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July 01, 2015 at 10:58 PM
In our experience working with client advisory firms that have acquired other firms, and some that have been acquired, we’ve concluded that much of the conventional wisdom about advisory M&A is wrong. In particular, what’s wrong is the focus on profitability.
Don’t get me wrong: if you are going to make an investment in an independent advisory firm, then its profitability would be very important. But if you’re going to buy one—either to mergeit into your own firm or run the business yourself—then the quality of the revenue stream (AUM fees, client retention, age of the client base, growth potential, etc.) is far more important.
That is, assuming that you (the buyer) has the know-how to run an advisory business profitably. In fact, you’d rather find a firm with low profitability so the current owner will sell on the cheap.
Recently, I was reminded of this insight at the TD Ameritrade Elite Advisor conference in San Diego, in a number of conversations that I had with some of the bigger advisory firms (with over $1 million in annual revenues). It seems that many of them are solving two of the industry’s biggest current challenges—recruiting young advisors and attracting new clients—with a novel strategy: buying smaller advisory firms. And guess what? They aren’t concerned about acquiring profitable firms: only firms that have good advisors willing to make the move to the buying firm, and a solid client base.
Here’s why. As with most businesses, when independent advisory firms get larger, their growth rates tend to slow down. Taking a firm from $100,000 in revenues to $200,000 is a lot easier than growing from $1 million to $2 million. So many larger firms focus on increasing their operating efficiency in order to keep owners’ income on the rise.
But there are limits on increasing efficiency as well, so at some point firms that want to continue to grow have to find a different strategy. I believe the strategy they currently are using–buying up smaller firms–represents a new stage in the evolution of independent advisory firms.
