Most independent RIA firms start with a dream of delivering their definition of ideal service in a truly distinctive way. Quite simply, the initial blood, sweat and tears involved with launching an independent wealth management firm wouldn’t be worthwhile absent the satisfaction of seeing one’s unique vision come to life.
But the reality is that every client service model, however unique, inevitably reaches a stage where additional resources and capital are needed to reinvest in the business and continue to drive the best possible client solutions.
And there’s certainly no shortage of potential capital partners for successful RIA firms, with private equity representing the most visible segment of the M&A landscape right now.
Unfortunately, RIA firm owners may not be fully aware of just what a gamble private equity money represents—and that there are better options.
The Private Equity Gamble
First, let’s look at how most private equity transactions are structured: They tend to be nearly all cash (sometimes 100% cash). Most of it is upfront and the balance takes the form of earnout compensation over two to three years after the transaction is completed.
As such, private equity deals will—and should—tempt any RIA owner with five years or less before his or her targeted retirement timeframe.
But for every RIA owner who has a professional horizon with at least another seven to 10 years left, selling to private equity is a gamble that everything that makes your firm unique can endure.
While private equity is not, contrary to what industry alarmists would have you believe, inherently evil, make no mistake: Portfolio companies of private equity firms are expected, first and foremost, to make their owners money. Lots of it.
And when the primary focus is on hitting quarterly numbers, the elements of what makes an RIA unique—including service culture and client focus—inevitably suffer.
Remaining 100% Employee Owned
If we accept that alignment of interest between the firm and the client is key to RIA success, then it begs this question: What ownership model best guarantees such an outcome? For us, the resounding answer is remaining 100% employee owned.
Not only does this approach allow RIA owners to maintain a robust level of quality control over how client service is delivered, it also ensures quarterly financial performance goals never become the tail that wags the dog.
Clients who know their wealth manager prioritizes client service tend to be very happy. And when a firm has a roster full of happy clients, the numbers tend to take care of themselves over the long run.
Strategic Mergers—A Better Solution
Industry pundits who would have RIA owners believe their only real choices are to keep bootstrapping growth on their own or sell to private equity masters are dead wrong.
There is a third way, and it involves identifying and pursuing a strategic merger with another RIA firm whose vision is aligned with yours, who shares a commitment to being 100% employee owned and who is willing to share a seat at the table with you. Those firms are out there.
When evaluating a strategic merger with a like-minded and strategically complementary RIA, it comes down to the following four key details:
1. Defining what successful growth and reinvestment in the merged firm looks like. The best mergers are the deals in which each of the partner firms are crystal clear from day one on what the shared future goals are and the areas of the business where further investment should be prioritized.
2. Ensuring the transaction encompasses a healthy balance of cash and equity in the combined entity. A strategic merger with a like-minded RIA can be compelling if the combined entity offers a meaningful level of true equity in the business for all parties involved.
3. Room to expand equity ownership to other employees who earn it. The equity compensation structure must be capacious enough to ownership opportunities for other professionals who are willing to step up to the plate in the future.
4. Commitment to a truly inclusive and shared leadership team between your firm and the merger partner firm. Only entertain strategic mergers that assume you and your key leaders will be part of the combined entity’s senior management team going forward.
At the end of the day, when contemplating how to grow via M&A opportunities, RIA owners owe it to themselves, their employees and their clients to seek growth-focused deals that focus on creating economic upside driven by client service enhancements and a shared vision for success, versus financial engineering.
Anne Marie Stonich and Josh Harris are co-founders and managing directors of Paracle Advisors, an RIA firm with $1.4 billion in client assets. This May, Paracle Advisors announced a merger of equals with Coldstream Wealth Management, an RIA firm with $4.3 billion in client assets in a transaction expected to close later this summer.