Many hybrid RIA business structures complicate this problem. Specifically, if a hybrid is a hub-and-spoke business any acquirer must weigh the threat of breakage—that the IARs might leave and take their revenue with them.
The RIA Firm Model
Many of today's RIA firms, by contrast, start with a new foundation, rather than retooling an old one. Owners have a vision for the business they want, and it often means creating an infrastructure to solve succession problems and increase partnership—which allows them to share the success of the organization with those who helped grow it.
What this looks like in practice:
• The RIAs own the client relationships, not the IARs, who receive equity in exchange.
• Advisors own a part of the firm; they are not merely affiliated with it.
• Advisor compensation is a combination of the amount of revenue they produce individually and profit distributions they get from the entire firm.
• Firms are led by full-time executives, not by advisors who are forced to divide their time between operations and revenue production.
• Services are genuinely centralized and integrated.
• When advisors retire, they sell their equity to the firm or to the next- generation advisor.
What advisors lose in freedom and flexibility under this model they gain in having added time to concentrate on what they do best, whether it's working with clients or business development, since others take care of all the operational responsibilities. What's more, they enjoy better support services and, through equity ownership, more opportunity to grow their equity value.
Meanwhile, the valuation process is the same for both hybrid and RIA firms—it's all about earnings multiples. The difference is that breakage is not as big an issue for RIAs (they own the client relationships), while profit margins, for all the reasons mentioned earlier, are far higher, as some of the more efficient firms earn up to 35%.
The Takeaway
For wealth management firms, the two main drivers of value are growth and scale. It stands to reason that RIA firms—which have a more collective and cohesive approach—are poised to deliver on growth and scale more consistently than hybrids, whose affiliations are based on looser connections.
Simply put, when advisors merge in the spirit of true partnership, the whole is greater than the sum of the parts. So with advisory revenue continuing to make up a more significant portion of total revenues industry-wide and consolidation on the rise, it will be incumbent upon hybrid RIA models to evolve.
In the current environment, that may be the only way to maintain their competitive edge and offer what RIAs do—efficiency, simplicity and enhanced equity.
Carolyn Armitage is a managing director with ECHELON Partners, a Los Angeles, Calif.-based firm that provides investment banking, valuation, and consulting services to registered representatives, IBDs, hybrids and RIAs nationwide.