When growth stalls, plan on a call from Focus Financial

Simon Hoyle


March 7, 2017

If you’d built your financial planning practice to $7.7 billion of funds under management, you might justifiably consider it a success. But US financial planning firm Buckingham, based in St Louis, Missouri, considered it a challenge: How can you grow to $10 billion?

Rajini Kodialam, co-founder and managing director of the New York-based Focus Financial Partners, says Buckingham’s situation is common to Registered Investment Advisors (RIAs) across the US and non-aligned financial planning firms across Australia; eventually, the business hits a glass ceiling and growth stalls. Buckingham hit the ceiling at several billion dollars; other firms could hit it at less than $100 million or at $500 million.

Focus Financial acquired a stake in Buckingham in 2007 and today the firm manages $28 billion.
It has shattered the glass ceiling, and Kodialam says what worked for Buckingham can work for other RIAs in the US and non-aligned advice firms in Australia.

“Let me be the first to tell you they did that because they are a great firm – maybe we helped
a little,” Kodialam says.

The foundation of the Focus Financial business model is to buy equity in advice firms and help them overcome impediments to growth. Focus now has 40 partner firms in the US and annual revenue exceeding $US400 million ($528 million).

Kodialam says the same approach will work in Australia, where Focus has so far made just one acquisition – a stake in MW Lomax, which has offices in Melbourne and Sydney – but is working on other deals that are expected to settle in the first half of 2017. With the attention of investors such as Focus, Australian advice firms can compete for capital on a global scale, and Kodialam says the best Australian firms stack up exceptionally well.

“The similarity between Australia and the UK is stunning, both in the way things are priced and
in how deals are done,” she says. “Canada is a tad different. It’s also a smaller market in the
non-aligned [space]. But Australia looks like the UK to me, and it’s not that far from the US in terms
of pricing; in fact, if anything, I would say you guys are a tad more aggressively priced than the
United States.”

Help the best get better

Wherever they are to be found, the most attractive financial planning investments are already excellent businesses, Kodialam explains.

“We do not do re-engineering,” she says. “We are not in the re-engineering business. I’m not saying it’s a bad business but it’s a different business. We want to buy people who are at the top of their game, who still believe they want to grow better, faster, cheaper.

“In the end, we are acquirers of free cash flow. The true metric is the EBITDA of the business. We don’t base it on revenue, we don’t base it on FUM. Of course, we would look at all those metrics and how [the business] grows, but we’re looking for a healthy firm, with a very strong cash-flow margin, with high retention of clients, and very strong recurring revenue.

“Good, established, fiduciary, profitable businesses, with good recurring revenue.”
Despite some differences in scale, the Australian and US advice industries share some striking similarities in structure.

“The whole genesis of Focus was the realisation of a couple of things,” Kodialam says. “[First], RIAs, which is our name for IFAs – independent, non-aligned, unbiased wealth managers” make up an industry in the US that was growing about 20 per cent a year, on average, in 2004, 2005 and 2006.

“If you look at [funds under management from 2000–10], the RIA industry in the United States was a blip. [Australia’s] got the big four banks; we have our wire houses. They still dominate, but at that point [the industry] was even more dominated by the Merrill Lynchs, the Morgan Stanleys, the Goldman Sachs. Less than 10 per cent of the FUM – in fact the number was closer to 6 per cent – was being managed by all these independents, with the rest in a very concentrated cluster run by these wire houses.

“But these were the guys who were growing, and they were growing 20 per cent a year, without marketing. For someone like me, who was operating under the billion-dollar marketing budget of American Express, it was a stunning revelation. They are running profitable, high-growth businesses simply because they are doing right by their clients. And these highly satisfied clients are giving them warm referrals, leading to growth. A beautiful model.”

Everybody has a ceiling

Kodialam says closer inspection revealed the RIA market is highly fragmented, populated by many mom-and-pop shops, “built around the genius of one, maybe two, entrepreneurs”.

She says that, regardless of their size, RIAs and IFAs eventually hit that glass ceiling and growth stalls, because managing a business through that stage is not necessarily a skill the firm’s entrepreneurial founders possess.

