All of the Liability and None of the Value

I’ve noticed a frightening new trend among strategic acquisitions around the country: the misalignment of liability and value.

Judging by the volume of deals reported this year, the wealth management M&A market continues to be on a tear. While many of these transactions will be wildly successful for all parties, I have noticed a frightening trend over the last several months when evaluating potential strategic acquisitions around the country.
To illustrate this trend, and why it’s concerning, I’ve outlined a hypothetical scenario that is effectively a composite of five firms our firm recently evaluated. Their owners have all acquired three to six smaller firms ranging in AUM from $50 to $100 million, personally guaranteed the debt used to fund the deal and failed miserably in creating any real value along the way. Of course, some nuances are different, but each firm ended up in the same precarious position.
Out of Order
Todd was 55 years old and was enjoying owning and operating a successful wealth management business with $400 million in AUM. The business generated great cash flow, and its modest growth was driven by the market and frequency of referrals. At every recent conference, Todd attended there was always a session on M&A, and the panelists touted easy access to money, the industry’s aging demographic and the alluring benefits of AUM and revenue growth. Todd was inspired. Over the next two years, Todd acquired four wealth management firms/solo advisors with assets ranging from $50 to $100 million. To facilitate these transactions, Todd took out a loan from a bank well known for financing advisory businesses that he personally guaranteed for greater than $3 million. Most of the acquired advisors moved physically into Todd’s space and operated a shared services model, while two remained physically in their own spaces. To this point, this is a yeoman effort, and Todd should be commended for putting this together — most people never get nearly this far.
Todd felt great, as he had just executed on his vision and became the owner of an $800 million RIA firm, up from $400 million just two years ago. Finding economies expanded margins, and while organic growth was pretty anemic across the business, the market had tacked on $100 million. Mission accomplished. Time to delever, hire a banker and find a buyer or strategic partner.
Our first conversation with Todd was great: good cultural alignment, shared vision on the future of wealth management, interested in continued sub-acquisitions, etc. The second meeting raised some concerns, and the third meeting, which included his acquired advisors, was a total disaster. What did we learn? While Todd contractually owned the clients and had acquired all of the financial and legal liability, the advisors still controlled the client relationships — and therefore all the value. In other words, they were enjoying the financial benefits of having sold their cars while still keeping them parked in their respective garages to drive at their leisure.
When it became clear we were not buying the firm; Todd shared that the advisors stalled in moving towards a consistent client experience and that the acquired clients mandated that their advisor continues to manage their money. The kicker was that some of Todd’s acquired advisors had mentioned to us that they would need to be paid to be on board with any transaction.
Wrong Way
Securing the financing and convincing people to take the cash while inadvertently allowing them to maintain the value is the easy part. The hard part, and where all of the enterprise value is created for a strategic acquirer, is the integration of clients, management, and relationships. 
The model Todd unknowing built was a roll-up. These firms acquire companies with a secured or preferred position (i.e., acquirer gets paid first), package the preferred income streams like Wall Street–securitized mortgages, and sell to investors for more than you paid the underlying businesses. This model only works on a massive scale with a real financial arbitrage, much like how Focus Financial has built their business.
The Better Path
What could Todd have done differently? First, his core business needed to be scaled with a strong client experience, operational capacity and a technology stack that integrated every aspect of the business.
He also needed a unique, low-cost or outsourced investment management platform that all acquired clients eventually migrated towards. Unfortunately, unique platforms tend to have inconsistent utility, while low-cost and outsourced platforms tend to be mutually exclusive.
The Hard Part
Every firm you buy must culturally and philosophically align with this model. They should view your client experience as a major improvement, ensuring their clients will be thrilled with the new offering. The acquired firm must believe the unique, low-cost or outsourced investment management platform can materially improve what they’re delivering to clients today, particularly when measured against the opportunity cost.
Once all of this is in place, an informed acquisition strategy can materially grow the business. The liability-to-value will align, benefiting the clients, acquirer, and advisors. I encourage you to make an honest assessment of your readiness, and that of your organization and staff, before making an acquisition. Most importantly, before pursuing any transaction, carefully consider the impact to your existing clients. You’ve worked way too hard to compromise your life’s work.