to run independently]. You have to look at how the firm handles OBA [outside business activities] and what kind of services they allow. You have to [ask], “Does it align with who you are and where you’re going, or are you just buying it to get head count?”

Green:  Eric Schwartz, Cambridge is a large firm. What would you look for in this situation?

Eric Schwartz, Cambridge Investment Research: To start with, this is a very secondary consideration in real life for us. We historically have grown entirely organically, and that’s how we’re built. It’s a lot easier for us to control the quality of the advisor, the cultural fit and all the other pieces if the reps are voting to join us one at a time, or as a group of five or 10, versus you buy a brokerdealer and you’ve got the whole package, and maybe 80% of the reps really fit, but 20% don’t.

You also have issues of products sold, liability, that [can make an acquisition] a little more complicated. We, in general, have not focused on this side. But if you are, certainly you’ve got to have the due diligence checklists. You’re going to look at hard items like did they sell Medical Capital, or whatever the latest issue would be?

Medical Capital has pretty much worked its way through now. You can look at all those [other] things, but culture is going to be really, really important. Because if you’re buying today, in general, you’re paying a lot of money. There may be exceptions; you can buy a firm that’s doing $8 million of business, to me that’s more like recruiting an OSJ.

We recruit offices that are $5 to $20 million on some regular basis, and so if you’re buying a brokerdealer of that size, to me that’s pretty much the same as [recruiting an OSJ]. That’s really recruiting to me. If you’re buying a larger firm, you’re going to tend to pay a high price, because Nicholas Schorsch [of Realty Capital] of course, and more recently LPL again, and now Securities America [Ladenburg Thalmann] and one or two others in that market.

I have a hard time when you get into competing with those guys to justify the prices they’re paying. If we’re recruiting, our average front money in the last couple of years has been about 11%.

When you’re buying a brokerdealer and people are paying 40% to 70% of GDC, I have a hard time justifying putting too much energy into that, when you’re paying three times or four times, when you could bring in an individual rep, making sure he wants to be there.

I’m not saying acquisitions don’t work, but for us, we’ve had a hard time being able to distinguish ourselves in a market where money is the primary driver. We’ve talked to some firms, and this is partly through education, that were interested in part because we had made a commitment, a lifetime commitment, never to sell the firm, even after I’m gone.

I have a program in place, a succession plan that may be a subject later in the day, whereby I’m gradually moving the stock from myself to senior management, advisors, an ESOP and to charity.

The stuff that goes to charity will be later bought back by the company over a 20year period so that the control can still be kept with the people that really care about the company rather than the traditional sell out.

That having been said, we have those pieces in place, but as far as acquisitions, there are people that we’ve talked to [who say], “Oh, that sounds much better than going to X, Y, Z, where we’re just going to be part of a gigantic organization”–obviously not necessarily in the case where you have a boutique firm doing it, but the traditional buyers that have 10,000 reps and are owned by a big insurance company or are public or whatever.

We’ve had some interest from people who said, “Oh, you know, that sounds a lot more appealing. Maybe we can work something out with you, and maybe you can be our succession plan.”

I like hybrid solutions, so we’ve talked about, “Maybe we’ll buy 30% of your company. Then we’ll fuse some technology, and some of our recruiters can help you grow, so we can up your growth rate, and then when you’re ready to retire in seven or eight years, we can buy the rest of your firm, but it’ll be worth way more than if you had just built it on your own.”

I like hybrid solutions, alternatives to the main line, and in this case I like it particularly because the cost is so high if you’re buying a $50 or $100 million firm, but what’s happened in the cases we’ve talked about; people are intrigued by the idea but so far the almighty dollar ended up telling the story.

It’s hard to explain why you took 35 cents on the dollar instead of 60 if somebody’s offering you 60, even if he’s the devil, so to speak, because, in the end, that’s a lot of dollars to give up for your whole life’s work, plus you may have other shareholders who don’t necessarily share your vision, even if it’s a better cultural fit.

I never say “Never” to anything because usually when you do that, you end up doing it the next week, but in my mind, it would have to be a really good fit because…everybody is trying to buy firms, there’s some very high prices being paid, and in our case, we’re fortunate enough, like I think some of the other people in the room, to have a really good value proposition that resonates with advisors.

We are able to recruit on average of about $60 million of GDC a year at…I said about 11% front-money total incost on recruiting for us is about 15% to 17%, with staff and all that. You’re not going to be buying a whole lot of $50 to $100 million firms at 17% GDC. You’re going to be lucky if you’re paying three times that.

We have it in the hip pocket if the right person comes along but, it’s a tough market to compete in. The one area where we’ve had success is…I don’t know what size the firm was that you acquired?

Stringer:  Small.

