The past several months have been fascinating if you are an independent adviser. Three large transactions have been announced that offer some telling signals about where the industry is headed. To wit:
• Lightyear Capital
bought a majority position in Wealth Enhancement Group (WEG) from Norwest Equity Partners. WEG is reported to have $4.7 billion in AUM and 13 offices around the Midwest.
• Hellman & Friedman
bought a majority position in Edelman Financial Services (EFS) from Lee Equity Partners. EFS reports over $14 billion in AUM and 41 offices around the country.
• Financial Engines
acquired The Mutual Fund Store (MFS) for $560 million. MFS reports $9.8 billion in AUM and 125 locations.
WHAT'S GOING ON HERE?
Since I help run one of the largest national RIA firms, I hear a lot of the industry scuttlebutt. If the information I've heard from several sources is to be believed, then both WEG and Edelman sold for significantly higher multiples than MFS (which sold for a reported 12 times EBITDA). Importantly, both of these transactions were made by private equity groups buying out earlier PE investors. These folks are fastidious investors, so why would they pay so aggressively?
I'd like to suggest that these transactions mark an important inflection point for our industry. There is a major bet being made by big investors. Here are some observations, along with how it might be important to you:
1. Big is good, bigger is better. The prices being paid for these businesses suggest that there is a meaningful premium for having scale. By scale I mean that the existing team has a proven ability to handle multiple location complexity profitably, from onboarding and training to overseeing the operations of a firm with hundreds of employees. This makes firms more valuable to investors because it opens the door to future expansion; the firms are platforms. All three of these enterprises have to expand rapidly over the next few years if they are going to deliver an attractive rate of return to the investors paying these prices. I
wrote about this phenomenon in 2014, but there is now a full-fledged race to create national wealth management firms with over $100 billion in AUM.
The independent smaller firm should expect more sophisticated and well-funded national competitors with resources to invest in better tools to engage clients and more technologically advanced systems and have more media reach than in the past. These firms will develop technology that is scalable for competitive advantage. If you are tired of the Betterment ads on CNBC and the Fisher Investments flyers in your mail, get used to it, because soon you will see big media spends for all these mega firms too.
2. Acquisitions will reach a boiling point. The PE folks at Lightyear and H&F both acknowledged that they intend to use their capital to increase the rate of acquisitions. This will give sellers (smaller independent advisers) more options to join an integrated strategic purchaser. Both of these firms are backed by shrewd investors and, while I suspect they will be quite disciplined about pricing, they will no doubt have quite innovative structures to compete in an increasingly cluttered market.
Of course none of these firms have proven that they know how to acquire and integrate in scale yet, but the equity folks are assuming they will figure it out. What's yet to be seen is whether the new PE investors create a capital structure that penalizes those who take their equity or lets the sellers participate as true partners. These PE-funded firms often have very complex capital structures that protect everyone differently.
3. The end of the cult of personality. It's quite interesting that both EFS and MFS were built on the backs of accomplished media promoters, Ric Edelman and Adam Bold. The transactions occurred with Mr. Bold having given up his role as chief executive several years ago and Mr. Edelman having planned his passage out of the role months ago. The investors believe that these brands have gone beyond the importance of any one person and built companies with lasting enterprise value.
There's a lesson here for every independent firm that is completely dependent on its founder: If your firm is valuable with you in it, it's even more valuable if it can operate without you in it!
INTO THE FUTURE
We all should have mixed feelings as we see the shifts happening around us, I certainly do.
On one hand, I recognize that our industry is maturing and is becoming a far more sophisticated marketplace. However, I also see that these new competitors have the same goal we have: to build a national firm that changes the industry. I assumed there would be several of us, but it's amazing to see the changes unfolding so swiftly. It will be interesting to see how each firm's culture defines its voyage and the impact each one has on the industry over time.
Now the big question for smaller firms is do they brave it alone in a world of larger competitors, outsource and partner with the capabilities of a larger firm, or join one of the big teams?
Joe Duran is chief executive of United Capital. Follow him @DuranMoney.
