Focus Financial has become one of the largest RIAs only months after it opened its doors. Founder Rudy Adolf says they're just getting started.
The Provost Monarch Summit has a zero-to-60 time of
32 seconds, acceptable speed for a 45-foot-long, 48,000-pound traveling
road mansion. But what about a nascent advisory network-one you'd
expect might share the lumbering qualities of a giant mobile home-that
in a matter of months has moved from zero to nearly $4 billion in
assets under management to become, according to some measure one of the
ten largest RIAs in the nation?
Merger interest among advisors notwithstanding, this rapid growth has taken some in financial services by surprise and left others to wonder if it will work. Not Rudy Adolf, the man behind the wheel. "We're not number one yet, but we're getting there," he says of the Focus Financial Partners network, which he launched in February 2006 after signing on four ground-floor firms. "Our aspiration is crystal clear: Within a very short time frame we will be the leading independent fiduciary wealth management firm in the country."
Adolf, a former partner at McKinsey and Company in New York and, most recently, senior vice president and general manager of the American Express Global Brokerage and Banking division, had for some time believed there was a better way to provide wealth management services than using the traditional sales-oriented broker model. The model he favored was that espoused by the fee-based and fiduciary-minded RIA community. But rather than reinvent their wheel, he set about to create a better platform upon which it might ride. As he explains, "Our platform is designed for some of these very high-quality firms to come together and operate on a scale that simply hasn't existed in this industry before."
Summit Partners, a private equity and venture capital group with a capital base of nearly $9 billion, liked Adolf's ideas and came on board as the lead investor in Focus Financial with an initial infusion of $35 million. According to Adolf, Summit will provide ongoing support in the execution of the Focus Financial Network growth strategy.
"With our model and relationship with Summit we have access to capital that is second to none," says Adolf. "Our limiting factor is less access to money than to quality." It's a factor the Focus CEO believes differentiates his company from other firms that have merged, and will enable it to become a wealth management firm leader. According to Adolf, Focus was built upon the complementary strengths of its four founding partners, who serve principal markets in strategic regions across the country. These partners-Founders Financial Network, StrategicPoint, CapGroup (Capital Advisory Group) and Geller Group Ltd-are said to represent the four "pillars" of the Focus model, with expertise in the areas of affluent clients, middle-market institutions, high-net-worth individuals and families, and benefit consulting for employees.
"We gauged a lot of criteria for partnership, and these four fit our model the best, providing us the scale and profitability that we needed while giving us a foothold into each of the four target market areas we wanted to have in the founding group," Adolf explains. For example, Founders Financial Partners serves the San Francisco Bay area, and Geller Group is headquartered in New York City, with offices in Boston, Washington and Los Angeles. Strategic Point and CapGroup cover the Providence, R.I., and Richmond, Va., areas.
In describing the basic Focus business structure, Adolf notes that each partner, or member firm, becomes a subsidiary of Focus Financial Partners LLC, sharing a portion of Focus' profits while retaining control over its own client services and local business operations. In fairly traditional form for consolidations, Focus typically acquires 40% to 60% of a selling firm's ongoing economic interest in exchange for cash and an ownership position. "Because it's a partnership, every partner needs to have an equity stake and ongoing interest which aligns his interest with the interests of his other partners and Focus overall," he says.
What's In It For Me?
According to Adolf, joining firms benefit from partnering with Focus in three significant ways. First, Focus can help firms or senior partners get liquidity to diversify their net worth. "Basically, they can use the transaction with Focus as a way to balance their own personal balance sheets, if you will," he says. Second, Focus is helping firms "by working with the partnership to grow even stronger, to leverage some of the other firms in the group, and, ultimately, be a catalyst for their further growth and that of firms coming in." Third, Adolf believes his "unique model" facilitates transition planning for founders with senior principals who are planning to retire in the next six to ten years. Focus also provides "highly attractive growth incentives" through earn-outs. And, as part of a transaction, Focus can establish "attractive incentive pools" for current and future employees.