Schwartz:  Yeah. We found that, that area we can do because it’s similar to recruiting, and they’re not trying to primarily make a big pile of money. They’re trying to find a good home for themselves and their advisors, much like the branch manager of a 30rep firm is trying to find a home for himself and a place where they can grow in the future and, for example, our story of being independently owned, I think like your firm [Prospera] is, is compelling to people that are entrepreneurs versus being with a large firm.

Doug Wright, The Investment Center:  To evaluate a firm [we’re] very similar to the other three. We’re probably in between David and Eric’s philosophy there. We really take an extensive look at a firm we’re going to acquire; delve into it. We do [things] a little bit different in that we will actually bring the senior management out, and bring in all the reps–we bring in everybody. We’ll have a whole roundtable so we all get to know each other real well. Talking about fitting in culturewise, that’s something that we really want to make sure happens, so we have a whole day of discussions with all the reps to make sure that we all fit.

We’ll go through analysis rep by rep, making sure that, like Kevin [Bachmann] said, we’re not buying something that we don’t know about, so we try to really delve in there deep, go through a pretty good duediligence checklist.

Like Eric [Schwartz], we also find it more valuable to recruit one or more small OSJs; the value prop is probably the best there.

That’s been Ralph’s philosophy for the last 5, 10 years [Ralph DeVito, president of The Investment Center] but on occasion we come across deals that you have to look at, and sometimes they really work out well, and we’ve done a number of them.

Green: Am I right in assuming that all of you want to grow your firms in terms of revenue, in profitability, and does that require that you grow in the number of reps that you have? Kevin, do you think that’s what you have to do?

Bachmann: It’s a twopronged approach. What we’re trying to do is attract higherproducing advisors, quality advisors, to our firm.

Our goal would be to recruit anywhere from $20 to $25 million of new GDC to the firm, and then the flip side of that is to also grow our existing rep base and help them bring up their additional revenue streams, primarily [by] finding new outlets for them, teaching them new outlets to really grow their practices.

So we put a big emphasis on training, education, practice management and working with our advisors to uptick the practices and the channels that they’re in.

Green:  David Stringer, you pride yourself on being a boutique firm, right?

Stringer: I would say you do not have to be a scale player to win in this business. It’s more about quality for us than it is quantity. I do believe that you need to grow at some level or you are dying, but that doesn’t necessarily mean head count in my opinion.

We think our advisors are becoming better business owners because they’re learning how to run their businesses more effectively; the processes are more efficient. You’ve got to evolve on a regular basis with this industry, so it’s about increasing your technology to leveraging your partnerships. Our clearing firms deliver quite a bit to us, so growth is important.

Green:  That’s plural? Clearing firms?

Stringer:  When we made our acquisition [discussed earlier], we acquired a second clearing firm. I would say growth is important, but not necessarily from the standpoint of head count. I would be happy with growth in our firm with the same number of advisors that we have because that would just mean that we’ve created a very fertile place for our advisors to run, grow and protect their business.

Green:  Eric Schwartz, you said you grow through organic growth. Do you need to keep growing?

Schwarz: I do agree. I think just in general, in any business, if you’re not growing, you’re dying, as I think David [Stringer] was saying, but [it’s especially true] when an industry hits the inflection point we’re in. We’re on this S curve in this industry, and we’re getting to the upper part of that, where you have far more capacity among the players on the street than you have new advisors coming into the industry.

That wasn’t true 30 years ago. Every independent brokerdealer would just sit there and grow because there was a huge influx coming into our market.

We’re in that phase that every industry goes through. The auto industry started with 100 car makers 100 years ago, and now there are three in the United States. Wire firms–there were at least 25 when I was growing up, and probably a hundred or two hundred before that, and now there are five.

We’re having the same thing happening. Fifteen years ago, the top five independent firms controlled 25% of the market. Last year it was 51%. In fact, two years before that, the top 10 had 53%, so all of a sudden now it’s the top five. That’s partly because Nick [Schorsch], of course, bought up a whole bunch of firms, so they all of a sudden jumped up a number, but that’s what happens. Now LPL’s bought another firm so that’s pushed those top five that much higher.

If I look at it in 15 years, I say that the top five to seven firms will be 80% to 90% of the industry, and I’m not saying that I think that’s a tremendous forecast. That’s just a statement of what happens in every industry as it consolidates, where you have cost issues, and big dollars, and you have, in our industry, a succession planning issue.

You look around the room here, there’s not a lot of 20yearolds that are running these big brokerdealers, so when the primary owner gets to 60, 65, some cases 50s, they have to sell, and most of them are going to do that, and the buyer’s going to be one of those top five or seven firms.

Now I’m trying to do it differently, as I mentioned before. I’m trying to set up a plan where we don’t sell, but what we’re trying to do [is that] we want to be one of those [top] five to seven firms. We probably expect to be the only one that’s still privately held and is growing organically, and I define “organically” as two things: helping your existing advisors grow and also recruiting on a one-office-by-one-office basis versus outright acquisition.

We’re by most measures number nine right now so we think we’re within striking distance. We suspect that the nine above us, [...] there will be several mergers between them before this is all done.

