Simonoff: Has it been your experience that there is a whole lot more merger talk on consolidation and consideration of possible consolidation rather than actual transaction activity?
Tibergien: The easiest way to think about it is that there are three types of buyers. There are strategic buyers, financial buyers and individual buyers. The strategic buyers would be the banks and CPA firms. There have been a fair number of transactions involving financial-advisory firms and banks and CPAs. If you look at the true consolidators like National Financial Partners, (Harold) Evensky's new firm, Highland Capital and others, there has been less activity in that market. But I believe that NFP said they closed about 70 deals, and I think Highland probably has done about a dozen or so. There is probably more motion than movement in the true consolidation market. Most of the consolidation has occurred among firms that are more heavily insurance-oriented and have a financial-planning and investment-management capability, but investment-supervision capability is more heavily insurance-agency oriented. The consolidation of pure financial-planning firms has not occurred in great mass.
Prince: Can you define financial planning?
Tibergien: Financial-planning firms would be those that either in a modular or holistic basis do some form of financial-advisory or financial-consulting work for individual clients and probably also have an investment capability either in supervising assets on a fee basis or buying and selling mutual funds on a commission basis.
Simonoff: Do you think the reason there has been more activity on the insurance side is because the prospects of that business are not as bright as on the financial-advisory side?
Tibergien: Perhaps. There are a lot of things that drive decisions. The biggest one may be the issue of control. The idea they might lose control is a real inhibitor. Secondly, finally financial planners are making money. Their belief is their income-generating capability is growing, and so they are hedging their bets. They don't know if they want to sacrifice that income now for giving up any degree of control in the practice.
Hurley: Isn't it also an issue that there is really a supply of clients who seek the demand for them? If you are sitting in the chair of one of these successful advisors looking at this, you are thinking, "I have no problem getting clients." The problem is getting a 48-hour workday.
Tibergien: A valid point. Clearly, for anybody approaching financial planners or advisors today, they have to be able to offer something notable to the acquiree. In some cases, they are not worried about clients. In other cases, they worry about not having the right types of clients. You hit on it. If you can't impact them positively from a revenue standpoint, you can't make a notable impact from a cost standpoint, you really can't help them in branding of the market positioning in a meaningful way, what are you really offering?
Simonoff: Whereas if someone has a high-end insurance business, and you look at the overall trend of insurance sales, flat for over a decade, and ...
Prince: Back up. Life-insurance sales have been flat. At the high end, they are booming. If you look at the high-end producers, you get a whole different picture.
Hurley: What happens if the estate taxes go away?
Prince: They will make a fortune. When you talk about business succession and things of that nature, buy-sell agreements, deferred comp, etc., they are not going away. If you look at the creation of wealth in this universe, more policies are being written for estate creation for people who see themselves projecting great income going forward and want to create a lifestyle. The other catch is that the current proposal [repealing the estate tax] has it going away in 2010. It will be stretched out.
Tibergien: You never know after this election.
Prince: Every time they touch tax laws of any significance, it is a revenue opportunity for advisors in the short term. It is how you define it. Are you putting those people in the same buckets? How about the ones that do the pension business?
Tibergien: I would suggest you have to stratify it. I would suggest there is an enormous number of people in at least one group who, if you describe their business from an economics perspective it would be they sell insurance policies to people with more than $1 million net worth to avoid estate taxes. Today, many of those people have $2 million to 3 million net worth. Life will become more materially entertaining for those people.
Prince: I don't see the negative. Companies like Lockwood and SEI, who have made their success keying in on a lot of insurance-driven financial-planning firms or insurance-background financial-planning firms, give them a turnkey product to go into the money-management business.
Simonoff: If there is a big change in estate-tax laws, aren't these insurance-oriented firms going to be driven to try to make more from their money-management operation than in the past? They will be looking for diversification away from second-to-die insurance.
Hurley: Everybody is looking for diversification. It is also a function of the fact that stockbrokers are becoming much more proficient at selling insurance. It is not estate tax that is driving that decision in and of itself. Everybody is filling in other areas. I work with all sorts of insurance professionals who are all over the street as far as what they offer ? everything from alternative investments to various tax-efficient investment strategies. We also are seeing coalitions being formed with groups who don't feel their first and foremost competency is to be the insurance expert. Coalition warfare has started. I describe this as the seventh-grade hop. All the girls are on one side and all the boys are on the other, and everyone is watching each other.
