question of whether upcoming teams of young advisors can continue to attract scores of new clients the way their predecessors did . Some consultants , like Mark Hurley , the CEO of Digital Privacy & Protection , suggest firms will have to develop client acquisition specialists ( see this month ’ s cover story .)
The worry is that private equity owners are now going to get more directly involved in management , and that older advisors , those who aren ’ t ready to retire , are unlikely to want to go along with this regime . “ Some older advisors are going to go their own way ,” Stern predicts , adding these advisors will argue that longtime clients won ’ t go along with the new regime either . So what are the risks for PE firms ? Those that bought into the industry early and racked up huge profits would appear to be sitting pretty . But conditions can change fast and the future isn ’ t so clear , even for the early winners . In the first place , the debt they took on to finance deals has become a problem — i . e ., increasingly expensive . At least one consolidator that owns some of the profession ’ s finest firms was forced to pay 14.5 % in pay-in-kind securities .
Also , replacing retiring advisors won ’ t be easy for these buyers . Hurley and others predict that the battle for talent is likely to intensify and resemble the seamier side of wirehouse broker poaching . In November , Edelman Financial Engines sued Mariner Wealth for allegedly luring advisors with $ 621 million in client assets .
The rising cost of capital will change expense structures for consolidators and integrators alike . “ Companies that are growing as fast as many of those growing through acquisition [ are ] may require capital to accelerate their growth , and possibly to achieve dominance in certain markets ,” says former Pershing Advisor Solutions CEO Mark Tibergien . “ I foresee M & A continuing for a number of years yet .”
At the same time , existing PE backers will face a dilemma . Some will want “ to roll over their investments every so
Others like Hurley argue that large , integrated RIA enterprises are perfect long-term investments , not only for PE firms but especially for their largest investors , such as sovereign wealth funds and pensions .
many years ,” Tibergien argues . Indeed , many big acquirers like Mercer Advisors , Edelman Financial Engines and Carson Group have already recapitalized on several occasions , marking up their investments along the way .
But others like Hurley argue that large , integrated RIA enterprises are perfect long-term investments , not only for PE firms but especially for their largest investors , such as sovereign wealth funds and pensions . Already , some of these big institutional investors are putting the screws to private equity funds , demanding direct co-investment rights and effectively squeezing the PE folks to eliminate a big chunk of their management and performance fees .
All three groups of owners — the aggregators , their PE backers and the RIA owners who remain invested in their firms — aren ’ t likely to want to sell until they have succeeded in “ fixing up the business ,” Hurley argues . This requires them to find economies of scale and improve profitability , something firms like Mercer , Creative Planning and Mariner Wealth are already doing .
Tibergien thinks this will probably lead to mergers among the larger firms . But if they need capital , will they get it in debt , private equity or public equity ?
Debt may be the less expensive option for owners trying to avoid diluting their equity , but additional leverage can place too much risk on the balance sheet and strain the cash flow . Tibergien notes that retained earnings could help build equity , but it probably won ’ t be at a rate that sustains these firms ’ current growth rate .
“ Public offerings are kind [ of ] off the table ,” he says , “ until some of these firms achieve critical mass and have legitimate branding . It ’ s not like technology , where someone is buying innovation — more like a retail or institutional service business . But the public markets haven ’ t responded positively to this idea .”
So a firm ’ s equity will need to come either from PE firms or from its employees buying in with current shareholders . It was already difficult for younger partners to buy into firms , and it ’ s getting harder as the firms ’ capitalization gets bigger . Logic , Tibergien says , indicates the PE sponsors will continue to be a factor for as long as the returns and growth rates are there .
Stern says there are still PE firms looking to invest in the advisory business . But unless the equity market enjoys another 15 years just like the last , some of these institutional investors are going to find they can ’ t meet their internal rates of return or hurdle rates .
Others will simply fail at integrating RIAs . Goldman Sachs , which boasted one of Wall Street ’ s best financial services teams in areas ranging from banking to asset management , saw its acquisition of United Capital end in a humiliating failure this past summer . It won ’ t be the last .
DECEMBER 2023 | FINANCIAL ADVISOR MAGAZINE | 21