True, this topic of consolidation in the investment advisory industry makes great fodder for the kind of trade press interviews that I and my fellow
consulting colleagues are known for, but taking a hard look at consolidation also has practical value. What is important about consolidation is to
understand whether it will change the competitive landscape of the industry and somehow force lower profitability or growth pressures on the
“unconsolidated” firms. From a career perspective, especially for younger advisors, consolidation poses the question whether you are better off
tying your career to an independent firm or just going with the larger consolidated entities and\or national firms who are already actively recruiting.
Obviously, working for 10 years in an independent firm just to make partner only to find that the industry is consolidating and profits are eroding
is the career equivalent of arriving late to the Christmas party—nothing left but salad, noodles and slow dancing. This is an alarming possibility
for many (except vegetarians who like slow dancing). To be able to discuss consolidation, we need to define what we believe to be the “dangerous”
levels of market share concentration. Some consolidation is natural for all industries and all markets; the question is, would consolidation in the
advisory industry ever reach Wal-Mart levels?
Consolidation in the industry will become a serious factor and begin to affect firms when one of the following happens:
• The rule of five - In any given local market, there are five or fewer firms who are seen as the market leaders or dominant providers and who are
well known to all clients potentially looking for an advisor. The reason I chose five is because that’s how many large accounting firms were left
standing after all consolidation was said and done in the accounting world. The big five (now four) enjoys dominance of the market such that they
are directly or indirectly affecting all new client relationships. Every client looking for a new accounting firm will consider them or at least have
them as a reference point. For a measure of their dominance, the number four firm today, KPMG, has annual U.S. revenue of $4.8 billion. The
number five firm, RSM\McGladery, has $1.3 billion.
• The college kid test – If a high number of matriculating college kids begin to say, “I wish I could work for…,” this means that the supply of new
talent to advisory firms will be restricted or at least “creamed” by the large and dominant firms. Talent is the biggest factor in the “production” of
advice, and the supply of talent will affect economics of the industry faster than any other change.
• The middle executive test – When a middle executive in a financial services firm begins to earn more than the principal of a relatively successful
advisory firm, then it is clear that the market has become heavily consolidated. To consider a parallel, that would already be true in the CPA
industry today. A manager in a big four firm will make as much as a partner in a small firm.
• The in-law test – If your in-law's tell your husband or wife that your spouse should have married a banker, this means that the industry is clearly
going down the drain. In all likelihood, the above three factors have already occurred, but if somehow you missed them, there's always the in-laws.
However, it is important to note that the industry is nowhere near these levels of consolidation, yet. In fact, in 2006 Pershing Advisor Solutions
commissioned Moss Adams to research M&A activity of the last five years . We looked into deals that occurred between January 2000 and
July 2006 and had more than $100 million in assets. We also tried to isolate firms that dealt with retail clients in an advisory capacity. In other
words, we wanted to strictly focus on advisory firms that do what you do and not taint the findings with large institutional money managers or
brokerage firms. What we found was a steady stream of transactions—the stream was not without its peaks and valleys, but it certainly presents
a steady pattern.
The pattern tells a story of strong liquidity, but at the same time, the average number of deals was 30 to 35, certainly not the most impressive
number. There are two things to remember, however. The first is that this reflects only activity that involved relatively large firms. There are
certainly many transactions that have occurred in this timeframe that involved smaller practices.
The second thing to remember is that the really interesting statistic is not how many deals occur but rather, if an advisor is looking to sell,
how many offers will he or she get? When firms did have the intention to sell and made active steps to find acquirers, in our research we found
that they received up to 15 different offers from all types of buyers—banks, consolidators, and other RIAs.
The consolidation discussion is also too myopically focused on the independent investment advisory part of the industry to the exclusion of
firms like Merrill Lynch, Goldman Sachs, Morgan Stanley and other smallish advisory firms. This focus on independent firms ignores the fact
that most consumers do not make such a distinction between independent advisory firms and large national firms.
Today, independent advisory firms own about 12% of the total number of advisory\planning clients in the U.S. , with some surveys giving
them as much as a 22% market share in terms of assets (the independent RIAs tend to have larger market share in the $1 million to $10 million
investable assets group). Even if all of the independent RIAs were combined into a single entity, they would still not be of Microsoft size and
proportion as far as the entire industry is concerned.
One of the tests we can apply to consolidation from that perspective is the branch office size test. A typical branch for a wirehouse firm would
have over $5 million in revenue. For an independent RIA to be of that size, it would need to have $1 billion or so in AUM. At present there are
only 97 retail RIAs who are of that size. In other words, only 97 RIAs are of comparable size as the local wirehouse offices.
The amount of money chasing after advisory firm deals, however, is very high. We estimate that there is more than $1 billion in total capital
that has been reportedly raised to acquire advisory firms. To arrive at this estimate, we simply summed the amounts reported on the press
releases of various consolidators. Let’s think about that number for a second. Making reasonable assumptions about valuation, this means
that the amount of capital being raised would be enough to buy firms managing as much as $300 billion in assets, or, roughly 1/3rd of the industry.
The real issue is what we are going to do as the younger generation. Are we ready to take over the advisory firms that would be ours to run in the
not-so-distant future? Are we ready to be true entrepreneurs? I vividly remember a meeting between the older founder of an advisory firm and his
six successors. The meeting was centered on the need to buy out a retiring minority shareholder—a transaction valued at about $1 million. Some
checks needed to be written to get that done, and of course, the checks were in exchange for equity in the firm. Unfortunately the enthusiasm among
the six junior partners very much reminded me of the construction of the trans-Siberian highway (which was strictly a volunteer effort). None of
the junior partners wanted to write checks, assume debt or in any other way risk personal capital.
I think this is the real danger of consolidation. The younger generation will take over the independent firms in the next 10 years only to find out
that they are uncomfortable taking any financial risks. They simply have not had to, but financial risks are unavoidable for entrepreneurs. What will
happen then is the younger generation will sell to the banks and consolidators rather than risk personal capital. This of course will be ironic since
most have been groomed to become owners so that the firm does not have to sell.
This is not to say that young owners don’t have risk tolerance or the entrepreneurial spirit to take on the challenge. I think many do, but as a younger
generation of professionals, we need to ask ourselves whether or not we are up to the challenge. Someone once told me that you are not a real
entrepreneur until you pay payroll with your own credit card. So when consolidation scares us a little, we should remember the famous words from
the Pogo cartoon strip: “We have met the enemy, and they are us.”
Philip Palaveev is a contributing writer on financial services and practice management for TodaysAdvisor magazine and todaysadvisor.com. Mr. Palaveev is an often-quoted industry
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