Tibergien: There is an issue here that both Russ and Mark are touching on. I think the Undiscovered Managers report on the future of the industry hit on a point that hasn't been apparent to others. That is, since everybody is trying the same strategy, they have to be thinking what is an alternative strategy so they can find their space and their market. Reality is that, based on our survey on financial performance of financial planners, it is pretty clear the economics of financial-planning practices are changing dramatically and poorly. The cost of doing business is rising much faster than I thought was the case. At the same time, margins for assets under supervision are being compressed and productivity is getting hurt. One of the oddities of this business is that, by the nature of what financial planners preach, your theory is that diversification is good. While that is good in investment allocation, it isn't good in small business. You have finite resources to allocate over different activities. If you only have $1,000, there isn't a whole lot you can diversify with from an investment standpoint. One of the compelling arguments for considering consolidation, maybe not on a national basis, but on a local or regional basis, is the power of numbers.
Hurley: I read the study Moss Adams did for the FPA. I think anybody in this business who hasn't read it needs to. In no uncertain terms, it quantifies just how vulnerable the business is. The issue, though, is: Will it be very consolidated at one end and be very fragmented at the other? A lot of these decisions are not being made under completely rational reasons. When I worked at investment banks for many years as part of a group that was involved in merger transactions of money managers, the high bid almost never won. Like advisors, many money managers were on a mission from God. Many advisors had started these businesses. They wanted to go out and deliver advice in a way that was in the best interest of the client. These are people who built businesses. I can't overemphasize how powerful the research is and that such a choice may not be there any longer. They may want to remain independent and do what they want to do. If they are making $200,000 a year, a modest decline in revenues and increase in expenses could change the economics radically. It's not out of the question for many firms that the proprietor will make $50,000 a year.
Tibergien: The real challenge today is moving from being a practice to being a business. That is conceptually very difficult for many professionals in the business. There is an allegoristic vent to many of the practitioners. There is the theory that they are not in it for the money.
Simonoff: But if they can earn a decent living and save for their own retirement, is that so terrible?
Tibergien: When you look at not being in it for the money, that also means you don't have the resources to effectively compete. That is the biggest challenge. How am I going to distinguish myself from the rest of the noise?
Hurley: One thing that makes an eerie parallel is when you study this industry versus others is the delivery of health-care advice. Fifteen years ago, you could be a general practitioner and make a very nice living and if you interviewed them, they said they wanted to practice medicine a certain way, and patients are most concerned about their health, and money will not drive their decision on how they do anything. Today, there are three people left in that business. There are those who own very big HMOs and the smart ones have sold them. Yes, you don't go to the low bidder for brain surgery, but there are thousands of doc-in-the-boxes. There are general practitioners who make $50,000 to $60,000 a year, despite eight years of medical school because they are part of an HMO or PPO.
Simonoff: Do you think something similar to that could play on this business over the next 10 or 15 years, even if it is not the HMO or managed-care phenomenon?
Hurley: I think exactly that will happen. If I were running a financial-planning firm, one of the things I would be looking at is, "How do I recruit some of that well-developed technical talent into my organization to increase capacity to serve clients?"
Prince: My turn. I don't think you need to build an organization the way you are describing at all. I would like to know what the definition of "dominate" means. If your criteria for success is the ability to service clients as competently as possible, that is hard to evaluate.
Hurley: It doesn't matter if you do it. It is how they perceive it.
Prince: Right. We will take that off the table. The next criterion is how much money they walk home with in their pockets.
Tibergien: The point is that is a choice that every practitioner is going to make. The truth is that most people in this business would rather be sole practitioners. It is probably no coincidence that everybody feels they should be, as well. By nature, it is a challenge to work with people who would rather be alone.
Hurley: Thousands will do that.
Prince: Some of those folks can be exceedingly successful by the criteria I am using. It is if they can outsource most of this back office, which I believe can be done; people I know are doing it. And if they can leverage their vendors with support services, they don't need to have all that infrastructure talent. They do need to build a relationship-management organization. They don't have to build the back office.
