Q103 – Should I Avoid Joining A Private Equity Backed RIA?

Also available as podcast (Episode #103)

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Should I avoid joining a private equity backed RIA?

When considering joining an existing advisory platform, you will want to understand what the current ownership structure is.  However, advisors often put more weight into the variable than they arguably should.  No matter what the ownership structure is today, it can always change tomorrow.  You are much better off overweighting the type of firm you might be joining and how future ownership changes will, or will not, disrupt the value proposition that has attracted you to their offering to begin with.

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Full Transcript:

Should I avoid joining a private equity backed RIA? That is today’s question on the Transition To RIA question and answer series. It is question #103.

Hi, I’m Brad Wales with Transition To RIA where I help you understand everything there is to know about why and how to transition your practice to the RIA model.

If you’re not already there, head to TransitionToRIA.com where you’ll find all the resources I make available from this entire series in video format, podcast format. I have articles, I have whitepapers. All kinds of things to help you better understand the RIA model.

Again, TransitionToRIA.com.

On today’s episode, we’re going to talk about something I get asked from time to time. If you listen to many of these episodes, you know I talk about there being multiple pathways to transition your practice into the model. For some of you that might be starting your own RIA, for some of you that might be joining an RIA, and then there are some flavors in the middle.

If you’re considering the path of joining an RIA, I have heard advisors say, “I don’t want to join any RIA that is private equity backed, P.E. backed.”

I wanted to do an episode on this to give you a couple thoughts of how I usually respond, and why I don’t think you should fear it as some folks do.

The fear I often hear is, “These private equity firms, all they want to do is sell. They want to buy it. They want to grow it. They want to pump it. Their goal is just to sell the thing and move on. All they want to do is sell, sell, sell. I don’t want to be along for the ride for that.”

With that theme in mind, you must step back and ask yourself, “Well, perhaps every firm is for sale?” I want to give some examples of what I mean by this, and why you’ll start to see that just because a firm might be private equity backed, who might have a goal to one day have some sort of liquidity event, that doesn’t differ a whole lot from almost every situation that’s out there.

These examples could be applicable to the firm you’re currently at now, or firms you might consider transitioning your practice to.

The first example would be if you work for a large brokerage firm now. Perhaps you’re at a wirehouse or a regional firm, and it might not be occurring to you, your firm is for sale as well.

I experienced this firsthand. This goes back to the ’08, ’09 turmoil in the markets. I worked for a large publicly traded brokerage firm. With all the turmoil, there was concern amongst the employees of, “Is someone going to come in and buy the firm and lay off employees?” There was worry about this.

At a firm-wide meeting where questions can be asked, I remember the CEO at the time said, “Keep in mind, we’re a publicly traded company. Whether it’s ’08, ’09, or it’s more normal years, every Monday through Friday between 9:30am and 4:00pm, we are for sale. Anyone with capital can come in and start buying the business. For the most part, we don’t have control over that.”

So, if you’re at one of those firms now, you are already for sale. You cannot control who could show up today when the market opens at 9:30am and starts buying shares, and potentially gains a big enough slice of the pie that they can start wielding influence on how the company is run. Any publicly traded company is already for sale every single day, Monday through Friday.

And to give you some reminders…..for those of you that have been around a long time, these are reminders. And for younger folks in the industry, you’ve maybe heard of these, but maybe didn’t live through it.

Granted this was during ’08, ’09, extreme market circumstances, but look at something like Merrill Lynch. No one would have thought that Mother Merrill was ever going to sell themselves. If anything, they were a buyer, not a seller.

As we all know, literally over a weekend, things had got so bad that Merrill had to be scooped up and purchased by Bank of America. I don’t think anyone would have saw that coming 2, 3, 5, 10 years prior, no one would have predicted that. But again, every firm is for sale.

Obviously, that’s a bit of an extreme example. But it shows that even the ones you don’t think could ultimately find themselves as a seller, have now been bought.

Another example around the same period, that a lot of people would not have predicted, was Citi selling their Smith Barney unit to Morgan Stanley. This wasn’t, in the case of Merrill, a complete acquisition. This was a carve out, a part of the firm was sold off to another firm. Again, I don’t think anyone prior would have ever seen that coming. It demonstrates that you’re always for sale potentially in some capacity.

Those are two initial examples of big firm situations that you could be at currently in some capacity. And you might think, “I’m immune to that.” Well, there are people that were at Merrill and there are people at Smith Barney that thought they were immune to it at one point as well. The world changed on them, in some cases very quickly. So keep that in mind.

Another example, perhaps you are currently affiliated with, or aspire to affiliate with, a privately held firm (though not PE backed.) You might say, “We’re privately held. We’re not publicly traded. So that whole Monday through Friday thing, Brad, that doesn’t apply.”

