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What You Think You Know About Advisory Firm M&A Is Wrong

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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. 

Almost 15 years ago, Mark Hurley (now CEO of Fiduciary Network) predicted a consolidation in the independent advisory industry. But as an investment banker, Hurley believed the consolidation would be driven by increasing returns on investment (ROI). Instead, the current acquisition trend appears to be driven by business dynamics: larger firms using their operating efficiencies to overcome increased competition and shortages of professional talent through acquisitions. 

Consequently, the profitability of smaller advisory firms is taking a back seat to the quality of their two most important assets: their client bases and their stable of young advisors—and the relationship between the two.

All three factors depend on one thing: their younger advisors.

In our view, advisory firms that will sell at a premium in the future will be those with experienced, well-trained younger advisors, who have been able to attract clients in their own generation, and who have formed relationships with all a firm’s clients, increasing the likelihood that those clients will move with them to a new firm. If that new firm runs its operations more efficiently, all the better. But the one constant in all advisory firm acquisitions is: to be successful, most of the clients have to transfer to the new firm.

A stable of dynamic young advisors make client transitions more likely, and therefore make an advisory firm more valuable, regardless of its profitability. 

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