It’s popular to refer to the stream of trillion-dollar federal deficits funding America’s burgeoning entitlement system over the last decade as generational theft committed by baby boomers against their children. That’s an oversimplification—today’s Social Security and Medicare recipients paid into the systems for 40 years or more—yet it also has a ring of relevance to it.

Attend an event in the advisory world, and it’s not uncommon to hear another generational beef—that the founding generation of RIAs has cashed out of the business at breathtaking speed over the last five years, tantalized by private equity buyers and the huge premiums they offered. In many cases, these deals made the original principals very rich while leaving next-gen advisors as minority shareholders of highly leveraged firms. Some are locked into non-compete agreements that require them to leave the profession if they want to quit their firms. Others are expected to earn their equity by helping institutional investors first repay huge amounts of debt, often issued at highly favorable terms to those same PE investors.

Again, it’s too complex to be called generational theft. Many next-gen advisors have won the opportunity to manage and profit as owners of large firms they never could have acquired with their own resources. Nonetheless, it still represents a massive transfer of wealth, this time from private equity backers to the founding cohort of first-generation RIAs.

For younger advisors and the profession at large, the story is just beginning as the makeover of the RIA world proceeds full throttle. What happens next is anyone’s guess, but it’s clear that outside owners, primarily PE firms, will play an outsize role in determining the business’s direction going forward.

This puts the RIA universe in a very different place than either the accounting or legal professions, which have remained largely owned by their principals for centuries or more and show few signs of changing.

Why has the RIA business captivated private equity investors? Largely because of its recurring revenues, coupled with client retention rates north of 95%. When these investors look at other industries, they typically see companies with client turnover rates of 30% to 50%. That means most of these businesses need to continuously replace a huge swath of clients just to avoid shrinking. In contrast, an RIA firm that loses only 2% of its clients a year can meanwhile expand that roster 5% and get 8% in financial market appreciation, thus generating consistent double-digit revenue growth.

It looks easy. Organic growth, however, eludes most RIA firms, despite the industry’s fast expansion. A recent analysis of the sector’s growth by Tiburon Strategic Advisors estimated that market appreciation accounted for 70% of RIAs’ asset growth while the organic component was only 30%.

And just because clients haven’t left their advisors doesn’t necessarily mean they feel the kind of satisfaction associated with 97% retention rates. Inertia plays a part, too. A recent study by CEG Insights found 14% of clients with $5 million to $10 million were considering switching advisors. Among individuals with $10 million to $25 million, that figure rose to 22%.

Topping the list of client complaints in the CEG study was that advisors had failed to provide comprehensive financial planning counsel in areas like tax and estate planning and asset protection. Though many independent RIAs stress the breadth of their services beyond basic money management, especially when competing against wirehouses and private banks, a major portion of their clients don’t believe they are receiving it.

Older advisors exiting the profession confirm some of these complaints in interviews. Several experienced advisors tell Financial Advisor that since their firms were sold during the pandemic, service levels have declined as the senior partners have pulled back. While the client attrition isn’t alarming, it has climbed noticeably.

This raises several questions. Did the founding partners who bowed out underestimate their own sense of importance, or did they simply do an inadequate job of training the staff they left behind? Or is everyone too distracted by the pandemic and all the money floating in and out of their firms with changing ownership to mind the store?

Liquidity Cliffs
Peter Lazaroff, partner and chief investment officer at St. Louis-based Plancorp, thinks the generation of founding advisors now leaving the business deserved the big exit checks they got. The 39-year-old advisor, who entered the business in 2007, also has little doubt that the older generation sincerely cared about their clients.

But when he attends industry events, he often hears complaints from younger advisors about their debt—and the rewards going to their first-gen colleagues.

It goes beyond just the money. “Some [younger] people feel like their clients don’t know them,” he says.

There are multiple disconnects, and they can be traced to poor planning. Indeed, the foresight of Plancorp’s founders (the firm’s current CEO and chief planning officer are both in their 40s), may be one reason Lazaroff is willing to go on the record when several other younger advisors interviewed for this article asked to remain anonymous.

