Focus Financial Partners is back on the acquisition trail, but a breach-of-contract lawsuit filed by one of its partner firms casts a negative light on the holding company of wealth management firms.

Launched in 2006, New York-based Focus has bought stakes in 18 wealth management firms with more than $31 billion in assets and more than 600 employees. Its stated value proposition is to provide firms with the technology, back office support and scale needed to grow their business while retaining their independence. The ultimate goal is to attain critical mass and take the entity public, resulting in a hoped-for jackpot for Focus' executives, private-equity backers and member firms.

In mid-November, Focus added its first major advisory firm in roughly a year when it brought Joel Isaacson & Co. into the fold. Isaacson, a leading registered investment advisory firm in New York City, has $3.5 billion in assets and is one of Focus' largest partnership deals to date. Focus typically purchases equity stakes of 40% to 70% in its partner firms.

Around that time, one of Focus' founding partner firms, StrategicPoint Investment Advisors in Providence, R.I., launched a lawsuit alleging breach of contract when Focus executives didn't allow StrategicPoint to fully examine its books.

The lawsuit was filed in Delaware Chancery Court by Progressive Financial Strategies, the management company that operates StrategicPoint. As described in the lawsuit, by mid-2009 Progressive grew concerned about several aspects of Focus' management and operations. For starters, they allege that Focus refused to provide any meaningful information about its continuing acquisitions or its overall financial position. As a result, Progressive couldn't determine the value of its ownership interest.

Additionally, says the lawsuit, Focus refused to disclose the amount of Progressive's ownership interest. Further, the Schedule K-1s provided by Focus listed Progressive's share of the profit, loss and capital as "various."

When a roll-up entity like Focus acquires multiple firms for cash and stock during the course of a year, it's natural for partners' ownership interest to change during the period. But one tax expert intimately familiar with K-1 reporting for private companies says partners typically are told what their stake in the company is at year-end. "When they put in 'various,' you are in trouble," this person says.

"One reason I filed the lawsuit was that I have minority shareholders and I have a fiduciary responsibility," says David Brochu, president and founding partner of StrategicPoint. "This is not a personal issue, it's a business issue."

Among other Progessive concerns: Focus wasn't adhering to its originally-stated guidelines for valuing its acquisitions based on earnings before owner's compensation (EBOC), and was paying higher multiples on EBOC on certain subsequent acquisitions in its quest to reach critical mass.

And Progressive says that recent acquisitions by Focus involved firms that generate a sizable portion of revenue from commissions, as opposed to fees. Progressive believes that sacrifices the long-term stability and value of the entity in favor of a short-term revenue boost.

"When you reach the scale of more than 600 employees, there will always be someone who's unhappy," says Focus CEO Rudy Adolf. "We're dealing with them through the appropriate channels."

Also in mid-November, Focus announced a capital infusion of $15 million from its original backer, Summit Partners, and $35 million from Polaris Venture Partners. At the same time, Focus extended its credit facility by $30 million.

Adolf says that Focus' recent capital infusion--which he says was approved by nearly 97% of its partners and which will help the firm make more acquisitions in coming months--and the recent addition of Joel Isaacson & Co. points to the success of the company's business model.

But there's concern in some circles that this new infusion of capital, called a "cramdown" in Wall Street parlance, could dilute Focus' original partners. That increase in the number of shares outstanding, combined with the changes in market conditions produced by the financial crisis, could possibly lower the value of each individual Focus share.

And with Focus now embarking on what could be another acquisition spree, some original partners may start to fear they are likely to suffer dramatic dilution. And there are concerns, as yet unconfirmed, that senior Focus management, Summit and Polaris will be not subject to the same level of dilution as the advisors who sold their firms to Focus before the recent recapitalization.

Adolf counters that's not the case. "To the best of our ability, whenever we do transactions we structure them in a way that's accretive to all shareholders," he says. "Ultimately, all of the value that's been created is through all of the transactions we've been doing."

How the dilution factor plays out remains to be seen. "If the money isn't used for good, productive purposes, it will be dilutive," says Bob Kresek, managing partner at Founders Financial Network in Cupertino, Calif., one of the four original firms that joined Focus in 2006. "But if it's used for good, productive purposes--just like any other company investing its assets--it ought to accrue to all other shareholders in a very positive sense."