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The RIA Roll-Up Unraveling

The RIA Roll-Up Unraveling

Consolidators, or roll-ups, were the biggest buyers of RIA firms just a few years ago. But as revenues and cash flows have declined, some consolidators are bowing out of the business while others are making adjustments to survive.

In 2001, Boston Private acquired Taylor Investments, an RIA with over $500 million in assets under management, for about $10 million in stock. Taylor had a reputation for investing in value stock, and Boston Private renamed the firm Boston Private Value Investors. Over the next six years, BPVI's assets grew to over $800 million. It became part of the Boston Private network, which was made up of private banks, wealth and investment advisory firms. By 2006, the network included about 12 firms managing $30 billion in assets, and Boston Private's shares were at $33, a 65 percent gain versus 2001. Just three years later, on April 1, 2009, BPVI and Boston Private severed their relationship. The parent company sold the firm back to the management team which renamed itself Granite Investment Advisors.

BPVI wasn't the only one to complete a management buyback. During 2009, at least four of Boston Private's other affiliates did so as well: Sand Hill Advisors, RINET Company, Westfield Capital Management, and Gibraltar Private Bank & Trust. The market bust had strained the profitability of the model for Boston Private, which also needed cash. It was a big retrenchment.

Banks like Boston Private and private equity-backed management companies often called “consolidators” have been among the biggest buyers of registered investment advisory firms in recent years, but with the recent decline in revenues and assets, brought on by a depressed market, some of them are selling their RIAs. Others are making fewer acquisitions, or reassessing how to make the model work. In many cases, the RIAs that leave do management buyouts or do deals with other individual RIAs. “I don't think the model is done,” says Elizabeth Nesvold, managing partner of investment bank Silver Lane Advisors in New York. “They're down, but not out. The slowdown will give both sides time to reflect on their model and see what works and what doesn't. We might see some of the firms fail, but the model will come out stronger than before,” she says.

In 2004 and 2005, bank acquisitions of RIAs represented between 40 and 50 percent of all RIA assets acquired. But through the third quarter of 2009, national banks acquired almost no RIA assets while regional banks accounted for less than 5 percent of RIA assets acquired, according to Schwab Advisor Services Strategic Business Development.

Meanwhile, private-equity backed consolidators like Focus Financial and WealthTrust, which offer back-office support and consulting to networks of RIAs, are also being less aggressive about acquisitions. In 2003, consolidators accounted for just eight percent of all RIA assets acquired. In 2005, that number shot to 20 percent, and in 2007 it was 45 percent. By 2008, they represented just a 28 percent share of acquired assets. Through the third quarter this year that number had tripped back to 35 percent.

“We will likely see fewer RIA consolidators in the industry,” says Dan Inveen, founder of FA Insight, a Tacoma, WA-based advisory consulting firm. “Two years ago there were probably 10 to 15 active players. Now, you have five or maybe 10 at most. And not all of them are making deals, they're just hanging on. There will be even fewer over the next couple years.”

Mergers and acquisitions activity in the RIA space is down across the board, industry consultants say. In 2008, there were 88 M&A deals in the industry. Through September 30, 2009, there were 50 completed deals. (At that pace, full year deals would total 67, a 24 percent drop from last year.) This is partly because market valuations are depressed, and fewer firms are willing to sell.

Boom to Bust

Dave Devoe, managing director of strategic business development at Schwab Advisors Services, says management buyouts will probably become increasingly frequent over the next couple years. As banks and holding companies make fewer acquisitions, RIAs themselves have stepped in and become the number one acquirers of other RIAs. Of all RIA assets acquired through September 30, 2009, other RIA firms accounted for 60 percent, according to data from Schwab, up from 30 percent in 2006.

Of these advisor-driven deals, about 16 percent are management buyout deals like BPVI's — where teams agree to purchase equity back from a parent company. In 2006, such spinoffs made up 3 percent of deals in asset terms. In 2007, that rose to 5 percent and in 2008, it was 7 percent. Devoe expects the number of management buyouts to account for almost 8 percent of these RIA-to-RIA deals in 2009. “In challenging business environments like these, parent company and affiliate relationships come under a higher degree of scrutiny. RIA principals are reevaluating as are the CEOs of the parent companies that own them,” Devoe says.

A principal at one RIA firm that was bought by a roll-up in 2005 says the idea of buying the firm back from the parent company has crossed his mind several times. “It would be great not to have to pay [the parent company] their share each month and just take it all home ourselves. I'd much rather buy it back. But I don't think the company is in enough distress to want to sell us,” he says.

In some cases, conflicts arise because the parent company and the RIA affiliate begin to offer competing services. When it bought Palo Alto, Calif.-based Sand Hill Advisors in 2000, Boston Private classified the firm as an investment manager. But Sand Hill has since evolved into more of a wealth management group and its services have overlapped with Boston Private's other affiliates in the area, the parent company says. Sand Hill and Boston Private officially split in June of 2009.

