Five factors you need to consider before taking the next step
In this day and age of stratospheric wirehouse deals, why are so many uber-productive, high-quality teams forgoing a huge transition incentive check to make the move to independence? While we can all agree that independence offers more freedom, flexibility and control (and for those with true entrepreneurial DNA, that is something hard to put a price tag on), at the end of the day advisors need to understand the economics of independence before they can determine whether it is a viable option for their business.
When looking at the economics of independence here are five key components to consider:
- Upfront Money: In the independent space, transition assistance is designed as working capital, largely to defray the costs incurred in setting up a business and to help normalize cash flow as assets are transitioned over. Transition money ranges widely in the independent broker dealer (IBD) space from a low of 10% of recruited T12 from some of the smaller firms, to deals of 30-40% of T12 from some of the larger IBDS. On the very high end, Wells Fargo Fi-Net and Ameriprise will structure aggressive packages of cash, loans and bonuses that can go as high as 100% of T12 for top individuals and teams. In the RIA space, custodians offer working capital financing and soft dollar allowances for marketing, technology or other infrastructure expenses but they do not offer upfront cash. For multi-million dollar teams that need or want more substantial upfront economics, equity investors in the RIA space such as Focus Financial Partners, as well as banks and private equity firms, will purchase a minority share of a breakaway team’s business, resulting in a significant monetization for the team within the first year. Lastly, there are a growing number of quasi-independent boutiques that deliver many of the benefits of independence, including open architecture, greater control, and less bureaucracy, combined with attractive transition packages that typically include both cash and equity.
- Payout: In the IBD space payout will range from 85-95% depending on the size and composition of the business (transactional- versus fee-based). After additional tariffs payable to the broker dealer and out of pocket expenses are deducted, advisors should expect to see a net payout in the mid 60% range. In the RIA space an advisor starts out with a 100% payout, and then subtracts custodial fees and the costs of running the business, which often include an outsourced compliance function. Again, an advisor should expect a net payout in the low 60% range. Although net payout in the IBD and RIA space are often quite similar, businesses that sit in the RIA space tend to sell for higher multiples since they are not limited by the restrictions – both platform and compliance related – of their broker dealer.
- Operating leverage: In the independent space an advisor, as business owner, captures the operating leverage of his/her business. Typically as top line revenue grows, expenses increase at a slower rate resulting in increased profits dropping to the bottom line. Independent business owners have complete control over their P&L and benefit from the growth of their business more substantially than they could as employees. In an employee framework, the operating leverage of an advisor’s business accrues to the firm.
- Inorganic growth opportunities: In the independent space, enterprise-building advisors typically employ multiple initiatives for maximizing the growth of their businesses. In addition to strategies that drive organic growth, acquisitions can leapfrog the growth of an independent business. Acquisition opportunities arise from a generation of aging independent advisors that are looking for a successor and from smaller independent firms that recognize that merging with a larger enterprise will allow them to leverage greater scale, bench strength and infrastructure.
- Valuation and Tax Benefits: Although the two times revenue metric is widely known as a benchmark for firm valuations, it is not always relevant. Multiples of cash flow/EBITDA combined with other criteria – such as client demographics, firm growth rates and whether a firm is dependent on one key rainmaker – also play into valuation. In broad terms, an RIA with assets of at least $100MM is typically valued at four to six times EBITDA, while larger firms with between $500MM – $1B in AUM sell for five to seven times EBITDA. Firms with over $1B in AUM can see multiples of six to nine times EBITDA. Keep in mind that the sale of a business can be structured to take advantage of capital gains tax treatment, so not only will a top RIA see multiples in the range of 6 to 9 times EBITDA, the sale proceeds will be taxed at a rate far lower than the ordinary income rate.
Clearly the outsized transition money offered by the wirehouses to incent recruitment far eclipses what an advisor would see from an independent model in the short term, yet we continue to see real momentum toward the independent space. (As I write this, a $3.3B Merrill Lynch team in California broke away and went independent with Dynasty Financial Partners and just last week, we moved a father son team in Florida with $1B in client assets from a wirehouse to independence as well.) Advisors who make the leap to independence are willing to take a longer term view, factoring in the accelerated growth opportunities, increased annual cash flow, and tax advantaged “sale value” of the business at retirement.
While an outsized incentive check may keep many advisors in the wirehouse world, there are still many others who are looking outside of their current space for opportunities that better suit their own business goals. Understandably, independence is not for everyone. However, for those advisors who have the entrepreneurial spirit and have looked closely at the economics, the move to independence offers not only the opportunity to build real wealth but also the satisfaction that comes from realizing a dream.