Editor’s note: This is the fourth in a series of interviews with thought leaders on the future of the wealth management industry.
Elizabeth Nesvold, The Deal Maker
Liz Nesvold has been one of the leading merger bankers for the wealth management industry for decades. Over the last 24 years, she has completed more than 150 advisory engagements involving trust companies, wealth managers, financial planners, banks and other financial services firms. An entrepreneur, Nesvold founded Silver Lane Advisors, where she and her five partners have advised on many of the industry’s largest deals. Liz shares her thoughts on how she believes the industry will evolve over the next 10 years and the role mergers and acquisitions will play in shaping it.
Hurley: Looking out at the industry 10 years from now, how many winners will there be and what will be their profile? And what happens to the other firms?
Nesvold: It’s easier to start with the second-tier firms. Many will hit terminal velocity; unless the principals are prepared to reinvest heavily to evolve their firms, they will find it difficult to grow their business, attract top talent and transition ownership.
Hurley: Jeff Thomasson’s “barbershops”?
Nesvold: Exactly.
Hurley: And the winners?
Nesvold: More sizable platforms. The big winners may have $150 million of revenue, whereas midsized winners perhaps $40 million to $50 million.
Hurley: Do you see any small winners?
Nesvold: Of course. It’s such a fragmented industry that there will always be successful firms operating at a smaller scale. They will likely be more specialized with at least $8 million to $10 million of revenue.
Hurley: How many of each size?
Nesvold: There were fewer than 10 firms with more than $5 billion of assets in 2007, and today there are nearly 40. My guess is that number will double again over the next decade. In terms of revenue, there might be seven to 10 firms with at least $150 million and perhaps as many as 50 firms in the $40 million-plus range.
Hurley: And the smaller winners?
Nesvold: Although there will be thousands of small firms, fewer than 200 will have any material enterprise value.
Hurley: What will be the profile of the big winners?
Nesvold: Firms that can attract people, grow organically and grow by acquisition.
Hurley: Can a firm get to that size without an acquisition?
Nesvold: It is possible, but not probable. The math is daunting.
Also, this is not about assets or even revenue. It’s about profitability. Many firms aggregate a fair amount of assets but surprisingly little profitability. It might be understandable if a firm is reinvesting heavily in the business. However, eventually those investments need to start paying off. Moreover, some firms have had to cut fees to scale. The old “we’ll-make-it-up-in-volume” philosophy doesn’t work in wealth management.
Hurley: How many of the firms with more than $1 billion of managed assets today would you estimate do not make much money?
Nesvold: About two-thirds.
Hurley: Wow!
Nesvold: It’s shocking. Some work with ultra-affluent families who have banded together to get Walmart pricing, even though the management of their 25 trusts and 100 accounts is complicated work that requires expensive human capital. Far too often wealth managers underprice their services because they don’t know their own costs.
Hurley: So, what are the future winners going to look like?
Nesvold: Strong regional players with trust capabilities, generational planning and other ancillary services all under one roof. But there are not many firms that can afford to build that kind of infrastructure, and putting all of this together is easier said than done. Even some larger institutions have trouble delivering a holistic service offering profitably.
Hurley: But what about the profile of winners that work with the “millionaires next door”?
Nesvold: To achieve critical mass with a $1 million to $10 million clientele, you’re likely doing it on a super-regional or national basis. It’s hard to gather that many assets in one geography because of competition.
Hurley: These firms will have to run a business in more than one location?
Nesvold: Most likely, which isn’t easy.
Hurley: How many firms today can conceive of doing this?
Nesvold: A handful.
Hurley: An element of self-selection?
Nesvold: It is. It’s often challenging for founders to accept that, while they are great at sourcing clients and are the chief architects of the strategy, there are roles that they are incapable of doing well that require outside talent.
Hurley: Let’s switch to robo-advisors. Your recent white paper was not too bullish on their futures.
Nesvold: It was not bullish on the independent robo-advisor. Companies like Schwab, Vanguard and Fidelity should do quite well. But the market will ultimately look similar to that of the original Internet banks. When billion-dollar brands jump in to offer a similar technology as a bolt-on capability to their traditional offering, it’s a game-changer. Many of the independent robos will invariably be unable to sustain their [cash] burn to profitability.
Hurley: But how will robo-advisors affect wealth managers that service $1 million-to-$20 million clients?
Nesvold: For that segment, not much. Probably those competing in the under $1 million category will feel some competitive pinch.
Hurley: What will operating margins look like 10 years from now?
Nesvold: It depends on how well firms are able to leverage solutions that are available in the market. Part of the profile of the winners is that they will be very good technology adopters as opposed to developers or legacy systems users. They will increasingly focus on their core value added and outsource the rest.
Hurley: What about those firms that have outsourced their asset gathering?
Nesvold: At some point, the pricing [of outsourced asset gathering] will change. So while it can be additive to a business, advisors who are incapable of developing business organically will see their profitability growth slow and eventually even shrink over time.
Hurley: Have most wealth managers figured this out?
Nesvold: Silver Lane’s clients have! We show them the quantitative impacts to franchise value. It’s important for the advisor to recognize that it has to build [its own] value and cannot be entirely dependent on any single source of distribution. Buyers are fairly sophisticated when it comes to assessing these business factors.
Hurley: What drives owners to sell?
Nesvold: For many wealth management deals, it’s demographics. But the savviest of clients often consider transacting long before they have only five years left in the business. They’re thinking about the future, and partnership decisions are more about growth and evolution than about near-term succession planning and monetization. Don’t get me wrong, though, invariably everyone wants some type of liquidity event.
Hurley: How does the age of client bases affect pricing?
Nesvold: It’s a bell curve. Buyers want to see a nice distribution of client aging in terms of revenue. The top of the curve should ideally average out to clients in the late 50s to early 60s.
Not too long ago, we looked at a firm on behalf of a buyer that had both an average partner and client age in the late 60s. Essentially, the clients were aging out along with their advisors. There clearly was value to the business, but the disconnect was on pricing—the sellers wanted to be paid as if they had been reinvesting in the firm and buyers viewed it as more of an annuity that would fluctuate with the market over time.
Hurley: This suggests that acquisitions are more about growth than cost savings.
Nesvold: Unlike bank transactions, wealth manager deals in the $500 million to $2 billion range are more about enhancing growth opportunities than cost savings. It’s about creating more collective value on the revenue side. Invariably, there will be some cost efficiencies in advisor-to-advisor transactions. But you’re not doing the deal because of the efficiencies; you’re doing the deal to enhance the growth trajectory.
Hurley: It also argues that the quality of successors is important and that they have some bargaining power.
Nesvold: No question. Unless the seller has a long lead time in the business, allocating value between owners and successors who do not own equity can be the most difficult part of a transaction.
Hurley: What happens if a wealth manager drops dead and the estate sells the firm?
Nesvold: I have been in that situation three times in my career. It’s at least a 30% discount to where the franchise would have traded, and that’s assuming there’s at least one other client-facing partner and a client servicing team. But in one transaction there was a 70% defection of value because [the successors] held up the estate of the prior sole owner of the business.