A couple of years ago, the principals of two high-profile financial advisory firms, one from Virginia, one from Chicagoland, were looking across a desk at one another pondering a merger of their firms when they came to a moment that almost crashed the whole thing.
Glenn Kautt, a Navy veteran in his mid-60s who had once been involved with nuclear reactors on warships and later spent a couple of decades cobbling together four or five advisory firms, had brought his McLean, Va., firm The Monitor Group to the table with Savant Capital, a Rockford, Ill., firm that had risen improbably in the soil of a declining Rust Belt city, raising a $2 billion firm entirely organically.
The crux of the matter was that both Kautt and Savant founder Thomas Muldowney were in their 60s, a time when people are starting to think of getting out of the business. Kautt was certainly thinking that way, wanting to leave by the time he was in his early 70s. That meant too many chips were about to come off the table.
“Tom looked around and went, well if Kautt’s out, I’m out,” Kautt recalls. “At that point, that represented more than 50% of the shares, which means we just killed the company, because you can’t extract 50% of a person’s blood, it just doesn’t work. So before the deal was done, it collapsed.”
The chance to add Monitor’s $500 million in assets to Savant’s $2 billion and change hung in the balance, but by the end of the deal, the principals had come up with a way to wed their companies, in essence by building a private business wrapped around a public company structure. It required them, says Kautt, to check their egos, give up the “benevolent dictator” model, think of the legacy they were leaving, and perhaps build a behemoth rather than a puzzle of self-interested shareholders.
Those are lofty words, but hard to make pennies out of. Kautt himself says, not joking, that the best way for a financial advisor to really extract the most value out of his firm is to drop dead at his desk. He was looking at that possibility himself as far back as 13 years ago when his older partner, the late legendary Lynn Hopewell, told him how long he’d looked for a successor. Kautt thought of grooming someone himself. But he consulted with Pershing-Moss Adams guru Mark Tibergien, who said the “white knight saving the firm” idea was nice, but didn’t work 95% of the time.
Beginnings
Enter Savant.
The firm was founded in 1986 by Muldowney, an insurance salesman suffering a bit of cognitive dissonance over the stuff he was selling and the real advice he wanted to be giving. The second-to-last child in an Irish family of seven kids, Muldowney had been a biology major in school with his sights on an M.D., working his way through school. (At one manufacturing job, he was involved with the “smart hinge” for the tailgates of station wagons.) During his internship in Swedish American Hospital in Rockford, however, Muldowney found himself running to the bathroom with dry heaves at the sight of blood, he says. He switched to finance and entered the workforce in 1974, just as the economy laid an egg. The warm embrace of the insurance world opened to him.
Muldowney recalls of the insurance recruiters: “They told me I was charming, that I was articulate, that I was handsome, that I was smart, that I would be a leader in the industry and lead agencies and be a revolutionary change to the world and that I would be tall,” he says.
He thrived at it, but when it came to selling insurance products, he came to the nagging realization clients didn’t keep them, and maybe that was a sign the selling culture had gone too far. His mentors said this about fiduciary scruple in the insurance world, “Do as I say, not as I do.”
He started a soft launch of Savant in 1986; the original model was to sell unbiased financial plans but not implement them, at least until he teamed up with Brent Brodeski in 1993.
The young, ambitious Brodeski had come out of academia with an MBA wanting to spread the gospel of asset allocation (for too much zeal, Brodeski had found himself fired from his previous job). These were the years just after Harry Markowitz won the Nobel prize for economics for contributing to modern portfolio theory. Like many advisors in the early 1990s, Brodeski wanted to get investors out of the trading (i.e., gambling) habit and into the new religion.
“We really kind of looked at what was going on in the institutional world,” says Brodeski. “Asset allocation was kind of a strange concept. It had just won the Nobel prize, but really practitioners weren’t using it.”
Brodeski and Muldowney rebooted Savant as an investment firm that would implement plans, not just write unused prescriptions, as Brodeski put it. The firm remained a boutique shop for a good number of years, Brodeski says. He was the analytical numbers guy. Muldowney was the larger-than-life storyteller—the charismatic client magnet. They were later joined by third principal Dick Bennett, a veteran of the trust world.
Around the year 2000, they decided to grow beyond the boutique into a “Mayo Clinic,” model—using teams of specialists and experts rather than one “doctor” for each client. The approach allowed the team to grow to just over a couple billion dollars in 10 years, he says.
