There has been a fair amount of talk over the past decades about consolidation in the financial services industry. Most of the white papers and articles addressing this concept have presented it in a negative light as though it signals the end of the lifestyle practices that dot the landscape in this profession. Forced by industry regulation, growth, technology, fee compression, competition, and, of course, aging advisors, this industry must consolidate in order to survive and prosper, or at least that was the working theory.
As the original organizers of the open marketplace for independent advisors seeking to sell or to acquire, we have a slightly different perspective on the consolidation process; we view it in a very positive light. This process looks very different than what the prognosticators laid out decades ago. From our vantage point of working with businesses below about $2B in AUM, the industry is indeed experiencing some consolidation, but it’s not due to acquisitions or roll-ups. The consolidation that we see every day are owners of stronger, sustainable enterprises acquiring smaller, one-generational books and practices about half their size.
Viewed in this light, how better to look after 250 clients or households when a single-owner advisory practice nears retirement than to find a very similarly structured business that can step in, take over and provide for the staff members as well? This process works for the buyers, the sellers, and most importantly, the clients.
As the financial advisory profession matures, practice owners have been compelled to grow and improve—a very natural part of facing competition head on. But, eventually, time and energy begin to wane. As retirement, or even simply slowing down, begins to appear on the horizon for single-owner books and practices, advisors are faced with three common choices:
- Maintain the practice as long as possible while gradually working fewer hours and thereby wind it down;
- Invest the time, money, and resources to grow and strengthen the business and transition to an internal successor team;
- Or sell to or merge with a third-party.
Many advisors tell us that they don’t want to sell to a third-party—ever. The problem is that these same advisors haven’t built a sustainable enterprise of their own, which leaves them with few options, including attrition. Letting a practice wind down slowly, as the founding advisor retires on the job, stops taking on new clients, and stops serving the small ones, is an attractive option for many advisors, as it preserves the cash flow and practice for an additional five to perhaps ten years. If there is a health event during that time frame, the business is not particularly salable since the owner has been scaling back. In time, there is nothing left to sell. Building a sustainable business, however, is the best option if the founding owner starts soon enough (at least ten years prior to retirement) and has the energy and acumen to turn his or her one-generational book or practice into an enterprise.
In our work, we see some very natural divisions in the construction and ownership of independent financial professionals—divisions that help to explain the choices that advisors have as they consider their transition options. These ownership structures fall into three distinct categories: book, practice, and enterprise.
We use the term book to describe the traditional model ownership structure. A book is best described as a single advisor, usually in a sole proprietorship arrangement, who works under someone else’s roof and often splits or shares revenue to cover expenses and to pay for office space, phones, support staff and basic services. While there may be multiple advisors sharing an office, each one is a single book owner. A book is all about production. About 70% of advisors own a book.
A practice is not only larger and stronger than a book, its owner will have invested in office space, at least a small support staff, and basic infrastructure. Practice owners also have set up a formal entity structure, usually an S-corporation, even though there is only one shareholder. Practices are larger than books in terms of cash flow and value. About 20% to 25% of advisors own a practice. Note that books and practices are, by definition, one-generational—without doing something more.
An enterprise is not only larger and stronger than a practice, it is more sophisticated in that it will utilize a professional compensation system that supports a strong bottom-line; profitability is a key to differentiating this level. Profit distributions are used to augment the compensation system and to reward and empower next generation advisors who invest in ownership and create an internal successor team. Sustainability is the key here. Enterprises have already–or are actively working to–establish a multi-owner, multi-generational structure. Less than 10% of independent advisors own an enterprise.
The key differences between financial advisories do not center on size or the amount of AUM, or even value–the difference lies in the structural elements of organization, entity, compensation, and profitability. Book owners simply don’t have the same choices that enterprise owners enjoy.
One clear trend in transactions that we’ve seen over the past two decades is that larger buys smaller; stronger acquires weaker. Consolidation is the natural maturation of an industry whose entire value is derived from professional abilities and personal relationships. If an advisor doesn’t choose to–or isn’t able to–build a strong, sustainable enterprise, then he or she can join someone who has already done so. The result is an advisor who still wants to work for only three to five more years but can still ensure his or her clients and staff members are taken care of beyond that time. Selling to a third-party buyer who is a mirror image of the seller’s practice, but operates a larger, stronger business that can take on 100% of the seller’s clients and staff looks like a much more palatable alternative.
We often use the term micro-consolidation to explain that a business with $250 million to $300 million in AUM is best suited to buy a practice with $150 million in AUM. (Rarely do we see practice owners sell further upstream than that; such deals with consolidators and banks often look good on paper and are tempting, but the cultural differences and the expectations placed on the seller post-closing are often just a bridge too far.) The meetings between the buyer’s advisors and the seller’s clients resulting from this micro-consolidation process offers a real value-add situation, but not something totally different. In this way, smaller but sustainable businesses can provide a compelling value proposition in that they are typically able to successfully transition nearly all of the seller’s clients and over 100% of the associated cash flow on a gross revenue basis measured one-year after the sale.
In conclusion, if you fall into the general definition of a book or practice owner, consider your options and decide at least ten years before your estimated retirement date or goal, as to which path you want to be on when that time comes. Are you poised to be acquired or to be the acquirer? Does attrition make sense after carefully analyzing the other options?
As a book or practice owner, start the planning or thinking process by doing one thing—go through the process of obtaining a formal, third-party valuation of what you’ve built. You’ll learn a lot more than just what an appraiser thinks your value is. You’ll also learn what drives value and what you can focus on to make the most improvement with the least amount of restructuring and work. You’ll also likely come to discover what most of our valuation clients have learned; your business is the largest, most valuable asset you own.