When they begin thinking
about their endgame, the largest firms may not be able to find a buyer within
their own broker-dealer network
June 2, 2020 By
Louis Diamond
An
interesting trend is developing among the largest and most successful
independent broker-dealer practices. They are essentially “growing themselves
out of the market.” That is, their practices have gotten to a point at which
there is not a viable successor within their broker-dealer network.
It’s a
high-class problem to have — one that we see at every IBD when the top 5% to
10% of individual practices (typically those generating in excess of $3 million
to $5 million of gross dealer concessions) reach a point where they begin
thinking about their endgame and how they will monetize their life’s work.
Typically,
advisers running independent practices would opt to sell within their own
broker-dealer as it’s the path of least resistance: Buyer and seller operate on
the same platforms and systems, typically have compatible businesses and are
familiar with each other on a personal level. Also important, an internal
transaction eliminates the need to change broker dealers, which triggers a
time-consuming re-papering event that is sometimes risky — especially at a
point when a business owner is trying to simplify his life.
But
there’s a catch: An intra-broker-dealer transaction isn’t always possible.
One might
think that the largest and most highly regarded businesses should have their
pick of buyers, yet that’s not always the case. We often find five key factors
limiting a business owner’s internal options:
1. Sophistication
and scale. In most M&A deals, sellers prefer aligning with a larger
entity because they typically have refined processes, institutionalized
businesses, a bench of next-generation talent and a demonstrated aptitude in
operating successful businesses. Since the top producers are in rarefied air
within their broker-dealers, there are very few (if any) practices that meet
this requirement.
2. Capital. Even
with COVID-19 altering the valuation landscape, top firms still expect premium
multiples and the majority of a purchase price paid at time of closing. As a
result, intra-B-D buyers will often lack the capital and risk appetite to
finance a transaction (even in cases where debt financing is available). This
means internal buyers require a “seller-financed transaction,” in which
retiring advisers, in essence, pay themselves out of their own cash flows or accept
a lower overall valuation.
3. Bandwidth. Many
compatible buyers are at capacity already, so they do not have the ability to
take on additional relationships.
4. Limited
supply: Regardless of the quality of an IBD, there naturally exists
a finite population of affiliated practices — especially ones that operate
compatible businesses and are located within a specific geography.
5. Incompatible
runways: Even if there is an ideal match, the top firms within a
broker-dealer are often in a similar place in their business life cycle and may
be looking for a succession plan themselves in the near term.
So when
it comes to identifying a succession plan, what are the options for these
larger independent firms? There are six paths to consider:
1. Sell within their B-D. As described above, this may lead to a less-than-ideal succession plan or deal structure, but if the conditions are right and there is an appropriate fit within the IBD, then it makes for a more comfortable and seamless transaction than may be found with external options.
2. Sell
within their firm. An internal
sale could mean promoting from within or using the carrot of
succession to recruit from the outside. Though this raises a question around
liquidity: How does the buyer access the capital
needed to fund the transaction? Plus, finding the perfect fit
is often difficult as most firms do not have suitable next-generation team
members in place, and external recruitment is far from a guaranteed result.
3. Sell to a
practice at a competing B-D. This path opens up
the field to additional succession partners and may enable the seller to “move
once and monetize twice” — a process by which the sellers can get an upfront
recruitment deal and monetize their practice. However, this strategy requires
the investment of the effort to transition and re-paper, and if it’s not
executed properly, could put the eventual monetization event in jeopardy.
4. Sell to
an RIA. By opening the field to RIA acquirers, larger practices can
exponentially increase the universe of potential buyers, leading to more
attractive valuations and deal structures, and a higher probability of finding
the best possible succession plan. The downside is the need to transition,
re-paper and take on transition risk.
5. Sell a
portion of the business to a financial buyer. Private equity sponsors,
family offices and even broker-dealers have demonstrated interest in buying
into quality wealth management firms. This type of buyer may take a minority,
passive stake in the company or offer up more of a strategic angle by helping
the firm to acquire, recruit or expand its service offerings to clients. Such
buyers also solve for valuation and capital challenges, and typically will
enable a retiring adviser to retain his brand, business model and
organizational DNA. However, these organizations typically do not have a bench
of next-generation successors ready to take over, so factoring in extra lead
time prior to retirement may be necessary.
6. Do
nothing. The wealth management industry is one where many business owners
choose to continue working well past the typical retirement age. Sticking
with the status quo is what some prefer as it enables them to
retain their equity and annual income into the future and does not require the
hard work of transitioning a business to the next generation. Of course,
leaving clients without a continuity plan is fraught with its own moral hazards
and is often the option of last resort should all other possibilities fail.
Any
succession plan requires a thorough self-assessment, due diligence and a good
deal of flexibility. Yet larger IBD practices are often asked to give up even
more than their smaller counterparts when selling to another IBD within their
network and risk compromising what is best for their clients and their own
retirement. The beauty of owning a business is that the principal can choose
how he wishes to solve for succession, as well as what is most important to
accomplish in that transaction.
Louis
Diamond is executive vice president and senior consultant at Diamond Consultants.
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