Hurley: You also cannot provide a generic service. I would argue that a financial advisor or investment manager does not get paid for giving financial advice. They get paid for solving problems. There could be literally 1,000 of these guys out there doing this and have very specific expertise analogous to an eye surgeon or a cosmetic dermatologist in the medical field, who people are willing to pay a premium for that service. The challenge is how to identify this niche and stake out a position. It is not enough to have the expertise but to have that perceived expertise that people are willing to pay premium price for.
Prince: There will be a whole slew of financial advisors with sole proprietorships, and they will target the total net-worth market of $1 million to 10 million; that means that their clients have a limited search cycle going every time they need services. It also means they have a limited ability to evaluate advisors. They have a limited set of resources to work with. There are only so many things you can do with certain amounts of money available. If their advisors can leverage somebody else's set of services and private-label them, they don't need to consolidate, and they can have a very successful practice. They don't need to build infrastructure and can manage the cost structure much better if they are taking that strategy and actively pursuing it, which they don't think to date very many people are doing. The resources are available to them.
Hurley: You are making a really critical point that was misinterpreted out of our paper. This allies-and-enemies point, today advisors don't recognize that they should demand more from their vendors. In fact, not only can you sell product if you are a vendor in this industry, you can be a direct competitor with the advisor, and the advisor will continue to blissfully wander along and subsidize their own extermination by the direct competitors. The smart advisory firms will recognize this coalition warfare and a big part is whom you pick as your vendors. However, the fundamental question is not whether they survive. It is their prosperity.
Prince: Using whose definition? I like mine.
Hurley: How much money they make. That is simpler. You can extract immense amounts of resources from everybody around you, and there are firms in that business that have $1 million to $200 million under management and the proprietor does not get a paycheck. How large do you have to be even as a small firm so that the proprietor can pay his bills? The notion of the $5 million practitioner and the $10 million practitioner, I am skeptical of that group. The big guys will be these monsters. The small person will be stopped at $10 million. There will be a lot of firms at $100 million to $200 million under management that won't make a lot of money. There will be niche competitors that will have $500 million under management, and the owners will make millions of dollars. Then there will be guys who start these big companies.
Prince: I see more players being very capable of bringing in a few hundred million dollars. They manage that through third parties or subadvisory or outsourcing. They do that by leveraging vendors and creating alliances with other providers that have more of a variety of services, and they walk home with a few million dollars every year. They still can keep a very small, tight group. I know a lot of these firms, and I see a lot of them persisting.
Hurley: Don't you view technology as commoditizing the treatment function? You don't go to a doctor to get good medicine. You go to a doctor to get well. You don't go to a financial advisor to get good financial advice. You go to a good financial advisor to get problems solved. Two years from now, it will be a pure commodity, and small firms will be out there, but they will need to go up the diagnosis function. How do you help someone, like in the case of Janet Briaud down in College Station, Tex., who built a business that works with college professors because her expertise is the intellectual-property rights area. There is a guy in the Northwest who works with McDonald's franchisees as an expert. He understands all the complex issues there, so the advice is very customized to the problems.
Prince: You have to understand your client. There is no way they can understand every type of client. You are saying I end up focusing some expertise across a smaller range, creating brand within that select universe, and I can be extremely successful if I outsource without having to be a monster huge business. My definition of success is what I walk away with in my pocket, after my expenses but before taxes.
Tibergien: The sole practitioner will always make a living but will never make an impact. The reason I say that is because the most common refrain you hear from sole practitioners is they don't have the time to manage their business and serve clients. One of the benefits of having numbers is that you can begin to create some sort of an infrastructure to help you to be thinking about how you run the business, not just reacting to opportunities. It is not to say there won't be some examples of sole practitioners who figure out a niche and exploit it. It is a bigger challenge when you don't have time to service new clients while servicing old clients. If you decide to be a sole practitioner, the key to having the kind of income standard you are talking about is finding that market and becoming the best at it. Being a generalist would be like what has happened in the accounting profession. If you are a $5 million CPA firm today, it is very hard to compete, and that is what is forcing the consolidation.
Prince: If you move beyond the sole practitioner, you can run a medical group as a business. Others are managing clients, but how can you make that profitable without having to be enormous? Every research study I pull out says there is an 80/20 rule in the industry. It is 90/10.
Hurley: That is valid. There are certain practitioners who have figured out how to distinguish themselves, but it is a lot of work.
