There are now multiple ways independent advisors looking to buy, grow, or transition their practice can unlock some liquidity.
What a difference a decade has made for advisors seeking capital.
Even as recently as 10 years ago, those looking for liquidity—whether to transition to independence, monetize a portion of their practice, or obtain capital to accelerate growth—could either self-finance or go to an independent broker-dealer for a nominal forgivable loan.
Then private equity got into the act. According to the latest Echelon Partners RIA M&A Deal Report, private equity investors were “directly or indirectly responsible for 209 total transactions in 2021, or 67.9% of the year’s total.” But with the continued growth of the independent channel, private equity is now just one in an array of liquidity options for advisors in search of capital to offset the loss of unvested deferred compensation, de-risk a transition, access capital for acquisitions, or buy out retiring partners.
Here are some additional options to consider:
Forgivable loans from independent broker-dealers
While not a novel concept, IBDs offer advisors who affiliate with them forgivable loans with five-to-10-year terms ranging from 30% to 100%-plus of trailing 12 months’ revenue.
Forgivable loans from RIAs
Historically, advisors affiliating with RIAs as independent contractors did so with no upfront capital. Now, some RIAs offer a version of supported independence in which the advisor gets a forgivable loan that allows for self-branding and 100% ownership of one’s practice. These loans typically range from 10% to 50% of trailing 12 months’ revenue.
Note that an advisor who subsequently decided to leave the firm would have to pay back the unvested portion of the forgivable loan.
Selling a minority stake to a strategic capital partner while retaining full control of a practice has become one of the more popular transactions in the independent landscape. Strategic partners may include family offices, private equity shops, platform providers—even clients. Here, an advisor typically sells 15% to 30% of their cash flow or revenue in exchange for cash, which will be treated as a long-term capital gain by the IRS.
A variation involves platform firms that offer “drag along” rights to an RIA should the platform have a liquidity event. This gives advisors the option of selling at a much higher valuation than the median 8.99x multiple RIAs achieved in 2021, according to Advisor Growth Strategies’ latest The RIA Deal Room survey. For reference, mega-RIA acquirer Cerity Partners reportedly sold for 20x Ebitda in its announced June 2022 recapitalization with PE investor, Genstar.
Note that in a minority acquisition, even though the advisor retains majority voting and operational control, the investor still has certain veto powers and the advisor sacrifices some of their upside earning potential.
Majority stakes while retaining some equity
National Financial Partners and Focus Financial Partners were the originators of this category. As demand has accelerated, we’ve seen numerous private equity investors, family offices, and RIA platform firms enter the mix. Here, advisors sell 50% or more of their free cash flow for a tax-advantaged multiple, which can be a mix of cash and stock. This can work well for firms looking to transfer ownership to the next generation while still retaining brand and autonomy. As in minority deals, these are permanent transactions so advisors must be certain that this structure makes sense for the long term.
Until a few years ago it was difficult for breakaway advisors to use bank credit to finance their move since those institutions shied away from lending to nascent businesses. Today, Small Business Administration lenders and loan brokers specialize in providing term debt or credit lines for those looking for a working capital buffer. There are also a number of banks and specialty lenders eager to provide financing for next-generation successors and those seeking to grow via acquisition.
Self-financing with custodian soft dollars
The “cheapest” form of financing is tapping one’s personal balance sheet. But this option can be amplified by tapping into “soft dollars” that leading RIA custodians may be willing to provide should a new custody relationship be established. In this case, however, the advisor is accepting more personal risk and needs to be comfortable with the opportunity cost of not taking other sources of capital.
We see in these liquidity streams a true reflection of the maturation and professionalism of the RIA channel. In our view, the variety of capital solutions currently available to breakaway advisors means that limited access to capital is no longer a valid reason to dismiss the opportunity to go independent.
As seen on Barron’s…