Growth of the Focus network, in terms of acquisitions beyond the four pillars, is to occur at an unhurried pace, governed by "quality and uniqueness," not numbers. Adolf is quick to make clear that Focus is not for everybody. "But there is a group of firms that has reached a level of scale, of professionalism in terms of client impact where, ultimately, our model can be very helpful in enabling these firms to reach their goals." Adolf believes that group consists of approximately 200 to 300 firms, out of an industry field exceeding 5,000. The company's medium-term plan is to target some 30 to 50 transactions in the next three to five years. "You cannot build something with the aspirations of Focus unless you're very disciplined about who meets our criteria," says Adolf, adding that Focus has already walked away from transactions that, "quite frankly, would have made us much bigger, but they just didn't fit the Focus partnership model."
What are these criteria? In general, prospective firms must act as fiduciaries, putting their clients' interests first, use a systematic and professional process for advice and planning, and provide services under a fee-based structure. While these firms may offer an array of services, wealth management must reside at the core. Prospective partners are generally required to have a minimum of $350 million in assets under management. According to Adolf, smaller transactions can be executed through Focus partners in the form of sub-acquisitions (the integration of a smaller firm into a partner firm). He notes that as a holding company, Focus cannot perform exit transactions. "Our model is partner firms with accountable partners running the individual firms under the auspices of Focus," he explains. "In exit transactions, there's no partner left, so we couldn't do the transaction." But, as with sub-acquisitions, exit transactions can be made with the help of a partner firm, he says.
As part of the Focus due diligence process, Adolf and his "leadership team," comprised of three senior vice presidents, interview clients of prospective firms, to assess quality of client service. The team also looks into client retention, range of services provided, operational and technology platforms, breadth of leadership, and financial criteria in terms of profitability and growth. "Rudy and his people know more about me than I know about myself," jokes Jill Schlesinger, co-manager of Focus partner StrategicPoint.
While Adolf believes there will be "some level" of industry consolidation, at least one advisory industry observer maintains the merger trend is rapidly accelerating. "Firms are queuing up faster than you can imagine," says the observer. "Kind of like a duck, where the feet are moving below the surface a lot faster than the calm exterior appears."
One reason for this growth, explains Mark Tibergien, a principal at Moss Adams Advisory Services, is today's unprecedented number of well-capitalized buyers of advisory firms. According to Tibergien, prior to the dot-com bust that started in 2000, there were only 25 to 30 consolidators of advisory firms. In terms of the wealth management space, not many of these firms managed to survive-most were undercapitalized-with a handful of exceptions that includes National Financial Partners. (Founded in 1998, NFP consists of more than 160 firms, and has been publicly traded since 2003.) "So what we're seeing today is a resurgence of institutional buyers, like banks, and financial buyers, such as Focus," says Tibergien.
These buyers are not only well capitalized, they possess "pretty solid management and talent within their organizations to drive them," he says. Current interest in consolidation has in no small manner been heightened by NFP's success, notably in terms of how quickly the company went to market following the acquisition of its first 120-odd firms. Tibergien says that Prospective sellers "saw how the aftermarket treated NFP's stock and figured it was a viable model."
It's not all about money, though. While the landscape is appealing for sellers today, the decision to sell is almost never a financial one, maintains Tibergien. The owner demographic creates a sense of urgency on the part of many would-be sellers, and is a powerful driving force behind advisory mergers. More than 50% of advisory owners are said to be over age 50. (For example, a 2003 study by Schwab Institutional and Neuwirth Research gave 51 as the mean respondent age of RIAs using the Schwab platform.)
"Advisors are aging along with their clients, and are similarly beginning to think seriously about funding their retirement," explains Sharon Weinberg, managing director of JPMorgan Asset Management in New York. "In many cases, the value of the businesses they've built will have a major impact on the quality of their retirement lifestyle. A sale of the business allows them to 'take money off the table' and to segue into the next phase of their lives."
Yet while there have been some transactions, there has been a lot more talk than action. Some experts have described it as "a market that's clearing" because most acquirers aren't offering enough to make it worthwhile to potential sellers/
Tibergien also notes many of today's successful advisors who are planning to work for another ten or so years say they don't want to give up ownership. "When business is good, and the opportunities are great, why would they want to turn the upside over to somebody else?" he posits, adding that due to capital flows into the marketplace, there is an oversupply of advisory clients, which, coupled with an undersupply of advisors, makes the advisory niche "quite an appealing business to be in."
