First Republic Bank’s announcement last week that it is buying Luminous Capital Holdings LLC has rocked the financial services world. Here are some banner reasons why and some questions to ponder. See: First Republic pays a staggering sum for Luminous Capital, sources say, and shifts the breakaway and M&A games in the bargain.
• The principals of Los Angeles-based Luminous are born-and-bred wirehouse advisors (by way of Goldman Sachs Group Inc.) and were pioneers in the breakaway-broker migration toward independence. See: Fidelity dissects the breakaway cycle with a new study.
• Luminous Capital has been a benchmark for the kind of growth that is possible when advisors leave the world of traditional brokerage firms.
• Mark Sear, David Hou and their team left Merrill Lynch less than five years ago, in May of 2008, at the height of the financial crisis. Is it really possible to “hit your bid” in such a short period of time?
• An all cash deal of this magnitude is largely unheard of in the M&A world.
• It raises a lot of questions about why quality financial advisors would choose to affiliate with a bank.
Why not us?
When I read about the Luminous launch in 2008, I was incredulous. It was astounding that a team managing $8 billion in assets would choose to turn away from transition packages being offered by other wirehouse firms — at the time, in the 250%-plus range — to build a firm from scratch, a venture that offered them little-to-no upfront money and that would require a seemingly Herculean effort to build infrastructure and a brand. See: Hou-Sear team makes house calls in five states.
From its inception, Luminous’ goal was to expand its assets by two to three times in five years. And, in fact, it had grown to $5.5 billion in assets under management as of Sept. 30, from $1.7 billion (not including the $6 billion of assets it chose to jettison as the majority of those assets were related to stock option plans). The vision was to build a fee-only multifamily office. See: Look before you leap: Six questions you must consider before becoming a multifamily office.
I have been very busy the last few days talking with top wirehouse teams who want me to help them to make sense of this showcase deal. The simple truth is that the vast majority of top wirehouse advisors have sought greater independence for years. In a perfect world, where the economics don’t matter, most would tell you that they would love to cut the ties that bind; they crave greater control over their professional lives and the growth of their businesses; and they want to create a customized service model for clients without fear of their firm’s making significant changes that impact their business and how they are compensated.
Giving to get
Alas, we don’t live in a perfect world and the economics do matter for most everyone. The vast majority of wirehouse advisors are most interested in the guaranteed cash upfront upon a move. They lived through 2008 and they know that being offered company stock won’t necessarily do them much good, and that the structure of most deals forces them to grow considerably before they can capture the lion’s share of it. See: 7 things to know about retention bonuses and why the post-check ether may be wearing off.
So, while on the one hand, these folks really want more independence, they are simply not willing to make a move that doesn’t, at a bare minimum, guarantee to make them whole on money left on the table. On the other hand, the value proposition for independence delays gratification for that payday, one that has the potential to far exceed the transition packages the wirehouses and other firms are offering. See: What is the value proposition of a financial advisor — and how is a budding RIA culture upping the ante?.
The Luminous/First Republic deal demonstrates that when a business is high-quality, well-managed, in growth mode and mostly fee- based, the possibilities for sale of that business are endless, and the wait time in order to cash out could be significantly less than the nine- or 10-year term of the forgivable loans attached to wirehouse transition packages. See: Wall Street’s big retention problem: RIA compensation is nearing parity with wirehouse brokers.
The real upside
I am not an investment banker, but I’m savvy enough to know that the multiples being offered for fee-based independent practices with earnings before interest, taxes, depreciation and amortization in the $10-million-plus space are most typically in the seven-to-nine-times range. Word has it that Luminous secured a multiple in excess of 11 times its EBITDA and four times its revenue. Furthermore, it is very rare to see an all-cash deal. In fact, the single biggest reason why deals fall apart is because the seller wants to be paid as much cash upfront, with as few contingencies built in, as possible, and the buyers want the opposite.
Will Mark and David and team be signing on for a life reminiscent of the one they left in 2008? Will being owned by a bank mean more bureaucracy, less autonomy and freedom, and less customized service for clients? No one knows for sure, but I suspect that these guys are smart enough to ensure that the integrity of what they built will be protected. Most important, I can’t imagine that they would do anything to negatively affect the way they could serve clients. First Republic is a different kind of bank — a boutique bank with a high-net-worth client base.
The real upside for the Luminous folks includes the likely cross-selling opportunity with First Republic’s bankers that will enable the firm to offer its wealth management services to the bank’s existing client base and the partnership with a like-minded entity that had the deep pockets to make the deal happen.
Deep buyers’ bench
To be sure, this is a seller’s market and advisors are in the driver’s seat. No longer are they limited to employee status unless it works for them and they choose to remain so. No longer does being independent mean operating alone without support. Models including HighTower Advisors LLC, Dynasty Financial Partners, and Focus Financial Partners LLC have made it possible for high-quality folks to monetize their businesses to varying degrees, to go independent without too much hassle and to access the most cutting-edge and robust platform, technology and thought leadership the industry has to offer. These firms as strategic partners help those that join them grow faster and more efficiently than they would have on their own.
What does this mean for our industry? It means that there will be more and more breakaway brokers because it is easier to achieve independence. It means, too, that going independent doesn’t have to be the endgame. Luminous, after less than five years, chose to sell itself to a bank. But, the bench of potential purchasers for quality businesses is deep, and it includes competitor RIA firms, private investors, private-equity firms, banks, CPA firms, consolidators and the like. By leaving the wirehouse world, Mark Sear and David Hou took advantage early on of a new kind of power available to those with the right mindset — the power of possibility. Those possibilities are expanding more rapidly than anyone had predicted.
Mindy Diamond is president of Diamond Consultants, in Chester, N.J., a nationally recognized search and consulting firm in the financial services industry. See: Why Mindy Diamond is morphing her firm away from pure wirehouse recruiting.