You don’t have to look far for warnings to financial advisors about opening their doors to private equity. The Faustian bargain for that infusion of capital, the conventional wisdom goes, involves giving up control over one’s business, submitting to a heavy-handed management style and being subject to insatiable pressure to deliver returns in a short period.
There’s a modicum of truth to this narrative, tired as it is. But it doesn’t tell the whole story of the options RIAs have when it comes to seeking private equity investment. For every crew of cutthroat operators seeking big exits in three to five years, no matter the collateral damage, there are outside investors with more nuanced and collaborative motives.
Neither is necessarily better than the other, and RIA founders can find private equity partners whose objectives and temperament fit with their own, if—and it’s a big if—all parties are clear about their goals upfront. RIA founders must know what their ideal partner would look like operationally, strategically and culturally.
The first step is to ferret out the misconceptions about private equity. Here are some of the common myths:
Myth: RIA founders give up control of their businesses
The stakes private equity shops take in the firms they invest in must be substantial enough to make the investment financially worthwhile, and that calculus is largely dependent on the fund’s investment mandates regarding expected returns and risk.
There are some private equity firms in the market for a substantial majority, or even 100%, stake in their acquisitions. But many others—in accordance with their objectives for the investment and what they have promised their general partners—are looking for smaller, passive ownership.
If RIAs are willing to give up only a small or minority amount of equity, the chances are good that there is a private equity firm out there seeking the same and, more crucially, willing to pay the right price. It simply takes due diligence to identify those potential partners.
Myth: Private equity investors are heavy-handed operators
A prevalent fear among wealth management firm founders is that once the ink is dry on the transaction, private equity managers will demand abrupt changes to operations and culture. No doubt, this is sometimes the case in private equity deals, and, indeed, some private equity investors argue that a shakeup is exactly what newly acquired portfolio companies need to spur growth.
But there are as many management styles among private equity firms as there are firms themselves. For every sharp-elbowed team of interventionists who put the hard sell on founders to adopt new policies and procedures, use certain outside vendors, and quickly shuffle out incumbent managers and employees, there are teams that take a more hands-off approach, preferring to listen first for what they can do to support a firm rather than making knee-jerk changes.
To be sure, the very nature of inviting private equity investment means that there will be more questions for founders to answer and greater accountability for results—there’s no way around it. Yet the way these new requirements come across—heavy-handed or with a light touch—matters and should be a major consideration for founders as they do their due diligence on a private equity partner.
Myth: Private equity firms are only in it for the quick buck and exit
It’s accepted as undisputed fact that private equity firms have a three- to five-year investment horizon in their portfolio companies, and during that span, they are trying to extract as much profit as possible from their investments. Founders fear this single-minded approach, not just because it threatens to upend all that they have spent years building, but also because, in extreme cases, it could negatively impact clients.
The reality is that though many private equity shops do seek exits in three to five years, there are others inclined toward a more deliberate approach in which long-term growth matters more than a shorter-term pop.
Know who you are and stick to it.
In the end, private equity is just a label, and one that can obscure the nuance and variety of what firms looking to invest in RIAs can offer. Private equity investors are far from a monolith, and founders would do well to do their homework to identify the right partner. Ultimately the question of whether a private equity firm is “right” depends on what the founders’ goals are and whether those goals align with those of would-be investors.
In the current market, it’s easy to get distracted by the hype and the dollars. But it will pay dividends in the long run for RIA principals to know who they are, what they want to accomplish, how they want to serve their clients and, most importantly, stick to it. More than likely, there’s a partner out there for them.
Lou Camacho is the chief operations officer of Stratos Wealth Holdings and president of Stratos Wealth Enterprises, Stratos’ mergers and acquisitions arm.