Star Value vs. Franchise Value

There’s a ton of money chasing wealth management firms these days, as recent blockbuster deals have once again demonstrated.

The soaring prices paid for wealth management firms have caused many to ask what’s the best way to get the most for ourselves, our families and our long-term legacy.

In fact, there are two clear paths a wealth manager can take. One is the Star Path and the other is the Franchise Path, as I like to call them. The Star Path is more immediate, and the Franchise Path is longer, riskier and requires more work.

The question is which path is right for you.

The Star System

The Star Path leads you to a brokerage firm, which currently pays three to four times trailing revenues to reel in top-tier performers. Those numbers are eye-popping, and it’s also an easier road to travel.

At a brokerage firm, you simply take the money and do your job as you always have. The brokerage firm is also likely to pick up the salaries of your team. In contrast, the expenses will be all yours if you chose the franchise approach.

But when you retire from a brokerage firm, the gravy train is over. Or, at best, it’s over after your five-year reduced trailing payout ends.

Franchise Value

The Franchise Path has been researched and written about by Mark Hurley in his seminal, 100+-page paper on the independent wealth management business. David DeVoe and Elizabeth Nesvold, the top investment bankers in this space, are walking the talk on this subject. Silver Lane, Nesvold’s firm, made headlines recently with the sale of Constellation Wealth Advisors to First Republic.

These transactions were also eye-popping. First Republic’s $115 million purchase of Constellation not only got the attention of the financial press, but also wealth advisors everywhere. Early breakaways firms, Luminous and Bel Air Investment Advisors, were the first to figure out how to realize significant franchise value.

The Long Haul

These mind-blowing numbers wouldn’t be as large if building franchise value was easy.

To realize a big payday, you have to be willing to work hard. You have to build a scalable business and team, and actually defer your ultimate reward for years. By contrast, the star performer at a brokerage firm signs a deal and gets instant gratification.

To create franchise value, you’re also going to have to evolve into a real business leader in two ways.

First, you’re going to have to master the art of operating under a new business model — running your own independent firm and all of the associated challenges. That’s far different from being in-house at a brokerage, where extensive business infrastructure and support are provided.

Second, you’re going to have to become an inspirational figure — someone who can galvanize teams and motivate people to reach the potential they didn’t know they had. That’s also far different than leading a small team at your previous firm, where you are the center of the universe.

To be a successful business leader, you’ll need to adopt the approach popularized by Jim Collins in his book, Good To Great. In that No. 1 bestseller, Collins refers to Level Four Leadership, a collaborative strategy for success that is anything but ego driven.

No Easy Choice

Deciding which path to take is not a lay-up. It depends on who you are and who you ask.

People who have stayed on Wall Street have done extremely well. They include top Barron’s advisors like Greg Vaughan and Andy Chase, and one of the former Constellation partners who stayed with Smith Barney.

They have enjoyed hefty retention bonuses and generous deferred compensation programs. They also benefited from introductions to investment banking clients, as well as introductions to other high net worth clients when their colleagues leave the firm. All they needed to do to reap the bounty was to stay in their seat.

Likewise, the breakaways who built franchise value have been rewarded with mega deals. They are doing just fine, too.

And The Winner Is?

So which way do you go?

I’ve approached the question like I would in choosing between investment managers — momentum investors vs. value investors. Momentum investors usually deliver impressive short-term performance. Value investors are typically rewarded with outsized performance over longer periods of time.

Can you name one momentum investor on the Forbes 400 list? The answer: No you can’t because there aren’t any.

What about value investors? There are many.

I think we have our winner.

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