That would be impressive enough if it weren’t for the fact they were doing it in Rockford, a city not on the grow—a place that has in fact been ranked on Forbes’ most miserable cities list after manufacturing left it to years of decline.
“We took lemons and turned them into lemonade,” says Brodeski of Rockford. “The competition primarily collected clients on the golf course, did not do financial planning, charged excessive fees, ignored taxes and failed to serve clients in a fiduciary capacity. We responded by delivering a far more robust value proposition that included comprehensive advice, eliminated conflicts of interest, focused on an evidence-based investing strategy, recognized the importance of minimizing taxes, eliminated unneeded speculation and approached marketing different.”
That reputation preceded them as they moved on to clients in Chicago, Madison and Milwaukee and eventually set up satellite offices, he says, building relationships across the client spectrum, though they concentrated somewhat on physicians, business owners and retirees.
Sink or Swim
It wasn’t enough for the future, though. A few years ago, Brodeski says he attended a seminar of professional services firms. One lecturer said that if a business wasn’t growing at 15% a year, it was dying. His own team had hit 15% annual targets easily, but there was no way they could keep it up, he realized.
“As we got bigger, 15% growth became a bigger number, [also] we were getting busier and busier managing our team and managing existing relationships.”
The three guys just bringing in people wasn’t going to work anymore, not to put too fine a point on it. The firm was going to go gray. Mergers became part of the calculus, and that’s when the Monitor Group came over the horizon. Both Savant and the Virginia firm were part of the Zero Alpha Group, an industry study group made up of like-minded, fee-only firms focused on passive investing, co-founded by Brodeski. Kautt joined, and after talking for years with Savant, they all realized their visions and cultures were similar.
“Our firms were almost mirror images,” Kautt says.
McLean, Va., Monitor’s home, was only about an hour away by plane and would serve the purposes of a disciplined hub-and-spoke model for Savant.
Monitor-ing
Kautt’s itchy succession problem, meanwhile, had gotten worse when the Monitor Group became too big to sell internally. He had looked at having younger advisors come in for grooming, but they became “runaway brides,” he says. Tibergien told him that for a firm his size, the only thing was to align himself with another firm with an established management structure and the same business philosophy.
The devil, of course, is in the details, and in Kautt’s explication, that’s where a lot of deals fail.
“A lot of people want to maximize the value of the cash flow of their firm,” he says. “How do we do that? … It’s real simple. The maximum value you can extract is if you run it into the ground and die at the desk.” That’s because the owner often fritters away his future cash value to make a deal, he says.
“Let’s take a million dollar cash flow guy,” Kautt says. “He’s making $200,000 as a salary. And he takes out $800,000 in cash. So I don’t care how big his firm is, and I don’t care how fast he’s growing. He’s taking a million bucks in cash. So some guy comes up to him and says, ‘Your company is probably worth, on a price-to-earnings ratio, 5 times net earnings, it’s probably worth 5 million bucks in cash. So I’ll stroke you a check for $5 million today. Here you go. See you. But oops! Wait a minute, you don’t get 5 million bucks. Here’s what you really get. You know we have to have someone to take your place, Glenn, so that’s going to cost, oh, $200,000. So actually your net cash flow is only $800,000. So I’m not going to pay you $5 million, I’m going to pay you $4 million.’
“Oops! Wait a minute, we have to pay taxes on that in most states—federal and state taxes. Oh, let’s call it 20%. Let’s just be real simple. So 20% of $4 million is about $800,000. So let’s say you’re now down to $3.2 million and you may have some other expenses, lawyers and stuff like that. Let’s say you walk out the door with only $3 million bucks. Go invest it. Now what can we make on $3 million bucks prudently. Six percent? Five percent?
“So let’s do the math here. I was taking a million out, now I’m taking maybe at best $200,000 out. What person in their right mind would do that? Nobody. Unless they are forced to by health or some other family or technical reason. … Nobody in their right mind would give up 80% of their income. That is reality.”
But letting the firm die, on the other hand, was unethical and unfair to family, friends and clients. Also, it’s harder for someone in his 60s to sustain the growth, he says.
In the deal that emerged between Savant and Monitor, no one took money out, Kautt explains. The assets of both firms’ assets went into a shell company (technically, it wasn’t even a merger, note the lawyers, but a “combination.”) Nor was it an acquisition. Kautt says he took a pay cut in essence with all the expenses, sold no stock and got no cash back. The new calculus was this: a massive company with accelerating growth of 20% (outpacing his 16% or so annual growth previously) would put him back to where he was in five years or so.