But there are compelling reasons to sell, mostly anchored to what Tibergien terms "issues of stress." The issues tend to revolve around a lack of resources-the firms are not leveraged adequately, they may not be in critical mass and they may lack a natural feeder for new business. "Some firms that have grown through referrals are now finding that their referral sources are competing with them," he says.
Then there's the stress issue of having no internal succession plan. The 2003 Schwab study revealed that a mere 20% of RIAs using the company's platform reported having a formal succession plan in place, and the vast majority had no immediate plans to implement one. Succession is not just about ownership succession but about client succession and management succession as well. "When a consolidator acquires a firm, they inevitably will have to address these problems, and they can't be passive about it," says Tibergien.
Another factor, even for an advisor who has a succession plan with multiple inside buyers, is that the intrinsic value of the better businesses is growing at such a rapid rate that the option of selling to the next generation becomes increasingly less viable. The next generation simply lacks the resources to pay for these firms, often putting their owners in a precarious position. Leveraging off a relationship with a financial buyer like Focus, or even using an ESOP [a program under which employees regularly accumulate shares and may ultimately assume control of the company] are ways to help finance the transaction when the successor doesn't have the capital, Tibergien notes.
One of the appeals of a selling firm aligning with a strategic buyer, like a bank, is that the strategic buyer can both enhance the selling firm's deliverable and be a source of business. (With strategic buyers, the prevailing strategy is growth, not exit, notes Tibergien.) A financial buyer such as Focus, however, provides capital enabling the selling firm "to do the things you couldn't do on your own or that you weren't willing to take the risk to do," says Tibergien.
Apart from enabling the selling firm to gain liquidity, the financial buyer enables the selling firm to exchange ownership in a smaller entity for ownership in a larger entity. "There's a size discount that occurs in the valuation of business," explains Tibergien. "When you're part of a larger entity, the multiple that you'll get will be larger. You're betting that if you exchange stock in your company for stock in a bigger company, you're going to get a better multiple on your same level of income."
The catch lies in the assumption that the bigger company will remain healthy and active. "It really takes deft management to be able to navigate through the growth cycle of the business, because you can outstrip your resources in a hurry," says Tibergien. "You can be extraordinarily discouraging to firms who you acquire if you're not able to give them the attention they want." Then of course, there's the danger of making the wrong acquisitions. "Frankly, there are a lot of these acquisitions that are pretty ugly. On paper they look pretty, but when the lights go on, it's kind of scary."
Sources say that Focus was in serious talks with several of the most prominent RIA firms in the business, all of whom ended up backing out when Adolf refused to limit the potential universe of target firms to fee-only RIA businesses. Apparently, the specter of dual regulation by the SEC and NASD, coupled with the potential loss of control over their own destiny, gave these firms cold feet.
Adolf acknowledges there will be many more conversations than transactions. "In the initial design phase, Focus spoke with many independent financial advisors (and industry experts) to get the benefit of their thinking and experience as we developed the partner criteria for our model," Adolf says. "Ultimately, we are looking for firms that act as fiduciaries for their clients - they can be fee-only or fee-based. Clearly, not every financial advisory firm is a fit for the Focus model for a variety of economic, personal or philosophical reasons. Again, some are fee only, others are fee based, but all operate as fiduciaries at the core of their businesses. What is most important for Focus is that member firms meet our rigorous set of criteria and adhere to our high standards that extends well beyond fee structures."
Going public is the way to liquidity for both seller and buyer. Networks or partnerships can be thwarted in their effort to reach critical revenue mass by having as selling partners firms that don't make much money but have a lot of assets under management. As Tim Hogan, chairman and CEO of Commonwealth Capital Advisors, explains, the critical factors for going public are sales volume and rate of increase. "It's not really capitalization or assets per se. Human capital is an advisory firm's real asset. Rather, it's sales and the historical and projected increases in sales that would attract an investment banker," he says.
