One of the toughest parts about being a writer is trying to have an opinion at least once or twice a month. Having interacted with some of you, that doesn’t seem to be a problem for everybody. But after 40 years, it starts to present some challenges.
Fortunately, my community is usually ready to step up with some assistance in this department. At the recent Insider’s Forum conference, the number one topic of worried conversation was not the markets, succession planning, or politics. People were discussing the growing flood of private equity money into the financial planning ecosystem, funding advisory firms that use these dollars to buy other advisory firms at increasingly outrageous multiples, and buying up fintech firms that advisory firms rely on.
Chief among the concerns was the fact that many larger firms are now introducing an additional greedy mouth to feed at their table, beyond the normal stakeholders of the equity owners, staff and clients. True, many of the larger advisory firms have been generating consistent profits in the 25% to 30% range, so there ought to be enough to go around as the acquisitions roll in, as the pie gets bigger and bigger. But some of us (in these conversations) wondered if private equity firms realized how fragile these profit margins can be, that they are subject to the whims of a bear market.
What happens when share prices fall, portfolios drop, AUM fees are diminished and that 25% profit margin becomes an operating loss? Does the private equity firm demand cost-cutting—aka cutting staff—thereby compromising future growth? And even in good times, does that other hungry mouth to feed start making decisions about how much (or little) service the firm’s clients need? (You can hear the whisper: You’ve been over-servicing your clients, but we can help you create a much more efficient model that will make the firm more profitable… And we also recommend that you switch your software stack over to this system that we’ve recently invested in…)
As firms are purchased by large PE-funded entities, will they change their service models to conform to something that is imposed on hundreds of other acquired advisors around the country—like a cookie-cutter?
There were other concerns, surprisingly focused on sympathy for the PE firms who may be naively moving into this market. Some of the firms they are purchasing at high multiples may have delayed their infrastructure and staff upgrades to (temporarily) raise their profit margins at the expense of growth. There is credible evidence that organic growth across the profession has stalled, that virtually all of the growth over the past decade has come from a bull market raising AUM amounts and fees. The overall growth rates in published studies is highly influenced by the inorganic growth—firms purchasing each other.
In order to get back on the organic growth track, these PE firms—and the firms they’ve purchased—are going to have to become excellent recruiters of new staff, and new staff these days comes at a fairly high price, perhaps especially at firms that dictate limited service and a cookie-cutter approach to planning. These recruiting challenges will threaten those profit margins that are already under siege in a bear market.
Many of the purchased firms are seeing their founders leave as soon as their contract allows—retiring after having built the firm from nothing. Are the clients of these acquired firms going to be loyal to the new acquirer, or will they seek out someone who provides the same kind of service that they were accustomed to? This is an especially pertinent question if those unprofitable extra service touches and personal care are banished in the name of raising profit margins.
Of course, everybody buzzing about this topic recognizes that most private equity investors are pretty savvy about what they’re investing in. Don’t they already know all these things? If there was a consensus at our conference, it was that the private equity investors’ due diligence might be relying on the profit numbers over the recent 10-year track record across the profession—which would be entirely logical, and certainly misleading.
And so, of course, we wondered what is going to happen. But I think most of us already know the possibilities. Large firms will become larger, backed by large pools of money that enable them to engage in (I kind of love this euphemism) inorganic growth, which basically means a buying spree of smaller advisory firms. Their service and culture will increasingly, inevitably, begin to resemble what we have seen at the wirehouses, even to the point of introducing pernicious incentives in the name of boosting profits.
What we think of as financial planning advice and service could be (I am choosing this word deliberately) corrupted by increasingly prominent large firms that purport to do what the rest of the profession has done for the past few decades, but is in fact a profitable watered-down version. As a result, many consumers will begin to think of financial planning differently, and their experience with it will be less-satisfying.
Beyond that, there are several possibilities. One is that the private equity firms will eventually, painfully, realize that their recent investments have been less-than-ideal, and that the firms they funded are less valuable than they thought they were. I happen to believe that the highly-leveragable AUM fee structures are going to shift to flat quarterly or hourly compensation, making advisory firm balance sheets look more like an accounting or law firm than what we have today. If the larger firms don’t follow the herd away from AUM, they will lose clients to the smaller firms offering the more attractive fee structure.
As the idea of a profitable IPO recedes, and there are no willing buyers who are willing to play the greater fool, these pools of money will cut and run, looking for ways to rob the coffers of their invested-in firms on their way out the door as a way to cut their losses.
Another possibility is that these larger firms will, indeed, achieve that profitable IPO, at which time the founders and key players will gradually cash out, leaving shareholders (not the private equity firms) holding a largely-empty bag. This might discredit, on Wall Street, any future efforts to take large agglomerations of RIA offices to the public markets.
Or we could see these larger firms get larger and larger and larger, becoming national in scope. As they redefine what most of us think of as financial planning—more a wirehouse model than personal service—their lobbyists will exert greater influence over the regulation of financial planning, with the same goal that FINRA has followed, looking for ways to choke the smaller competition out of existence, clearing the way for them to own the marketplace.
It is worth remembering that, for reasons like this, the accounting and medical fields forbid outside owners to have a controlling interest in their businesses. Both professions, which are much like financial planning in their focus on benefiting the consumer, have decided that outside investors who are not invested in a customer-first relationship should not be deciding how their organizations should be run. What’s best for the balance sheet is seldom best for the consumer.
I confess that we, at the Insider’s Forum conference, did not envision any happy endings to these PE investments that are invading the fiduciary turf, and I suspect that executives at the firms that are happily taking PE money are going to say that this buzz at our conference is driven by smaller firms owners fearing the competition that they are creating. Remember that an individual named Mark Hurley gained widespread attention, 20 years ago, by predicting that, long before now, increasingly giant advisory firms would consume the smaller players in the profession, leaving just a small handful of national firms to provide financial planning in the business ecosystem. Maybe (the large firm executives might argue) this dynamic is finally playing out, and our conference attendees are dead-enders hanging onto an increasingly outmoded (small is beautiful, personal service trumps efficiency) business model.
My own view is that the executives at PE-backed acquirers are themselves the endangered ones. Advisory firms with fewer stakeholders—themselves, their staff, their clients—are always going to have an advantage in the marketplace over firms that have additional mouths to feed, especially when that extra stakeholder is primarily focused on achieving a huge payoff on its investment, rather than great service to the client base.
The smaller firms might do what they have been doing to the wirehouses for decades: take market share and become more prosperous at their expense.
So now I have an opinion: the profession is under a well-disguised attack from firms that appear on the surface to be benefactors offering money. Their investments would seem to be moving us off of the client-first momentum that the profession has maintained over the last 20 years.
I just wish that I had a good opinion about what we should do about it.