First Republic pays a staggering sum for Luminous Capital, sources say, and shifts the breakaway and M&A games in the bargain

Recruiters are getting renewed interest from big wirehouse teams and the $125 million deal shows that breakaway brokers can realize big enterprise value in short order

Wednesday 11.7.12 by Brooke Southall

Brooke’s Note: When David Hou and Mark Sear first executed a brilliant breakaway from Merrill Lynch in 2008 — complete with synchronized watches and trips up and down an elevator with their team of in-the-dark associates — it was both a coup and a turning point. See: Hou-Sear team makes house calls in five states. Until that moment, the RIA business had failed to lure away a wirehouse team that enjoyed all the perks of Wall Street glory and glamour. Heck, Hou and Sear were the advisors for top wirehouse executives. I even got a glowing report from Bob McCann himself about his former underlings when I wrote about them. So what do you do as a follow-up act if you are Hou, Sear and partners? Aside from building assets from $1.7 billion to $5.5 billion in a matter of three years, they have now pulled off a very enviable deal that more than makes up for retention or signing bonuses forgone. It shows how much enterprise value can be established in such a very short time under an RIA structure. Here are some people opining on the matter — and it was all delivered, I can tell you, with a tone of respect and admiration.

The $125 million in cash — according to an SEC filing — that First Republic Bank paid for Luminous Capital has acted as a major shot of adrenaline to recruiters who poach big breakaway teams and to investment bankers and M&A specialists who sell them. See: A $5.5 billion LA-based RIA is getting purchased by First Republic Bank.

The San Francisco-based bank, trust company and wealth management firm brought one of the fastest-growing and most profitable RIAs into its fold by not only paying a multiple of earnings that harks back to 2007 days but by simply, so to speak, writing a check. Deals of this nature are likely to involve all kinds of earn-outs, equity with a no-sell period and other types of delayed gratification.

World series-class deal

See: How the Luminous deal is rocking the recruiting world — and why it could be hard to replicate.

Despite the size of the deal, industry observers agree that the transaction does not appear to be one-sided. Luminous partners have literally gone from serving ultrahigh-net-worth investors to being UHNW investors. And, not only did they get a big payday, but — unlike wirehouse brokers who get bonuses — the income isn’t counted as W-2 salary on their tax returns. It’s a capital gain that is still kindly treated by the IRS in 2012. One source says Luminous appears to have been deliberate about reaping the low tax rate and has been shopping the practice for a while.

But First Republic may have hit its own home run. It’ll suddenly gain a world of high-end banking clients. It can also use Luminous as its in-house managers for, for instance, relatively unmanaged pledged assets sitting in its possession, sources say.

“It’s a very attractive valuation and outside the bands we usually see,” David DeVoe, chief executive of DeVoe & Company, says in response to information communicated to him from the RIABiz source. He adds that the all-cash aspect stands out all the more considering the price paid. “That can be a negotiating point, to talk down the price.”

David DeVoe: It's a very attractive valuation and outside the bands we usually see.
David DeVoe: It’s a very attractive
valuation and outside the bands we
usually see.

Luminous Capital and First Republic declined to comment on any of the performance metrics or price information provided by these sources. First Republic did say that the partners of Luminous were signed to long-term deals, though it declined to say how long that long is. The companies affirmed, however, that the Luminous brand will stay intact — for now. It is expected to eventually be phased out.

Banking jolt

Mark Sear, CEO of Luminous Capital, says that he doesn’t need a contract to make him want to continue to do his job.

“I’m 48. What am I going to do — sit on the beach? I love my clients; [serving them] is what I enjoy doing.” See: Hou-Sear team applies Goldman Sachs marketing approach in second year as RIAs.

Besides the handsome deal, Sear says that he found that he had other incentives to become part of First Republic. High on the list is the immediate jolt it gives Luminous in providing banking services. “People need lending solutions, and we don’t have them,” he says.

Luminous has been frustrated by having to refer business to various banks and then having those banks provide second-rate service. The problem is that the clients hold Luminous partially responsible, he adds. Bringing banking services under Luminous’ control with First Republic backing closes that quality gap.

'A godsend’

Though the deal appears plenty favorable to Luminous Capital and its personnel, it has also lifted the boats of RIAs and the RIA business in general, according to M&A people, platform providers to breakaways, and recruiters.

Shirl Penney, CEO of Dynasty Financial Partners LLC, counts himself among the admirers of the coup pulled off by Hou and Sear, et al.

“It’s remarkable to consider they left the wirehouse model in late 2008 at the peak of the downturn and over the next four years as independent advisors leveraging the fiduciary model were able to essentially quadruple their business,” he says. “This provides an interesting road map for other very large teams considering independence for any or all of those reasons.”

Shirl Penney: This provides an interesting road map for other very large teams considering independence.
Shirl Penney: This provides an interesting
road map for other very large
teams considering independence.

As an executive at another platform provider said, not for attribution: “For us talking to breakaway brokers, this is a godsend to us. The good news, bad news for a firm like HighTower is that, good news, they can use it to value their entire business, but, bad news, the amount they pay to acquire firms could go up.”

Rising tide

DeVoe says that this valuation doesn’t come completely out of the clear blue sky, in the sense that valuations in general have risen to a more historically normal level during the past year. And banks in more booming times were known to pay these kinds of prices. See: M&A market reaching a new normal based on RIA-driven deals, say competing reports from Pershing, Schwab.

“It shows [valuations] may be continuing to move up, and it’s a strong vote for the [RIA] business.”

But the deal — even without the benefit of knowing the exact terms — had phones ringing (notwithstanding makeshift arrangements after Superstorm Sandy) at the Chester, N.J., offices of Diamond Consultants, a top recruiter of wirehouse brokers.

Mindy Diamond, principal of the firm, says she spoke, for instance, to a Merrill Lynch team leader with $15 million of production with whom she has spoken to off and on for an extended period. The issue she faces with these teams, she says, is their belief that all the landing pads of a breakaway are, at best, marginally better. The Luminous deal caught the attention of big producers as something with an aura of head-and-shoulders better.

An earlier version of this article pegged the purchase price at $200 million based on information from two industry sources. The article was changed to reflect an 8k filing made today showing a price of $125 million.

David Hou | Mark Sear | Bob McCann | Mindy Diamond | David DeVoe | Shirl Penney

Diamond Consultants | Dynasty Financial Partners | DeVoe & Co.