Well, guess what? Every private company is ultimately for sale as well. No matter what management says about, “We are growing this firm and we feel best being independent.” If the right buyer comes along and enough shareholders were to agree to it, the company could be for sale. There’s nothing you could potentially do about it if you don’t have the same influence that the shareholders do.

Typically, with these scenarios you’ll hear rumors surface (this is all industries, not just our industry.) There’ll be rumors about, “So and so company might be on the verge of acquiring this smaller company,” or whatever the case is.

The response from the PR people of that smaller firm is always, “We don’t comment on rumors in the marketplace.” They try to act like nothing to see here. And the reality is because at any given company, public or private, suitors could be reaching out.

With most large companies, it happens all the time. But that doesn’t mean it turns into anything. So out of fairness, it is fine for them to deflect that. But the reality is those private companies deflect those messages all the time right up until a sale happens.

They’ll say, “We don’t discuss rumors. We’re not looking to sell.” And then the next day they say, “We would like to announce this wonderful partnership acquisition. We have been acquired by this firm.” And they give you all kinds of spin about the cultural alignment and blah, blah, blah. But prior to that, “We’re not for sale,” is generally the message.

The point is, even if you’re at a non-publicly traded company, and even if they claim they’re not for sale, you don’t know what’s happening behind the scenes. Your company could be for sale at any given time, or a company you could join that’s privately held could be for sale at any given moment as well. Just something to keep in mind.

Next example…..assume you plan to join an RIA, but you don’t want it to be PE backed.  Instead, you find a firm to join that is “founder owned.” Maybe it’s the original founders of the company that started it 5, 10, 15, 20, 40 years ago, they own it. And you feel comfortable as it’s not private equity backed, not publicly traded, no one can just start coming in and accumulating shares. You believe the founders are in it for the long run.

Many such founders are in it for the long run. But the reality is everyone needs liquidity eventually. Even if they say, “We’re in this for the long run.” At some point, they must have some sort of exit strategy. It might be near term. It might be long term. But at some point, everyone needs some sort of liquidity for their life’s work.

Even if they were to say, “We’re going to keep this in the family. Even when I pass away, it’s going to be handed down to my kids.” Well, guess what typically happens when the kids take over and have the shares. They sell it.

Point being, even if it’s founder owned or closely held, whatever terminology you want to use, everyone needs liquidity eventually. Everything is for sale. It’s just a matter of when that could occur.

I’m not trying to harp on this. The point is just because a firm is PE backed, it’s not the only type of firm that can be for sale, and could change on you.

The final example, and then I’m going to jump into ways you can protect yourself knowing this is the world we live in. I often hear an advisor say, “I don’t want to risk any of those scenarios. I’m going to start my own RIA, and avoid any of that.”

There are several reasons it might make sense to start your own RIA versus joining an RIA. I’ve done episodes on that, talking about the pros and cons. But if your main motivation for starting your own RIA is because, “I want to own it 100%. I don’t want to worry about potentially other owners in play.” You’re still not immune from potential M&A changes being forced on you.

For example, there are a lot of RIAs where a couple years ago their primary, if not sole, custodian was TD. They chose TD, and were perfectly happy having their assets at TD. They had been explaining TD to their clients for years, if not decades, why that was the best custodian to hold their assets. And that’s why the RIA chose them as their custodian.

And then, with no vote of the RIA, Schwab came in and acquired TD. And there was a time many thought, “TD is so big, no one’s going to come in and acquire them.” Sure enough, Schwab comes in and acquires them.

Suddenly, there’s all kinds of disruption – which we’re thankfully now more on the tail end of. But for those RIAs that were using TD and had this forced conversion to another custodian, they had no vote in that.

Even if you own the RIA outright, and you don’t have to worry about any other ownership slices or structures or whatnot, the world can still change on you and potentially in a big way. Such as with your custodian, again, with no vote of your own, being forced to change on you, and all the work that goes into that, and having to explain to clients what’s going on.

I don’t want to be a Debbie Downer, but there’s not any situation where you can be entirely immune to these kinds of changes. So the question is, how can you best protect yourself?

But first, the takeaway from me giving these examples, why fear that just because a company’s private equity backed, that that’s any more risky than any of these other scenarios?

A publicly traded company – and it’s usually done right after market hours – there could be an announcement that the company, which you might be affiliated with now, has been acquired and your world is about to completely change. The dance partner you chose has now changed with no vote of your own.

So, just because a private equity backed company might one day look for a sale, every time of firm is at least eligible to be sold if not also followed through with on that. Something to keep in mind. Don’t automatically assume just because a firm is PE backed that it’s necessarily riskier.