Simonoff: There are a lot of people going out to hire outside CEOs.
Hurley: The guys going from mid-sized to big have recognized that the core competencies of a CEO tend to be recruitment, training, infrastructure, technology and capital. The proprietors find the things they like least to do are infrastructure, technology, training, recruitment and capital. In the case of one shop in Atlanta, they hired a senior exec out of Eli Lilly. There is a gentleman on the West Coast who has hired a senior exec out of Schwab. They are hiring professionals to run that aspect of the business. That is not generally for the small practitioner.
Prince: You have to make it a business. There is a big spectrum of how much you need in that business to make that business successful, which does not always correlate to assets under management.
Tibergien: It does correlate to how much income is adequate so you can achieve your own financial-planning goals. For a number of practitioners, they are very far away from that. It also has an impact on the big question, and that is: Does my practice have value? The point is there is a big difference in value between a book of business and a business. If they are content with keeping their practice in managing a book of business, then they are realizing the value on a current basis but are not building equity. They have to recognize that in this process.
Hurley: A dominant competitor is someone who competes on the ability to deliver the low-cost producer of the generic product so they can offer a lot more and do it for a lot less and still make money. The two key things are operating efficiency and brand. Operating-efficiency studies and research show that even generics will need to find a lot more operating efficiency. Back to the medical analogy, 15 years ago, you used to see a doctor who would draw your blood and take information from you. Today you have support staff leveraging the time of the professional. Today, you see 15 patients a day and you don't even pay your bills. The issue of brand is in some cases even more important than operating efficiency. If you are trying to offer something at a premium price, which is what a specialist is trying to do, you have to be able to deliver value added and have the perception that you deliver that value added. Brand is three years down the line that no one has had to think about yet.
Simonoff: There aren't too many firms in this country with brand identity when you go below the Schwabs and Merrill Lynchs of the world.
Hurley: Northern Trust.
Prince: A selective universe. I will give one that I like a lot, my CFO is tremendous, and people outside of Silicon Valley don't have the faintest idea.
Hurley: But there is a lot of new wealth in Silicon Valley they are targeting.
Prince: Who is their target audience and who can they service? I am in New York City and some guy in California calls up, is that relevant to me? For some people, it won't be, and others would rather the brand be local.
Tibergien: The challenge I would offer here is the assumption that everything has to be defined by market. I think for many practices, their whole positioning and driving force may be something entirely different from the market. It may be a technological advantage. It may be service expertise. They may decide to be a generalist. They may decide to be market-responsive. The issue is what kind of organization will they create, and where can they focus their resources? If they can learn to concentrate the resources in areas where they can make the highest impact, they can win. If they think in those terms, I think they can create a higher impact on their income and productivity. Right now they allocate resources among too many different choices.
Hurley: Anybody who thinks they can plan a strategy that will last for the next 20 years is kidding himself. I think strategies for the next five years are getting toward the end of the horizon. Big businesses change their strategies as they evolve. I think that is true. I would go to the fundamental question of what is controllable. One is defining where you can concentrate resources, and the other is where will you be most productive. In most small practices, it is really a question of not diversifying too broadly so you get no return on what you are doing.
Simonoff: What you are seeing is senior advisors partnering with younger advisors who become partners and eventually take over the firms.
Tibergien: Through history, more than 70% of the transactions of practices have occurred that way. The seller has found a successor internally to make that transition. It is the most practical and easiest to control. I think you will find much of that. When you are negotiating with a consolidator or even a strategic buyer, that is not an exit strategy. It is a growth strategy. The only exit strategy is when you sell and get out. Otherwise, you are committed for the long term and that long term could be at least five years. That is an important distinction.
Simonoff: Assante is pulling way back, and it turns out they went public much too soon. Their stock did not do what they expected. It dropped about 50%. It became an issue with many leading principals. They decided to slow down their acquisition pace, partly because they would have diluted themselves if they went ahead with deals.
Hurley: Any time you take currency other than dollars, you are at risk. That is one of the things that occurs. There is no roll-up strategy in the history of time that has worked if it hasn't been quick and hasn't been well-capitalized. If it hasn't improved the basic operations of the business, it doesn't work. What complicates this business is that it is not like rolling up muffler shops. You are talking about people. It is much harder to systemize the way in which people do business. The thing that inhibits an organization like Assante and others is they haven't found the unique selling proposition. There hasn't been the compelling issue that says the average financial advisor should go for it because economically this will be better than what they are currently doing. Would you buy that stock if you were buying it on the open market versus a change in ownership in your business?
