The rising RIA sector requires capital but that's not easy to unlock from banks. An organization that says it is breaking new ground expects a major national business to rise before long.
Brokers and other financial professionals who quit large firms to be their own boss can end up losing control because they need capital, even on unfavorable terms. Such RIA creators will wonder why they made the move in the first place.
With the trend of registered investment advisors and other firms taking root in recent years, there’s a definite market for organizations that can build networks and provide capital in ways that respect independence, argues Dynasty Financial Partners, the business-to-business network of wealth firms. In May last year, it launched its Dynasty Capital Strategies program, overseeing advisory work for RIAs seeking to tap capital markets.
On June 12 this year, Dynasty unveiled Dynasty Enterprise Group, a division within Dynasty focused exclusively on “network partner” firms with more than $1 billion of assets under management. That division is led by Ed Friedman, director, and Gordon Ross, senior vice president. Such a development fits with how Dynasty is taking advantage of the rise of RIAs and consolidation in the sector as organizations seek economies of scale.
Some big firms could become a greater market presence.
“I expect to see national RIAs in the next 10 to 15 years and increased consolidation in the industry; there’s no reason why we could not have a Goldman-sized RIA eventually. The need for capital is therefore more critical than it used to be,” Todd Thomson, chairman and co-founder of Dynasty, told this news service recently. As firms grow, so do their human resources, legal and other costs and risks – all requiring more capital than in the past, he said.
Dynasty provides RIAs of a certain minimum size of AuM with capital – taking a percentage cut based on AuM and revenues; it also takes stakes in firms via its revenue protection note model (RPN) but it does not take majority holdings. This gives firms independence. Firms’ growth means more fees for Dynasty, so everyone wins, Thomson said.
The Dynasty Capital Strategies offering is a revenue participation program. Dynasty targets revenue purchases in the 5-10 per cent band. The program allows RIAs to repurchase their revenue shares after a fixed period of time. That program is built on Dynasty’s existing RIA Financing Services through which the group offers financing structures for use in the funding of RIA start-up expenses, ongoing working capital, and acquisitions.
All this activity is happening amid continued ferment in the industry. Regardless of shenanigans about the Department of Labor Fiduciary Rule, there seems to be a clear trend towards more fee-based advice and a desire by financial industry professionals to set up wealth management shops, a process Thomson describes as “deconsolidation”. But ironically, with new firms getting started, they realize the need for scale, which drives M&A and a need for capital to handle issues such as succession, acquisitions, tech investment and other areas. In fact, there is now a shift towards “consolidation”, he said.
Right on cue to illustrate some of the pressures, Cerulli Associates, the analytics firm, said in a recent report that billion-dollar RIAs go through “growing pains when they achieve the coveted threshold of $1 billion in assets under management”. Billion-dollar RIAs grew 9.8 per cent annually during the five years ended 2016. RIAs with $250 million to $500 million in AuM grew 11.8 per cent, and firms with $500 million to $1 billion grew 10.6 per cent. The seven RIAs with $10 billion or more at the beginning of the period grew by only 6.0 per cent, even underperforming the growth rate of small broker/dealers with $10 billion to $50 billion at 9.5 per cent.
There have been some notable deals. At the start of May, Hellman & Friedman, the private equity house, agreed to buy Financial Engines, the US’s largest RIA, for $3.02 billion, intending to merge it with Edelman Financial Services, a previous acquisition. The deal, one of the largest to date in the US investment management sector, highlights the pressures that falling fees, rising compliance costs and low-cost robo-advice are placing on industry participants, prompting them to merge to achieve economies of scale and remain competitive. The Financial Engines transaction is the fourth largest takeover of an asset or wealth manager since the beginning of 2017, according to data compiled by Bloomberg. The market for M&A in the RIA space has been busy so far this year. ECHELON, a US investment firm that advises wealth managers on M&A deals, said that the first quarter of this year saw a total of 46 transactions, and the company predicts the US market will clock up more than 185 deals in 2018.
The wealth sector has seen its share of M&A activity as well as launches of new players and expansions. A notable M&A pact last year involved Tiedemann Wealth Management (see here.) To capture such trends, ECHELON Partners in June launched RIA Group, a new entity designed to manage businesses focused specifically on the registered investment advisor industry.
Thomson said his firm’s business model is relatively novel, with some firms for example, such as Focus Financial, ending up buying firms outright, and turning their owners into employees. Bank finance for RIAs seeking to expand is relatively limited, and a few family offices can help with capital, but this area is not yet developed. (One lender that operates in this space, Thomson said, is Live Oak Bank, based in Wilmington, North Carolina.) So, in some ways, Dynasty is leading the field, he said.
As unlisted businesses, independent wealth firms do not have “hard assets”… "it hasn’t been the kind of business that banks have been interested so far in lending to”, Thomson continued. Even private equity funds in some cases have not been particularly enthusiastic on the area, he said.
Dynasty’s work with advisors covers a variety of fronts, such as the transition and set-up of newcomers (the fee for this varies based on the complexity of the team and how long Dynasty is needed on-site with them during transition.) Another area relates to “core services” - the running of the middle and back office, or essentially all that is required to run an RIA successfully. This includes all third-party services and costs as well as Dynasty’s proprietary advisor desktop technology and support of Dynasty’s home office team. Then there is financing, such as support for RIAs, as mentioned above, and finally it has an area covering products and services to implement strategies for end clients such as life insurance, capital markets, investment banking, TAMP, SMA, UMA, and – one of Dynasty's fastest-growing businesses – outsourced CIO.
Thomson said that providing capital to RIAs at a time of such wealth management ferment is smart business. With a need for wealth firms to consider succession plans – some RIA partners are not far from retirement age – demands for capital and support are likely to go on rising.
“It’s such a great business: good growth and reasonable margins. I’d expect more equity to come into this industry,” he said. By giving RIAs more scale and potential to diversify, Dynasty helps wealth managers to make their businesses more sellable in the future.
Capital infusions and guidance can help make independent wealth firms more resilient in the event of an economic downturn, Thomson said. Firms that have diversified portfolios of stocks, bonds and other assets should be reasonably protected against, say, a 20 per cent equity market drop that might translate to a 10 per cent revenue fall at most, he said.
“Our firms have [gross] margins of about 62 per cent and that’s plenty of protection against tough markets. We say the industry can handle a drawdown with no real stress on the business,” he added.