If an IPO is feasible, selling partners must be clear about what they're receiving in currency, cautions Tibergien. "If someone gets, say, two times revenue, you have to ask, did he get all cash, did he get an earn out, or did he get stock? Because you can only say you got that multiple if you got all cash; if you got terms, including stock, then that's a different story." For a consolidator, a three- to five-year wait before going public is reasonable, says Tibergien, but any longer can create problems.
Going public is an "attractive option" for Focus Financial Partners, says Adolf, "but it is not the only option we have." While the Focus business model creates highly attractive cash flows, he says, it is hard for him to predict when a potential IPO might occur. "There are a number of internal and external factors that influence this decision." According to Adolf, market capitalization at Focus will have to be well in excess of $100 million. He notes that in his industry, EBITDA is the best benchmark for valuation, and assets under management are "certainly not a major determinant of valuation."
As for Focus going public, StrategicPoint's Schlesinger says it doesn't much matter. "I think the people that do transactions are looking for some liquidity event, but are not counting on it," she says. "We're all very patient here. Anybody who is worth anything in our business has the patience to be able to say we'll do it when the time is right. If you just want to cash out, don't do the deal [with Focus]."
Sheldon Geller, co-manager of the Geller Group, which he co-founded in 1984, points out that he has granted incentive units with respect to Focus stock to all his employees, and while he and they would participate in any financial reward that a Focus IPO might bring, if it doesn't happen, he still retains the asset of an ownership interest in Focus.
Worth Any Risk
Because Strategic Point's Jill Schlesinger manages the investments at StrategicPoint, she is accustomed to looking at upsides and downsides. While neither Schlesinger nor any of the other partners will discuss the details of their contracts with Focus, she knows "anything has risk. Our belief was that the risk was greater going it alone; that, in fact, we had a much greater ability to achieve something pretty exciting with this group."
For her, one of the strongest selling points was the Focus consolidation model, which maintains the selling partner's operational ability to, as Schlesinger puts it, "Create my own destiny. And for an entrepreneur, how could you not like that?" She finds it important that selling shareholders can remain "on board" as long as they wish, as long as they name successors. "I envision working for 15 more years," she says.
According to Geller, most other partnering or acquisition models look to take functionality from a selling firm and centralize it elsewhere, or shift clients' asset custody to their own custodian. "Those are really roll-ups," he says, a term Focus and its partners eschew in favor of affiliation. "This isn't a roll-up at all. With most roll-ups, the buyer will want to replace a firm's founders or senior management." With Focus I have the same job I had before the transaction," he says, adding that the Focus model lets the selling shareholders continue servicing their clients on the same platform with the same people and the same fee arrangements.
Like many sellers, Geller became interested in the Focus model because it would "take some risk away" by enabling him to effectively liquefy, and monetize, his 20-year investment in his firm. He finds attractive the ability to take advantage of resources he didn't have before the transaction but can now access through the other member firms, such as financial tools and services, as well as "organizational level" pricing that a growing network of firms can bring to the table. Geller also values the Focus manager agreement that enables sellers to retain a significant portion of their previous salaries with the ability "to replace that compensation over time," and name successors "to take the firm forward as you see fit." This management agreement, he says, is an asset that can be sold to a firm's successors.
That Geller's benefits consulting practice is different from the typical investment advisory practices likely to join Focus gives him an advantage in terms of referrals from Focus partners, with whom he can "cross pollinate" since most don't handle 401(k) or pension plan business but have clients who need those services. Geller Group is already doing business with one of the member partners.
"These are just our humble beginnings," says Adolf, "but already we are seeing some very changeable value-add" across the firms through sourcing technologies, making the best of enhanced negotiating leverage with vendors, and sharing in best practices.
Focus has taken the successful, independent RIA fee-based fiduciary model that exists for thousands of firms nationwide, and is bringing some of these firms together to create "an intensely strong brand," says Schlesinger. "I really see this as a stamp of approval." So, of course, does Adolf. "The Focus name, and over time, brand, stands for quality in fiduciary wealth management," he says. "We believe that there is enormous opportunity to build the brand in fiduciary wealth management." Or as Adolf tells Focus partners: "You ain't seen nothing yet."