How Breakaway Clients are Influencing Their Advisors to go Independent

Breakaway clients are driving the movement to independence as much as breakaway brokers, according to Shirl Penney, president and CEO of RIA network Dynasty Financial Partners.

“Clients are not simply following their advisors, but sometimes giving them the idea to break free,” Penney says. “That’s the dirty little secret that not a lot have been talking about.”

These clients want their investment advice to be separate from where investment products are manufactured and sold, according to Penney.

RIA networks – such as Dynasty, HighTower Advisors, Focus Financial – have democratized the so-called triangulation advice model, says Penney.

Dynasty’s RIA network has essentially given all its RIAs “$30 billion of aggregated buying power” when it comes to access to investment products, according to Penney.

“So if you’re a million-dollar client of one of our advisors, you now can get independent advice, separate and safe custody and products from around the street the same way that may have been reserved for a billionaire 20 years ago,” Penney says. “And once clients understand that, it makes a ton of sense.”

Schwab Advisor Services’ informal survey of advisors in December shows that those in the independent space were able to take with them around 87% of their client assets at their previous firms, according to Tim Oden, the firm’s Newport Beach, Calif.-based senior managing director for business development.

Penney, who works closely with Schwab Advisor Services for the needs of Dynasty RIA network, says around two-thirds of the net asset flows into Schwab are coming from “same store sales,” referring to new assets being generated by the roughly 8,000 RIAs that already have Schwab as their custodian.

Those same store sales “are stronger than new breakaway advisor flows,” Penney says.

The awareness – including via ad campaigns – of what custodians like Schwab and Fidelityhave been doing have been very helpful in “creating a more mainstream awareness of what’s going on in the independent space,” Penney says.

Penney contends that the only advisor demographic that’s growing is in the RIA channel.

Cerulli Associates has identified the independent RIA channel as one of the “largest pockets of opportunity” to generate revenue and increase market share in the financial advisory space. The research firm projects that independent RIAs and hybrid RIAs combined will increase their market share to 28% in 2020 from 23% in 2015.

The exit of certain high-profile broker-dealers from the Protocol for Broker Recruiting hasn’t slowed down the movement to independence in the way it had been first feared, according to Penney.

Advisors look at the ones who broke away before them, and use them as a gauge for what their own future could look like, Penney says.

“Success has bred more success,” Penney says. “The road is now kind of a highway towards independence. It’s pretty well-paved at this point. There are a lot of case studies that advisors can look at to follow.”

There are now more than 680 RIAs with more than $1 billion in client assets – and those firms are growing fast because they have resources that are being deployed toward pursuing M&A transactions, according to Penney.

Yet Penney acknowledges there are many advisory firms which aren’t ready for M&A.

“A lot of advisors start to go down that M&A path and then they get busy with their day job and take care of their clients and they lose focus,” Penney says. “It’s the firms that are really committed to rapidly professionalizing their business and then commit to going through the process of getting ready that are the ones who can get out to the market.”

One of the biggest mistakes advisors commonly make when pursuing M&A is talking to the principals of the target firm “without truly understanding what it is they are saying,” according to Penney.

“The first thing to do is get the right brand infrastructure in place,” Penney says. “There’s a readiness that has to occur and that takes time and work and effort.”

Logistically, capital operating documents, equity structures and compensation plans must also be in place, Penney adds.

Out of the 47 firms in Dynasty’s RIA network, around 15 were “realistically ready” for M&A as of last year, with a number of them already executing transactions, according to Penney. Dynasty provides its RIA network with M&A support, including a credit facility.

There’s a “naiveté among a lot of advisors” who think pursuing M&A isn’t difficult, but the reality is “it takes a lot of real effort and focus,” Penney says.

There is currently an abundance of “unrealistic expectations” when it comes to valuations, according to Penney.

“You have a supply and demand imbalance. You have more demand on behalf of more buyers than you have sellers, and I think that’s contributed to the pushing up of the pricing,” Penney says. “I think a lot of that dry powder kind of goes away with a market pullback in some of the revenues, and then when earnings go down with the market pullback, I actually think you’ll see more transactions get done right.”

Penney notes that valuations are very specific to each deal.

Typically, “in the current environment,” an RIA with “a couple hundred million in client assets, growing north of 10% per year, doing a couple million in revenue, with nice 25% margins,” it wouldn’t be unusual to see valuations at “six to seven times multiple,” according to Penney.

Once RIAs go up to around $1 billion in client assets, growing more than 10% per year, those firms can attract “anywhere from eight to 10 times EBITDA (earnings before interest, tax, depreciation and amortization),” Penney says.