Conflicts of interest are culprits in the extreme positions being taken in the debate, he says

March 28, 2011 — 2:10 PM UTC by Bob Veres, Guest columnist

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Elizabeth’s note: RIABiz has compiled the entire Hurley-Veres debate about how to value RIAs on one page. You’ll see how two of the best-regarded thinkers in the business come at this critical issue from two different angles, Hurley suggesting that only a few wealth management firms have the wherewithal to build real value, and Veres saying that the market is prepared to pay for RIAs, and for good reason. Here is the link to the Hurley-Veres Valuation Debate. The exchange is mostly quite civil — but Veres wasn’t shy about pointing out Hurley’s potential conflict-of-interest, and Hurley shot back against that 'concoction.’ The following column is the third volley in their back-and-forth.

Mark Hurley’s response to my article (See: Mark Hurley takes on Bob Veres in round two of the valuation debate) opens up an interesting discussion, because it goes right to the heart of the ancient debate about whether planning practitioners would ever be able to build value in their advisory firms.

I remember back in the 1980s, independent broker-dealers would recruit wirehouse brokers based on the idea that, in addition to the higher payout, they would also own an increasingly valuable business—but at that time virtually no advisory firm had ever been bought or sold. It was a totally speculative argument.

Today, it is still rare for advisory firms to be bought/sold, but the argument doesn’t seem as specious as it did back then—and my article was an effort to help brokers who are hearing these golden promises decide what to believe and what to expect. On the one hand, he/she is told by the BD representative that a firm grossing $1 million might sell for $20,000 or $30,000 for every $1 million the broker could gather in client assets under management (three times gross revenues). On the other hand, he/she hears from Mark Hurley, who says that the firm will almost certainly have no value no matter how many clients or assets the broker might be able to lure in the door.

Interesting coincidence

The trouble with both numbers is that the people giving them out have a conflict of interest. The broker-dealer recruiter might actually believe that advisory firms will routinely sell for three times gross revenues in the future, but this optimistic valuation also, by an interesting coincidence, bolsters his argument that you’re better off (financially, anyway) leaving Mother Merrill and going independent. In fact, if you work out the numbers, the projected future value of the firm offsets the deferred compensation that the broker might be leaving on the table when he/she goes independent. How convenient!

On the other side, if Mark Hurley can convince you that your firm has zero enterprise value to an external buyer, then his internal succession financing proposal looks considerably more attractive (again, financially, anyway). I think he really believes in his evaluation, and has certainly processed a lot of data—but this, too, is convenient from a business point of view.

My point, (See: Bob Veres adds his bottom line to valuation debate started by Mark Hurley) is that a realistic assumption probably lies somewhere in between two estimates, and I offered several reasons why you might be safe projecting $10,000 in business value for every $1 million of client dollars under management.

Speaking specifically to Mark Hurley’s side of the discussion, notice that he’s talking almost exclusively about the sales of larger firms to buyers who were considerably more sophisticated than the sellers. My own view of the future is that there won’t be very many sales to lending institutions or roll-ups. A far more common transaction will be small-to-moderately-sized advisory firms sold to other advisory firms as the profession consolidates itself from solo to multi-planner practices. Thereafter, the sales will be internal succession transactions.

Easy to envision

Truncating this lifecycle a bit, I can easily envision a broker setting up his own firm, gathering $100 million under management, buying a local firm or two and taking on another $100 million for an investment outlay of $1 million, financed over a period of years by the seller. Some years later, when the firm reaches $500 million in assets, the owner might decide to retire and sell his company to five internal successors, each of whom would pay a total of $1 million over a 10-year period out of revenues from the firm.

The advisor’s retirement would include $500,000 a year for 10 years. Assuming a 20% profit margin (which I think is very conservative), the successors would be paying roughly half their firm’s profits to the original owner in the first year, and somewhat less than that percentage as the firm grows in subsequent years. They own the firm outright after ten years, the owner doesn’t have to dip into his retirement portfolio for the first ten years of his third stage of life, and the clients receive seamless continuity of service. Win-win-win.

Mark Hurley makes a great point when he says that many sellers could have made more if they had simply held onto the firm, rather than sold it. This would certainly be true in my hypothetical transaction. But for many advisors, that’s beside the point. The owner probably has three goals, in this order: 1) continue to take good care of the clients; 2) not have to put in time at the office any more; 3) get paid for the value of the firm. Selling to an outside buyer for a higher multiple would certainly compromise goal #1 (ask anybody who has sold their firm to a bank), and might delay retirement while the advisor works to transfer client relationships to the new owner. The scorecard on that transaction: Lose-lose-win slightly more.

Hurley’s report as challenge

I think overall, the Fiduciary Network report did an excellent job of making everybody think about what we mean by practice value, and how we should calculate it, and how the deal terms affect the quality and quantity of the transition from owner to seller. If you’re a broker, reading this, take Hurley’s report as a challenge: when you start your own business, make sure it’s profitable, well-managed and healthy, and look around for advisory firms that are not. They’re great acquisition targets, because you can buy them on the cheap, elevate the quality of operations and management, and ultimately sell those assets for full price somewhere down the road.

You might even end up making something close to what the independent broker-dealer representative said you would.

Editor’s Note: These position pieces by Hurley and Veres were sparked originally by a 100-plus page study covered (and linked to) in this article: What to make of Mark Hurley’s latest prophesy that most RIA firms will go out with a whimper.

Bob Veres has been a commentator, author, speaker and consultant in the financial services industry for more than twenty years. He authored The Cutting Edge in Financial Services (Bloomberg Press, Jan. 2003), and has presented at many of the financial planning industry’s largest professional conferences. Mr. Veres is also editor and publisher of Inside Information, an interactive subscription-based information service for financial planning professionals. Download his controversial white paper at www.BobVeres.com.

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Laura Kogen said:

March 28, 2011 — 10:42 PM UTC

Good points Bob, although I don’t think as many advisors put the clients’ interest first as we’d all hope they would, when considering their own retirement / exit plan. I think one of the key challenges facing founders of RIA firms who are now in their 50’s or 60’s is that very few funding sources (to fund successions and mergers or acquisitions) have entered this relatively small and unknown space. Mark Hurley saw that gap in the marketplace and started Fiduciary Network to fill the funding gap and make a nice return for his investor (Emigrant Bank). Only when more private equity, corporate funding, or commerial lending becomes available, most firms will face one of a few scenarios:
1) seller financing his/her own exit from the firm and succession to gen2 owners
2) mergers or acquisitions with little to no cash out
3) intergenerational succession funding from a source such as Fiduciary Network (which does allow the seller to get cash out)
4) sell to one of the “aggregators” (which usually requires you to stay for some time)
5) sell to a bank or similar (least attractive for your clients)

Because there is no public market for RIA businesses, these are typically privately held companies, and the owners who built those businesses have to make a choice between building a firm with enterprise value that can be sold to future generations (or larger RIA firms), or take the cash out as income every year, leaving little economic value remaining at retirement date. If you don’t plan for this, you’ll have fewer choices.

I’d love to see one of the custodians figure out how to step into this space as an intergenerational funding source. Problem for them is which horse do you bet on?


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