Hurley also could find himself a hostage in the middle of the potential prison riot he describes, and he's making a nine-year commitment to the business. "Because he is never buying too much of the firm at one time, he's in partnership with them and his fortunes are going to rise and fall with theirs," Temple notes.
Still, it's a value proposition that's suddenly very hard to ignore, and one that's likely to send other financial and strategic buyers back to the drawing boards. Both PWM and FN aren't interested in smaller firms, where some principals are mainly interested at cashing out, while making sure their clients and employees are taken care of.
For its part, PWM will only acquire controlling interests in wealth management firms at the principals' request as part of their succession plan. "If you look at most of these wealth management [firms], they have real value built up but they can't access capital to grow," Goldberg says. "Banks look at them as brokers so they can't get any liquidity."
To justify the multiples FN is offering-and for advisors to realize the full potential value of their offer-the firms in which it acquires equity stakes must achieve and sustain strong growth rates. Hurley says that the lion's share of his time spent negotiating with both Regent Atlantic and Evensky & Katz involved the younger partners and next generation far more than it did the founders. And he is extremely high on the abilities of the key marketing and sales executives at both firms, Margaret Prentice at Regent Atlantic and David Evensky at Evensky & Katz.
Indeed, several advisor/owners who looked at the FN deal thought it was a good deal for them but could place tremendous stress on younger, junior partners and want-to-be partners. To a large extent, the appeal of this deal hinges on the strength, depth and ambitions of the next generation.
That's because a dirty little secret of this business is that few of today's largest advisor/owners ever imagined a decade ago that their firms would reach their current size. Everyone wants success, but the scale of today's largest firms, coupled with the lack of liquidity for the businesses, is spawning a series of challenges that pits the founding partners against the next generation.
As Hurley describes it, owners of RIA firms face very few attractive succession alternatives. "They can sell it to the next generation at only a de minimis price, like an 80% discount, because that's all the next generation can afford to pay," he says. "That gives the next generation a huge incentive to flip the business very quickly." And while many founders would like to offer the next generation a fair deal, the last thing they want to do is sell the business that they labored decades to build for a song so someone else can hold it for a year and get a 400% return.
The other alternative facing wealth management firm owners is to swap their shares for those of roll-up firms and wait for an IPO. The problem is, if there is no IPO in five to ten years, the roll-up operation probably would be sold to another private equity firm at a discount, diluting the original RIA firm's shares.
Until now, advisors looking at exit and succession strategies have faced an array of either high-risk alternatives with a shot at high returns or options with low risks and returns that at least offer some certainty. These options include swapping a portion of an advisory firm's shares for those of a consolidator like NFP, selling all the firm's shares to a financial institution like a bank or allowing junior partners and senior employees to buy out part of the founding partners' interests over time. All these different transactions involve some or total loss of control.
Swapping shares with a consolidation firm offers the most potential upside if the consolidator can complete enough transactions, probably 60 or 70 deals, to pull off an IPO. That's because these roll-up vehicles typically purchase control, say about 60%, of a firm's equity at five times earnings and, when they accumulate a critical mass, take them public at 15 times earnings or more, creating enough value to justify ceding control. But in the noninstitutional asset management space, only NFP has done an IPO, and most of its acquisitions have been estate planning/insurance firms or benefits administrators.