I do think there is a space–because even if the top five or seven are 90% of the market, it may only be 80%, but it’s going to be some number like that–there’s still room for a firm like David’s, [Prospera], whether he has 150 reps at that time or whether he has 500 but is still considered a small boutique by the standards of an LPL.

It’s only going to be the really good ones, the ones that have a true value proposition, that are going to be the survivors, and they’re going to have to really want it. Again, my succession plan is something that I’ve been working on for 15 years, but most people aren’t willing to do what I’m doing, meaning I’m never going to take all the money off the table. I’m going to probably have 80% of the money on the table when I pass away.

Green:  For the record, we hope it’s not soon.

Wright:  You got it really planned out.

Schwartz:  I started working on my succession plan 16 years ago when I was 45 just because the reps wanted to know, especially since we sold stock to them for the first time then so they wanted to know, “What happens if…”. It was more theoretical then because the firm was 2% the size it is today, so it wasn’t a multihundredmilliondollar estate tax potential, and that’s where the charity comes in.

Whatever you have left when and if…well, I won’t say, “When and if you pass,” because…

Green:  It’s likely that…

Eric:  It’s likely that when…if I still own, say, 51% at that point instead of the current 85%, if you don’t put that into charities, you’re selling the company just to pay the taxes, like the classic old family farm situation. That’s another thing driving our industry.

There is a good value to these things, but it’s unlikely that the next generation is going to be the buyer unless you’re willing to be very creative in how you get it done, or have been, in my case, trying to help the charities at the same time, and then allow the senior management to still keep control, have the reps, advisors, and the ESOP do it all, but absent that, it’s a challenge.

It’ll be a very interesting story to see what happens with some of these groups that are fiercely independent, like Dave’s firm [Stringer; Prospera Financial] and I think your firm, too [Kevin Bachmann of Questar]. In fact, you’re the first firm in a couple years that wasn’t privately held that’s in this room [of winning broker-dealers].

That is the challenge to maintaining independence, whether you’re my size or your size, is when that shifting of ownership takes place, is it going to be one of those top six or seven firms that does the buying? Can you find another way?

We have found a way, partly because of what my own personal desire is, but that will determine a lot, whether these boutique firms exist or whether they get rolled up, even though it’s the last thing that David [Stringer] might want, but at some point you’re trying to take care of your family, and you have those issues.

That’s really the challenge that faces us as small business owners, and I still think we’re small business owners even though it’s all relative compared to firms that have more revenue in an hour than we do for a year, the Facebooks or whoever else.

Green:  I think it was last year when Investors Capital was here [as a winning Broker-Dealer of the Year] and they were acquired by Nicholas Schorsch in the meantime. Doug Wright of The Investment Center, do you have thoughts on this?

Wright:  As far as growth, you have to grow. I work with Ralph DeVito as far as his plans in growing the firm…

Green:  It was his father’s firm before, right?

Wright:  He founded the firm back in 1986, so 28 years later, still a single owner, which is now Ralph DeVito Jr. He’s made a commitment to grow the firm organically and externally. Actually, we just brought in a new director of recruiting. He [Ralph DeVito] is adamant on growing the firm.

I think like all the firms out there, it’s something that you have to do to survive. You have to continue to get your GDC higher and higher. We’ve been doing it, fortunately, internally by raising the revenue within the firm, but [considering] the aging rep force, we do [need] replacements.

We have to keep bringing them in because you’re going to have people retire or pass away, so you need to have succession planning not only for yourselves but also for the reps; we’re also very high on that.

Green:  Normally when we think about succession planning, we think about individual advisors, but now it’s succession planning for brokerdealers as well?

Wright:  It’s both. Advisors ask that when they join you. “What’s going on?”

Green:  ”What’s the broker-dealer’s plan for the future?”

Wright:  Yes, you have to have that available for them, and then they’re looking to you. We get calls all the time, “Hey, help me out. I may retire in five years and we need to put a plan in place,” so we work with them to put a plan in place for them, too.

Green:  Is part of [the reason recruits] ask you about the corporate succession plan is because they’ve been in other situations where the culture has changed?

Wright:  I think they read your magazine a lot and they see the articles…

Green:  I’m sorry, I didn’t hear that. What, they read our magazine?

Wright:  [laughs] They read the articles. No, really. They see what’s out there. They see brokerdealers either being bought or failing, especially this last round where we lost, I think, 20, 30 independents through purchasing the wrong products, so that’s very important.

The other thing they focus on is your product [line]. What exposure do you have to risky products?

Green:  Thank you, because that’s a perfect segue into our next scenario.

Click here to read the Broker-Dealers of the Year’s discussion on “Scenario 2: Keeping Your Top Producers.” Visit the 2014 Broker-Dealers of the Year home page for more coverage. Click here to view the complete rules for voting in the Broker-Dealers of the Year.