“If I have massive growth for the combined firm and the longevity of the combined firm is bigger than my net present value, whoa! We’ll be bigger. It’ll be bigger than if I crashed it against the wall.” And the real growth rate actually turned out to be higher than the forecast growth rate. (He’s now back where he was, but in a much better position, he says.)
But there was that nagging point: What to do in seven or eight years when Muldowney and Kautt were in their 70s? To Muldowney, it was important to “protect the dividend,” Kautt says.
That’s where Brodeski and Kautt say the deal got novel—novel enough to be a model for others in the industry. The logical response, he says, was to treat the company as a public company in its organization inside a private wrapper, says Kautt. Public companies, after all, survive hundreds of years.
“So we have an active board of directors and everything works the same inside,” he explains. “We spent a lot of money on legal bills to set it up so the active board of managers, or directors in this case, hires and fires the CEO … approves the overall budget and sets and manages the dividend.”
That meant a permanent governance structure and a flexible management team and a growing handful of shareholders who represented the interests of the people who work at the firm, he says.
And most important, “Even if I step off the board, the firm will go on,” says Kautt, who is now Savant’s vice chairman. “And my dividend, such as it is, will be protected. And every one of the shareholders feels that way.”
Regional For Now
Savant recently reached $4.1 billion in assets after changing focus from organic growth and moving toward acquisitions. It finished the Monitor deal in mid-2012. At the end of last year, it bought Paragon Advisors in Naperville, Ill., which has about $150 million. So far, says Brodeski, the firm has not had to use private equity money or even tap much of its munificent credit line.
What Brodeski and Muldowney started in a bungalow house in a residential neighborhood in 1993 has since turned into a firm with 3,379 client relationships and 106 employees laboring in 10 offices. That employee count might seem large for the asset amount, but only if you look at it superficially, says Brodeski.
“AUM levels can be deceiving as a metric for the size, profitability and success of a business,” he says. “For example, there are many advisors that have similar or more AUM than Savant with fewer team members, but their average client size may be $20 million to $50 million. [In other words] they have far fewer clients. And as such, they may have similar AUM to Savant but serve only a few hundred clients. Typically, this type of RIA may charge only 10 to 25 basis points or flat retainer fees, as the family office client has far more assets. As a result, they can boast high AUM but sadly don’t make much money.”
Kautt puts it even more succinctly.
“Our margins are damn near 40%. Does that sound top heavy?” he asks, comparing the firm to more giant concerns with 5% margins. He says the fact that the Savant staff specializes means that the firm has inverted the usual formula of having one overcompensated person at the top doing all the jobs, supported by less qualified staff.
“Our growth rates have been in excess of 20%. How can you scale that quickly if you’re top heavy? Because all that growth has to be supported by competent service professionals.”
The Future
Brodeski says the firm might do two acquisitions a year if it finds the right cultural fits. But the firm wants to be deliberate rather than go pell-mell into a national strategy with private equity money, which requires a faster pace and quicker return.
“The United Capitals and the Focuses of the world, they get all the headlines,” says Brodeski, “but they are really in the M&A business. And they’ve got outside capital [investors] that they need to deliver high returns to, and they’ve got a fairly short fuse, because within a few years they need to go public and create liquidity for that private equity venture capital type. … When you go there, it’s like a confederation of firms who really don’t have that much in common outside that they’ve taken money from a new parent company.”
To illuminate his thinking about the hub and spoke model, Brodeski says—hypothetically—that you could look at a city like Cincinnati that sits among other large population centers such as Columbus; Lexington, Ky.; and Indianapolis. Such a place would offer access to satellite offices within an hour by car or plane. But there are no deals there now. The focus is still tight and regional.
“I mean right now we still think there’s a ton of opportunity in the Midwest right where we’re at,” says Brodeski.
Muldowney says that all he had in the beginning was the vision but that he would have to hire people smarter than he was to implement it, and that was to create the trust people have with their doctors in a planning setting.
“Right now,” he says, “not only do we not trust Wall Street, but our institutions. We don’t trust our governments, we don’t trust our municipalities. We don’t trust many of our corporations; the church has certainly come out of this with a couple of black eyes, and the institutions have been damaged. So what people want is someone they can trust, and specifically when you’re in the position where you don’t sell a product people are willing to bare their soul.”