The rise of super-sized firms

Smaller firms look to hold their own amid industry consolidation

Oct 19, 2014 @ 12:01 am

By Mason Braswell

Consolidation in the independent space is turning large firms with $1 billion in assets into $10 billion enterprises — putting pressure on small and midsize firms who do not envision selling.

While $1 billion in assets used to be enough to classify an independent firm as a so-called super-ensemble, firms in that category now have at least $10 billion in assets and bring in an average of $16 million in revenue, according to InvestmentNews' 2014 Financial Performance Study of Advisory Firms. There were 16 super-ensembles in the 2014 study of more than 300 firms, and 44% expected to make another purchase or absorb another firm.

“They are among the fastest-growing firms in the industry and voracious acquirers,” the study reported. “The ambition to acquire and merge is no longer left to chance and opportunity, but is rather part of a well-thought-out and executed strategy.”

(Related read: Advisers face hurdles in the race to grow)

Participants in the study, which included 310 investment advisers and broker-dealer affiliates, showed much less of an appetite to sell their practices. Ninety-six percent of respondents both large and small said they had not sought to sell their firm in the past two years, and 95% said they don't plan to sell in the next two years, either.

But an increasing number of buyers could make it harder for them to sit still, according to Philip Palaveev, CEO of The Ensemble Practice, a consulting firm for independent advisers that collaborated with InvestmentNews on the study.

(More: Adviser M&A activity suggests sellers firmly at the helm)

“Business owners tend not to want to admit they would sell, but if the right offer comes most do,” he said.

Those who do not want to sell may need either to double down on their current specialty or try to get into the acquisition game themselves, said Brandon Odell, director of business consulting at The Ensemble Practice.

“You can use [mergers and acquisitions] to get to critical mass to have the staff and process and size and scale to compete with your market,” Mr. Odell said.

ACTIVE ACQUIRERS

Focus Financial Partners, led by chief executive Ruediger “Rudy” Adolf, is one firm that is capitalizing on the industry's consolidation trend. Focus, which provides investment advisers with funding for acquisitions in exchange for an equity stake in their firms, recently inked a deal with $800 million Gratus Capital Management, the 10th largest fee-only advice firm in Georgia, according to InvestmentNews' RIA Data Center. Focus has added 31 such partners with around $80 billion in assets since its founding in 2006.

Mr. Adolf said other industry forces — such as increasing compliance costs and the need for succession deals — could ultimately create more sellers.

“There are many different factors that come together and lead to a decision to either sell the business outright or merge with another firm,” he said.

Even those firms that may already fall into the category of a super- ensemble show no sign of slowing down. HighTower Advisors, a hybrid firm founded in 2008, has grown to around $30 billion in assets under management, and received a $100 million loan this year from BMO Harris Bank and PNC Bank as it looked to continue to make acquisitions.

(Related: Will HighTower be the next Raymond James?)

United Capital Financial Advisers, which has around $10 billion in assets among about 50 offices, is aiming to add about 20 offices in the next two years as it acquires established advisers, according to its founder, Joe Duran.

NEW ENTRANTS

New firms also continue to enter the market. Steward Partners, which has funding from Raymond James Financial Services Inc., quickly recruited over $1 billion in assets from breakaway advisers since it was founded in October 2013 and is looking to grow to 30 or 40 advisers concentrated in the Northeast.

“An advantage for the big firms is that they can design modern service models that small firms have a hard time keeping up with,” said Alois Pirker, a research director at Aite Group. “Particularly in the very small registered investment adviser space, and particularly when it comes to technology, you have a huge lag and very little innovation.”

Mr. Adolf, however, said he still sees room for smaller firms to compete.

“We don't believe that small firms will disappear,” Mr. Adolf said. “One of the great things about this industry is that you can really perform on many different levels.”

But size is no guarantee of profitability. Even among super-ensembles, there was a big difference between the top 25% and the rest of the pack. The top quarter of firms had average revenue per professional of $1.15 million compared to around $848,000 for the bottom third.

The test for super-ensemble firms will ultimately be how well they are able to drive internal growth, according to John Furey, principal and founder of consultancy Advisor Growth Strategies.

(More: 3 ways top-performing firms stand out)

“Acquisitions help, but you still have to back it up with ongoing growth,” he said. “I know a lot of firms with $1 billion in assets but only $5 million in revenue.”

(This article has been updated to indicate that Focus Financial has about $80 billion in assets, not $70 billion, and United Capital has around 50 offices, not 40.)

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