Simonoff: Some insurance offices are quite successful and quite profitable on the financial side.
Prince: I ask them how the deal will make them more successful today. Then they say about going public and throw in the stock. Let's say you don't go public, how are you going to be more successful today by being associated with this organization than you are going to be if you stayed by yourself?
Tibergien: That is the right question all the time.
Prince: They cannot answer that question. They tend not to do a deal.
Hurley: There is a new model that is emerging. It is the strategic-growth partnership model, which is raising an enormous amount of capital and they own a smaller piece of a larger business. But the value proposition is investment of $1 million to $2 million of resources just into your particular part of the business, as well as in the business as a whole to change the model. These resources will allow you to grow much larger. The fundamental business is not giving financial advice; it is getting paid to give financial advice. Most of these organizations have never had marketing forces. Most don't have enough capacity even if they did. To create that will require a lot of capital.
Tibergien: That again points out that consolidation is a growth strategy and not an exit strategy.
Prince: They are thinking of exiting when they call me. It is easier to consolidate where MBAs are talking to MBAs as opposed to advisors talking to wealthy people. It is easier to consolidate on the corporate side around insurance and high net-worth side.
Tibergien: The whole idea of consolidation might make more sense if they took a regional strategy. We find in most service businesses that if you are one of the top three firms in the market, you will get twice as many opportunities than the fourth one. It is very hard when you look at consolidating practices across 50 states and hope to make an impact. It is tough, even with technology. It's expensive to create the branding to do it effectively nationally.
Prince: I don't think you will brand nationally.
Simonoff: There are people I know who are merging with another firm in their area and trying to build a real strong regional firm. Greg Sullivan is expanding and trying to create a regional firm without merging so far.
Hurley: They are trying to build the Montgomery or Robbie Stevens of that region.
Simonoff: That seems like a more realistic strategy than trying to go national.
Hurley: Initially, it is more controllable. It is one where they can create a higher impact more quickly. It works for them. They look at it in terms of the market opportunity and competition and their own definition of success. It becomes clear that they can see the D.C. area presents an opportunity. If you asked an advisor, "Can you name the top 10 financial-planning firms in the community?" you will find that most planners struggle with the answer. That paints a picture that says there probably is an opportunity to create dominance in the segment of the market.
Tibergien: Traditionally, the national firms are national because the economies of scale of being bigger provide marginal value. This is a high-touch individual business, and one of the great things to watch is whether you create a dominant regional competitor, and whether there is that much marginal benefit to being a dominant national competitor.
Prince: If he really achieves what he wants to regionally, there will be a bid for him.
Hurley: An enormous bid.
Prince: I think they will get a bid out before they show up at that level. There will be somebody bigger who will offer a tremendous amount of money.
Hurley: Having worked at a very large investment bank, the real loony bids occur when very big organizations that have to be in a business and have tried to build it and have failed decide they have to become strategic acquirers.
Prince: Banks.
Hurley: German banks.
Tibergien: Also known as greater fools.
Hurley: Where do they start going through the roof? I helped sell RCM to Dresdner, and that company went for more than 20 times cash flow. You are talking la-la land. Those prices only occur when the acquirer perceives what they are acquiring as strategic to them. For very big organizations, for something to be strategic it has to have some material in excess of $25 million EBIDTA.
Prince: They are still going to get offers along the way.
Hurley: Anyone smart enough to build a firm like Greg is going to do will make so much on a current basis that it is not as though they will be clipping coupons on weekends to pay the rent.
Tibergien: The beauty is that they can build a firm that gives them the flexibility to walk away.
Hurley: That is what is appealing.
Prince: I think the term "consolidator" is thrown around too easily, and there are too many different people trying to do different things that all get lumped under consolidators. Can you become profitable and successful and have the lifestyle you want and do it well and have a great time and be somewhere in between a sole practitioner and clipping food stamps?
Hurley: The answer is yes, if you define your focus.
