In the wake of Thomas H. Lee's $257 million proposed acquisition of The Edelman Financial Group, private equity firms are swarming the RIA space for potential acquisitions. Several sources said Summit Partners had retained Goldman Sachs to explore the sale of Focus Financial Partners, a network of advisory firms headquartered in New York. However, they said that no transaction was imminent and that talks with potential buyers were still in the preliminary stages. But word has it the proposed Lee-Edelman transaction has piqued the interest of private equity investors in RIA firms and other consolidators suddenly are attracting interest from prospective buyers as well.
Focus was launched with much fanfare in 2006 by former McKinsey & Co. partner Rudy Adolf and Summit Partners with the idea of consolidating a network of RIA and other advisory firms in much the same way that Jessica Bibliowicz acquired a network of estate planning, benefit providers and RIAs through her National Financial Partners (NFP). Like NFP, Focus had hoped to create a liquidity event for management, Summit and advisors in its network via an initial public offering (IPO). Adolf did not return several phone calls.
Then came the financial crisis. As many advisory firms experienced 40% to 50% revenue declines between 2008 and 2009, the IPO market dried up and investors lost their appetite for any investments associated with financial services. NFP saw its shares fall from more than $50 to less than $2 a share and spent several months in early 2009 under assault from short sellers.
Though NFP has since righted the ship and shares have recovered to about $14 a share, the once-reciprocal love affair between advisors and public investors appears to be over, as evidenced by Edelman's decision to go private. Edelman shareholders evidently concluded that being a public micro-cap company that traded by appointment was not a particularly attractive option.
Executives at Boston-based Summit, a private equity firm with a strong record, could be reasoning that while retail investors are enamored with the Facebook's of the market, more value-oriented private acquirers are looking for deals with strong cash flow at reasonable prices.
Focus and the various firms in which it owns controlling interest are believed to generate about $40 million in earnings before interest and taxes plus depreciation and amortization (EBITDA). Of that amount, Focus is believed to own about $22 million, with the individual advisory firms controlling the remainder.
Prior to the financial crisis, it was believed a company needed at least $50 million in EBITDA to successfully launch an IPO. After the crisis, investment bankers say that figure is closer to $100 million.
In late 2009, Focus negotiated a second round of financing, raising another $15 million from Summit and $35 million from Polaris Venture Partners. Polaris was believed to win certain rights that might give it preferential treatment, or so-called "cramdown" provisions, in the event Focus stumbled, but this could not be confirmed.
Focus's network includes some of the nation's top RIA firms, including St. Louis-based Buckingham Advisors, Westport, Conn.-based LLBH Private Wealth Management and New York-based Joel Isaacson & Co. But not all of the firms possess the same scale or viability as those three.
It should be noted that other consolidators, notably WealthTrust, have run into more detours on the road to IPO-ville than Focus. At least one firm that was part of the WealthTrust network grew dissatisfied and was able to repurchase itself.
And as this article is being written, several RIA firms are in negotiations to buy themselves back from other acquirers. In previous interviews, officials at NFP, which has acquired more firms than any other consolidator, have said they have sold at least ten firms back to the original owners. Not every marriage works out, particularly in this individualistic world.
Sources said Focus had about $175 million in debt and $80 million in preferred stock, adding that Goldman told potential acquirers Summit was unwilling to take less than 10 times EBITDA, though it was unclear whether that figure included just Focus's $22 million or the $40 million total for both Focus and its affiliated advisors.
If it were the former figure, there would be little or no funds left for common shareholders, including advisors affiliated with Focus. Any acquirer then would need to renegotiate a new deal with those advisors or find another way to deal with its new business partners. But if it were the latter figure, advisors who sold majority stakes in their firms to Focus might be sitting pretty.
Still, sources thought there might be few takers if Summit holds out for the higher selling price. Six years after its initial investment, Summit, like other private equity firms, typically is trying to place a value on the business while looking for an exit strategy. But Focus, like many private equity ventures, has proved to be neither a roaring success nor a resounding failure, as the 2008-2009 financial crisis unquestionably upended financial projections conceived back in 2006.
The upshot is that, like other consolidators and their acquirees, Summit, Focus management, and their affiliated advisors could find themselves together for longer than they expected without a liquidity event. As Humphrey Bogart said to Claude Rains at the end of Casablanca, "This is the beginning of a beautiful friendship." That IPO at the end of the rainbow remains distant.