If merger mania isn't sweeping the financial advisory business, interest in it is. That was the message that Mark Hurley, a consultant with JP Morgan Asset Management and a senior advisor with Headwaters AB, a Denver Investment bank, had for attendees at JP Morgan's annual wealth management conference in Chicago in early May.
   Hurley and JP Morgan managing director Sharon Weinberg are in the process ofupdating a study he authored five years ago on the future of the advisory business. "The first ten people we interviewed all asked how much they could get for their firm," he remarked. If an advisor wants to sell his firm, it will probably take from between six months and two years to complete a deal. Most transactions are likely to be legacy deals, or sales to employees.
   "These represent the lowest risk-adjusted prices you will get," said Hurley, a former Goldman Sachs merger specialist who has consulted on a few deals himself. "They (employees) think they deserve the business, they know its strengths and weaknesses and they know you. If it blows up, your firm is shot. It's almost a suicide pact." Furthermore, it's quite possible that employees may purchase firms from the founding partners and flip them.
   If that's not enticing, getting acquired by a financial buyer isn't much better. "This industry is besieged with financial buyers," Hurley contended. "Why? Because there is a disconnect between the public and private markets. They can get $15 for the cash flow they pay you $5 for. The roller-upper adds no value but gets 40% of the economics of the business."
   Additionally, roll-up style financial buyers are under heavy pressure to keep growing faster and faster to go public and subsequently support their stock price. Otherwise, the deal will implode. And it gets worse. The economics of financially driven acquisitions are stacked in favor of the buyer, who typically uses a class of cumulative preferred stock to acquire a majority, say 60%, of the firm, according to Hurley.
   After dissecting the economics of a few transactions, Hurley found some eye-opening details. "A financial buyer will tell you that you are getting a 56% internal rate of return (IRR) for the firm," he explained. "What they won't tell you is that that they get a 118% IRR. They love all stock deals where they put down no cash, keep most of the return and give you all the risk."
   One of the biggest risks for advisors who sell is that the acquirer never goes public, but instead sells in desperation to another financial buyer who dilutes everyone. "To go public you must do 70 to 100 deals," Hurley claimed. 
   If one of those 70 firms turns out to be a rotten apple, it can derail an entire IPO. "You sleep with everyone they (the buyer) ever slept with," he quipped.
   Hurley had one final prediction. "At some point, custodians will have to start buying advisors' firms because they are in a precarious position," he argued. "Big RIAs will be able to cut out custodians."

-Evan Simonoff