Prince: We all agree on that. If you turn these into small businesses, they can be very successful at different levels doing different things. We are back to my 90/10 numbers.
Hurley: The other element that is traumatic to people is that these entities have been in a business where there really has been no risk. There has been such a supply of clients that if you are half competent and work hard, you have almost certainty of success. The advent of competition appearing on the horizon is that there are no riskless choices. I can remember talking to a very sophisticated advisor that was very large, and we were talking about the alternatives and he said, "You are telling me there isn't a right answer." That is exactly right. If you are wrong, you lose a lot.
Prince: There are a lot of wrong ones. There is more wealth being created than ever in history. There still will be an onslaught of clients. But the point being that the number of competitors is growing at an exponential rate.
Hurley: This is a fabulous business. Anyone who looks at it and sees only danger is missing half the picture. This is an opportunity of a lifetime. Very few organizations have staked out these specialty practices yet. There are even fewer organizations trying to build dominant regional or national competitors. The people who succeed, quite frankly, will not be the ones who give the best advice. They will be people who are the best business people. Many functions advisors attend a few years from now will see people who have made $200 million to $300 million and wonder how that idiot ever pulled that off. The people we talked to, 1% see the opportunity and 99% see the danger. Those seeing the danger are like deer staring into the headlights of a car.
Tibergien: If you look at the history of the financial-planning industry, it isn't that mature of an industry. It has been dominated by sole practitioners since the beginning. It is really an evolution, where people are beginning to recognize the business issues. The reality is that the ability to fulfill their own personal financial wishes or goals is limited by the decisions they make in the business. They are affected by time management, capacity, keeping up with technology and improving efficiency. Part is because they are bombarded with so many ideas on how to market, brand, get more clients etc. When you are trying to focus on servicing clients, making business decisions about these kinds of things, that is what becomes the biggest challenge
Prince: That is a revelation for many.
Simonoff: Don't you think more people are conscious of this?
Hurley: Advisors are falling into two camps. A very small camp of people who see this as an unbelievable opportunity and another who say we are right, but I don't want to do it now.
Tibergien: That is why they get pushed into the arms of other people.
Hurley: Their choices are the broadest that they will ever have. There will be fewer choices for these firms as time passes on.
Tibergien: Many I talk to are saying they don't enjoy managing a business. They don't enjoy running a business. I think they are forced to consider some kind of a partner. They need somebody else to help them make that decision if they want to grow their income.
Hurley: If they want to keep their income. For people giving financial advice to others, most have no financial plan for their own retirement.
Tibergien: When we are doing consulting on the sale of a practice, that has become a common question. Can you afford to retire? You would be shocked at the number of people who are counting on the equity of their practice to bail them out in retirement.
Hurley: These are practices not with $10 million or $25 million. These are practices with $200 million to $500 million.
Prince: Not to depress everybody.
Tibergien: That is the wake-up call. For many people, there is an opportunity to do something different. The issue is what decisions would I make for the success of this business, just like they recommend to their clients. That is a major omission in their own personal financial planning.
Hurley: If you went to see the CEO of a company and you were thinking about investing in their company and asked who their clients were and what their market share was and so on, the CEO looks at you and says he never thought about it, that they just come through the door. You ask how they plan to sell products in the future and he says we hope they keep coming through the door. You ask how they will change what they make so people will buy it in the future, and he says he has never had time to think about it because he is too busy with people coming through the door. You ask who their competition is, and he says we never thought about that. Many advisors have put over half their net worth into such an investment.
Simonoff: A pretty big wake-up call.
Hurley: Many will be content in their own little world. That is OK. If there are individuals in this business who are interested in growing their practice and achieving personal goals then it is time for them to dust off their business hat and think about this difference. If you examine what your choices are and recognize that you don't have the resources in people, skills, money, energy then you have to figure out how to get them.
Simonoff: People find somebody to help them get some efficiencies of scale or start to specialize.
Hurley: The first step is to define what your driving force is for your business. You have to answer the question of what you want that business to be. You have to look at that from the perspective of the marketplace and competition and your own capabilities and personal definition of success. If you evaluate your options and they are very local and you start thinking about what your business will look like, the strategy will become clear what you have to do. You have to start asking the basic strategic questions that you should take the time to do.
Simonoff: A lot of people don't even want to go there. Well, thank you all very much.