Now, with all that said, I want to put this in a positive path of what can you do to protect yourself from the scenarios I’m talking about here.

If you’re looking to join an RIA, unless you are looking to join as part of a succession plan, where they are acquiring your practice – that is a different scenario – only align yourself with what I call a free agent model.

Those are firms that say, and put in writing, “If you join us, here’s everything we’ll do for you. But if you one day feel you need to go in a different direction, whether you want to have your own RIA or simply don’t find them to be the best partner anymore, you are free to leave, free to take your clients. You don’t need to worry about TROs or anyone being sued or anything like that. You are free to go. You are a free agent.”

Also consider what such a model requires of an RIA firm. Because that RIA isn’t putting up a wall to try to keep you in – which a lot of wirehouse firms do – because you’re a free agent, because you can leave whenever you want, they must try to do everything they can to keep you happy, to keep you to want to stay there.

Which, being sarcastic, what a crazy idea! Trying to keep advisors so satisfied that the simply don’t want to go in a different direction, not because of handcuffs we put on them with deferred comp or non-solicitation agreements or things like that.

Such a model is generally going to be a much better experience for you because those firms must work hard to keep you. If you always have the option that no matter what the circumstances, you could always leave, those firms must work arguably harder (to keep you satisfied) than these other situations.

If a private equity firm comes in and buys one of those firms, you’re all free agents. They know you are all free agents. They can’t just come in and start making draconian changes because all the advisors could just up and leave if they were to do that. Your incentives are much more aligned with that model.

That’s an entirely different dynamic than if a PE firm or whoever comes in and starts buying a firm where there are captive constraints and ownership agreements or whatever the case is. That is going to be a different dynamic. But if you’re in that free agent model, that is the number one way you can protect yourself.

Hopefully you find a firm to join that you will be happy with and ride out the rest of your career with, and you won’t need to one day pivot. But you always want to have that optionality down the line to be able to do so if needed. Because if nothing else, that keeps that firm and the management, the ownership, aligned with making sure your incentives are on the same page.

The second tip to protect yourself is simply to accept that change will happen.

I don’t care what kind of firm you’re at now. I don’t care what kind of firm you join. I don’t care if you start your own RIA. Change will happen over time. There will be regulatory changes. There will be vendor changes, M&A in the vendor space, technology firms. There will be acquisitions of various firms.

Change will happen, and you should accept that it will happen. But then ask, “How can I best position myself to weather that storm?”

Consider when joining an RIA. Don’t just do due diligence on their value proposition, meet and understand the people that are in charge of running the firm. When you know change will happen – again, we don’t know what regulatory changes could happen 5 years from now, 10 years from now, 20 years from now. We don’t know what the market environment could change, any of that stuff.

You want to ask, “Who are the people running this firm, making the strategic decisions that will impact me as an advisor? I want to align myself with people that I think will best manage those changes when they come in my best interest.”

We don’t know what those changes are, but you can evaluate who the management team is. And yes, there will be turnover from time to time and team members will change. But you can get a feel for the kind of folks that work at a firm.

Do they have a good culture? I know that gets thrown around way too easy. But you want to say, “When change occurs, am I comfortable that these are the people that are going to be looking out for me?”

I encourage you to put more weight on that, then worrying too much about what the current ownership structure is, because again, all of that could change. You want to know who’s the captain driving that ship that’s going to be looking out for your best interest.

To recap, this is a long way to answer the question, should you fear a PE-backed firm?

I would say they’re no more risky than a lot of other scenarios. Your current firm, with no vote from you, could change underneath your feet. Or if you go in a new direction, will that new path one day have an ownership change? It may involve PE. It may not involve PE. But change can happen.

I would encourage you not to fear that, not to cross off solutions just because they’re PE-backed. Because even if you find a solution that’s not currently PE-backed, there’s no telling what the future will hold. Two years, 5 years, 10 years from now, they might be PE-backed. You just need to protect yourself in the ways that I’ve been talking about here.

As I said at the top, my name is Brad Wales with Transition To RIA. Having these kinds of conversations is the type of thing I do with advisors all day long. I’m happy to have that conversation with you as well.

First things first though, head to TransitionToRIA.com where you’ll find all the resources I make available. This entire series in video format, podcast format. I have articles, I have whitepapers.

At the top of every page is a Contact link. Click on that and you can instantly and easily schedule time to have a one-on-one conversation with me, whether you want to talk about today’s topic or anything else RIA-related and how it might apply to your practice. I’m happy to have that conversation.

Again, TransitionToRIA.com.

With that, I hope you found value with today’s episode, and I’ll see you on the next one.

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