He says some foundering generation advisors sell because they haven’t hired talent to replace them. But even if they do have the talent, the younger advisors, or their firms, might not otherwise have access to capital to buy in. That’s particularly true among wirehouse reps, who don’t enjoy the prospects of selling their firms at the big multiples RIAs are currently commanding.

Such failures to plan are the root cause of today’s generational resentment. Plancorp, unlike most firms, had a well-structured succession plan in place for several years before Lazaroff joined in 2015. A few years later, the firm developed a robo-advisor, BrightPlan, as a joint venture with a family office that eventually invested succession capital in the firm. Today, Plancorp has 24 shareholder employees, up from three a decade ago.

Lazaroff himself is two years into a 15-year plan, which ends when he turns 52. That doesn’t mean he will retire then, “but I hope my successor will be in the building.”

By 2035, Lazaroff thinks Plancorp could have as many as 50 shareholder-employees. But even with its current base of 24 advisor owners at present, the firm doesn’t face the liquidity cliff crisis afflicting many other firms with concentrated ownerships. If a few partners want to cash out, outside capital won’t be needed.

IPO Pipe Dream Fades
One solution firms often turn to when they want to give everybody a happy ending is to go public. But that’s turned into a pipe dream. For at least two firms, Focus Financial, which recently decided to go from public to private, or CI Financial, which postponed an IPO for at least five years and instead took money from private equity firm Bain Capital, going public obviously isn’t the answer.

Public investors on Wall Street are decidedly less impressed with the RIA aggregation business than private equity is. The fact that a founder wants to cash out simply isn’t a compelling reason for public investors to put money in a business. Moreover, the equity market has rarely liked serial acquirers in any industry.

Former Pershing Advisor Solutions CEO Mark Tibergien has long questioned the logic of IPOs for RIA firms. “Why are firms consolidating?” he asks. “Is it to finance the buyout of the founder? To create continuity of the practice for the benefit of the clients and employees? Is it to build a large regional or national brand? To achieve scale? If so, how would you measure success in each scenario?”

Legal and accounting firms historically have managed to merge and scale their businesses largely via stock-swap transactions that require them to assume only small amounts of debt, which banks have no problem loaning them. “Historically, RIAs have not been balance-sheet-heavy enterprises, since they’ve been able to fund current operations out of cash flow and haven’t needed to rely on debt and equity,” Tibergien continues.

“Why is going public even important?” he asks. As the experience of the handful of RIAs that did IPOs proves, the markets clearly don’t value these enterprises the same way private investors do. Moreover, “most are at such a small market cap that they are not particularly appealing to institutional investors, let alone the public.”

Bringing in private equity, on the other hand, creates an opportunity to increase leverage—and return on equity. Still, leverage can work against a business in a bear market—if the firm has to refinance debt at higher interest rates.

Many wonder what would happen to many of today’s PE-backed firms if stocks were to enter a prolonged bear market, or even go sideways, and interest rates were to remain high. Some have even predicted bankruptcies. A more likely outcome is that original investors would cut their losses and sell their interests to other PE firms, massively diluting their own shares as well as those of advisors.

Future Growth Is Critical
Ultimately, a big part of the question is whether firms can generate the organic growth to create career paths for younger advisors as well as attract outside capital. “We can’t attract or retain talent if we don’t grow,” Lazaroff says.

Yet the most talented young advisors aren’t likely to wait around to become an older advisor’s succession plan. Unless they are tied down by non-compete agreements, they could leave. Even if they do have non-competes, these might eventually be nullified in some states.

Private equity firms are already starting to assert their control. Cl Financial, for one, has (gently) eased a number of CEOs and founders into retirement (some of whom probably wanted to go) and promoted the next generation of leaders.

New issues arise, of course, when you bring in C-level executives from other industries and place them above longstanding advisors, something that’s likely to happen as organizations get bigger. But it remains to be seen if either younger advisors or executives from outside the profession can maintain double-digit growth rates for businesses that are much larger than past advisory firms.

For many firms, staying private probably is a more appealing way to raise capital without having to over-disclose to the public what’s actually happening in the business. That way they can stay out of the spotlight and they’ll face less short-term pressure to produce results, giving themselves time to integrate their diverse operations—and hope favorable markets eventually make the debt manageable.