“Our largest partner firm, Buckingham – nothing to do with the UK – was a $7.7 billion firm when it became part of Focus in 2007,” she says. “And you might rationally ask, ‘What glass ceiling?’ [Reaching $7.7 billion is] no mean feat. But they had a glass ceiling, and it was $10 billion.”

Focus Financial also recognised that firms that mastered growth often ran into another problem, Kodialam says.

“The very success of the founding partners created this big gap in economics between them and the next generation,” she explains. “Unless the founding partner [basically decided] to walk away from the value they’d created – which is wrong for them and their family – or the next generation decided to mortgage their first- and second-born … you had this huge gap that leads to one of two things happening.”

The first possibility, she says, is the founder selling to a bank, “in many ways decimating the very thing that he or she has built, every promise they made to a client and every promise they made to an employee”.

Alternatively, the next generation of leadership, priced out of the business, simply “walks away and hangs up a shingle 100 yards down the road. That’s why we had 18,000 of these RIAs,” Kodialam says. “Simply too many.”

A better deal for founders

On the other hand, if a firm’s founders sell a sizeable chunk of equity to a single investor, it changes the economics, enabling the next generation to come through.

“We have to buy enough to make it worthwhile as a hub,” she says. “But we also have to leave enough behind for it to be worthwhile for them to want to come to work every day to grow the firm, and for somebody else to want to buy it from them when they retire.

“You’re not selling 100 per cent of your firm to the next generation. Focus is buying a piece of your firm at a premium multiple, which allows you to sell the rest of your firm to your next gen at maybe a more normalised multiple. That’s not necessary, but it’s one way you could play.

“Usually, people say, ‘I’ve got one person who has to buy my business.’ It doesn’t work that way. Most founders wear multiple hats. They’re chief cook and bottle washer, but as the firm grows and you think of transitioning to the next generation, you don’t have that entrepreneur coming in, you have the hired-gun approach to it, which is good.”

Kodialam says having a large investor behind your advice firm helps it attract individuals from a deeper pool. It broadens the skills of the firm’s owners and senior management, and lowers the entry cost for each of those individuals.

“When your sale is not to one but to two or three people, you’ve divided your risk and it’s easier to do,” Kodialam says. She adds that the equity partnership model Focus pursues works in markets where regulations have created a clearly client-focused environment, where advisers have a fiduciary responsibility to those clients, and where conflicts of interest have been removed.

Consolidation pressure means scope for growth

There has to be scope for growth in the non-aligned advice market.

“There has to be an understanding of the benefits of unbiased advice, among both advisers and clients,” she says. “The GFC was brilliant in a sense. No one wants it again – believe me, I don’t – but there was a huge silver lining. It completely highlighted the lack of transparency, the double-dipping, the pricing anomalies, the service anomalies in the biased versus the unbiased market, to clients around the world. And there is a good understanding [now] of what an unbiased adviser can do for [people].

“We look for either demographic or regulatory circumstances that suggest a need for consolidation among some of these players. Your FoFA, [Retail Distribution Review] in the UK, [Client Relationship Model Phase 2] in Canada, [Financial Advisory Industry Review] in Singapore – these laws are all dramatically increasing the burden on smaller firms, suggesting consolidation.

“We like these things, because we’ve lived with the first cousin of each and every one of these regulations – the Securities and Exchange Commission’s Investment Advisers Act – since 1940. We’re very familiar with it. Regulatory changes don’t worry us. We actually welcome them.”

Finally, Kodialam says the trends toward non-aligned advice and consolidation create an environment where whole teams can potentially walk away from institutional ownership and set up viable businesses of their own.

She says Australia may become Focus’s second-largest market outside the US, ahead of both Canada and the UK. The firm is also “interested in Singapore and Hong Kong”, she explains, but will probably use Australia as a hub, with investments in Asia the spokes.

TOPICS:   Focus Financial Partners,  growth for advice firms,  industry consolidation,  MW Lomax,  non-aligned advice market,  Rajini Kodialam

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