One advisor who was involved with another former Boston Private RIA affiliate says Boston Private didn't get what it expected from some of the investment advisor firms it bought. “We became competitors with some of their in-house businesses, so they were hesitant to market us. They had their own in-house trust department. For every dollar that goes through the bank, that trust department wants all of it and doesn't want my wealth management firm to get it,” the advisor says.

Scott Schermerhorn, principal with Granite Investment Advisors (formerly BPVI) says now that the firm is owned by management again, there are some noticeable changes. “There were definitely some bureaucratic and administrative tasks that had nothing to do with our business, but we had to do them because the bank operates under different rules than just a straight investment advisory firm. A bank has rigid systems and processes that must be done efficiently. They are much more structured in how they operate. Now that we're a pure RIA again, there's more room for opinions and discussion in the way things are done,” Schermerhorn says.

Rethinking the Model

Those banks that remain in the business will probably take a more hands-on approach, actively helping the firms they acquire to generate new business rather than letting them remain completely autonomous. “A couple years ago, you had all kinds of folks clamoring to set up roll-up operations and make relatively quick financial gains. There are few buyers that remain today that are buying RIAs for reasons of pure financial gain. Buyers are going to be much more thoughtful and deliberate about entering a deal,” says Inveen. Perhaps, more importantly, as Devoe puts it, “Holding companies are crunching numbers and are not willing to pay what they were paying for firms the last couple years.”

This is evident at National Financial Partners (NFP) of New York. NFP was arguably the first of the private-equity backed serial RIA acquirers. Back in 1999, Apollo Management injected $125 million into the firm. NFP has faced a bumpy road since its 2003 IPO when it closed 14 percent up in its first day of trading. The roll-up, which has acquired about 180 firms, has seen its stock plummet 65 percent since its public offering.

One advisor affiliated with NFP says the firm has shifted its strategy to avoid further losses. Instead of continuing to make acquisitions, NFP is encouraging its existing subsidiaries to make acquisitions of their own. “The thought is there will be more success if sub-acquisitions are done through the firms they already own. They want us to suck up smaller fish and get bigger that way, as opposed to NFP itself taking the bite and finding a whole new, large firm,” says one of the firm's principals. NFP has always been known for making the deal and then letting the management of the acquired firm operate with a business as usual approach, the principal says. “Once upon a time we were just a wholly owned subsidiary of NFP with the right to manage our own business and some of the cash flow. I think now NFP is looking for more ways to help us without stepping on our toes, which would, in turn, help their bottom line and share price,” the principal adds.

Consultants say those firms with private equity backing may be facing pressure from their debtors these days. “Anyone who has private capital has to be mindful of the investors' return requirements,” Nesvold says. And Inveen says some investors may be demanding a return on the investments they made in the RIA consolidator model. “You're seeing buyers redefine their target acquisitions. Some that were targeting RIAs before are considering acquiring breakaway brokers from wirehouses and some others are going offshore for their acquisitions. You might see more adjustments being made in the way these firms do business, who they acquire and how they add value,” Inveen says.

Focus Financial in New York, which received an initial $35 million from Summit Partners when it launched in 2006, says it's not facing any pressures from its investors. Founder Rudy Adolf says cash flow at the firm has actually increased every year since 2006. He says none of his affiliate firms — 17 in all — have expressed interest in buying themselves back and none have exited the group. Meanwhile, the firm received a new capital infusion last month from Polaris Venture Partners and Summit worth about $50 million. It also announced its first deal in over a year with the acquisition of Joel Isaacson, a tax services and advisory firm in New York.

Newport Beach, Calif.-based United Capital, like Focus, is an acquirer of financial advisory firms. But unlike Focus which acquires just a portion of firms, United Capital purchases 100 percent of each firm it acquires. And unlike other holding companies of RIAs, CEO Joe Duran seeks to transform the acquired firms by taking over all back office and support chores, moving their books to a predominantly fee-based model, and standardizing operations. Duran says his hands-on approach is one big reason his firm is not seeing the same problems that other competitors are. “We're changing the way these firms operate and looking for ways to improve them and help them grow,” he says.

Another difference: “We don't get a claim on preferred cash flow,” Duran says. Whatever the cash flow, United Capital splits it evenly with the firm's principals. “If revenues go down, they go down for all of us. We're all grumpy together.” Duran says for that reason he's not seeing any pushback from existing partners. “They're not struggling to make fixed payments to us. We're in this together. It's a true partnership,” he says.

However, Duran explains that some of the original advisors who joined might be feeling a little anxious about liquidating their stock in the company. “We assumed it would be a quick path to some liquid event, whether it was going public or selling. Some of our advisors may be disappointed that it didn't go quite as planned. But the market changed everyone's plans. Revenues dropped and cash flows dropped. Thankfully, we are well-funded with no pressure from our investors,” Duran says.

“At the end of the day, everyone likes to play up that these serial buyers are having major issues. But there is a general slowdown in the market and valuations are depressed,” says Inveen. “There are not many willing sellers out there, and now these buyers are having to compete with other RIAs for deals. This is a shaking out of the best firms,” Inveen says.

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