Flush PE firms see the broker-dealers as poised for growth, but others fear such purchases could lead to 'pump and dump' scenarios
Brooke’s Note: There’s irony here. Many independent advisors left the world of big New York money to, well, achieve greater independence. The money, it seems, wants to follow them as private equity funds take stakes in independent broker-dealers. On balance, this seems like a good thing because well-funded IBDs will be better armed to lure more advisors into independence from the wirehouses. IBDs, in turn, incubate future RIAs. But executives at well-respected Cambridge Investment Research and Commonwealth Financial Network say there could also be a downside to receiving cash from this variety of investor. This article looks at both sides.
Despite razor-thin margins, a reputation for going out of business and a tougher business model to support in this regulatory environment, private equity firms have been hungrily buying up what some folks are all-but giving away – ownership interest in independent broker dealers.
Where some see an antiquated business model and a minefield of liabilities, private equity firms see what all investors are looking for: The opportunity to make a relatively small investment that will reap a much larger amount of money in return. (Just yesterday InvestmentNews revealed that B-D CapWest was shutting down.)
Additionally, PE firms see giant growth potential due to retiring baby boomers and an ongoing march toward independence by advisors, ensuring a giant pool of talent pre-trained compliments of the ailing Wall Street wirehouses.
Finally, amid massive consolidation in the IBD space, private equity firms are convinced they can provide the cash flow needed to ramp up technology features, making these locations even more attractive to breakaway brokers.
“PE firms are eyeing the IBD industry because they like industries where they can offer strategic thought, scale and capital,” says Chip Roame, managing partner of Tiburon Strategic Advisors in Tiburon, Calif.
If the old journalism saw stating that three of anything makes a trend, the PE prospecting fest, which heated up over the summer, could be turning into just that.
In August, Lovell Minnick Partners LLC announced its buy of First Allied Securities from Advanced Equities See: Private equity firm acquires First Allied. That same month, Ameriprise Financial Inc. announced it was selling Securities America Financial Corp. to Ladenburg Thalmann Financial Services Inc.
In June, Parthenon Capital Partners announced it is acquiring H.D. Vest Financial Services Inc., which is owned by Wells Fargo & Co.
A year ago, Lightyear Financial LLC purchased majority ownership of three broker-dealers from ING Groep NV and named them Cetera Financial Group. See: Cetera spends millions on rebalancing software to make its reps more RIA-like.
It all started back in 2005, when LPL Financial Holdings Inc. became the first IBD to be purchased by private equity firms Hellman & Friedman LLC and Texas Pacific Group.
Not so fast, says Dan Seivert, CEO of ECHELON Partners, an investment bank in Manhattan Beach, Calif. He does not consider those deals to represent a trend considering the relatively tiny number of deals to the thousands of IBDs out there.
Other analysts, however, say there may be more of these deals being contemplated in the war rooms of PE firms – often considered reservoirs of smart money.
If private equity firms pump cash into these IBDs, continuing to make their platforms superior to wirehouses, then IBDs will easily attract even more advisors, says Aite Group senior analyst Greg Cherry
“If the value proposition is perceived as better on the independent side and the capabilities are still there, then wirehouse advisors will have the incentive to make that switch,” he says.
Given the problems in the IBD arena, private equity firms can purchase IBDs at bargain prices.
Still, PE firms must perform their due diligence because there are certainly some IBDs out there with questionable reputations, cautions Bing Waldert, senior analyst with Boston-based Cerulli Associates Inc.
But when firms like Cetera bring in top talent, it increases the firm’s reputation and will make it more attractive to advisors.
“If you look at the quality of people Cetera is bringing in, they’re bringing in senior people from other firms and that’s all by design,” Waldert says.
Blood in the water
Executives at private equity firms say they are attracted to large IBDs with strong platforms because they believe they can grow a brand and succeed while smaller IBDs are left to die on the vine.“I think one reason for private equity interest in independent broker dealers is finding an efficient platform and being able to effectively create scale with the firm. Frankly, that’s how we’re looking at it. We think this is a fantastic well-run platform.” says Bob Belke, managing director of Lovell Minnick.
While other IBDs are cash-strapped, Belke says his firm can step in and immediately start making investments to improve the technology offering, making First Allied’s platform more appealing to advisors.
He declined to say how much the company intends to invest in the first year, calling it “meaningful additional capital.”
Lovell Minnick hopes to grow organically through its own advisors, Belke says, and also aims to make additional acquisitions.
While PE firms are grabbing larger IBDs, they’re not likely to invest in ones with less than 500 reps, though It is possible these small firms may get bought by existing PE-backed IBDs, Roame says.
For its part, Parthenon Capital Partners is attracted to the IBD space because of the emphasis on savings for retirement, says Brian Golson, managing partner of Parthenon Capital in an e-mail.
Furthermore, IBD models demonstrate an impressive percentage of recurring revenue, highly diversified revenue and “significant potential for growth through investing in the growth of new and existing advisors.”
“In the case of HD Vest, we were particularly attracted to the company’s exceptional track record of delivering a complete platform to the tax advisor market,” he says. “When we had the chance to partner with the company’s talented executive team to buy the business from Wells Fargo, we jumped at the opportunity.”
Flush with cash
Private equity firms don’t stint on spending. In fact, since Lightyear bought the three broker-dealers the company has spent $30 million to transition ING’s systems and to build a robust technology platform. The company intends to spend another $8 million on technology improvements this year. See: Cetera Financial shores up its technology as it prepares to take on LPL for big hybrid RIAs.
Cetera has also created 31 new positions in the last year and has wooed top talent from other firms like LPL.
By making these types of investments, the company is already being rewarded with higher assets, says Cetera president Valerie Brown.
Cetera has $82.5 billion in assets and the firm is up 18% from a year ago.
“Once we show advisors that we’ve got a willingness to invest in the business and that we’ve invested in technology it goes down pretty nicely,” Brown says. “The fact that we’re supported by private equity isn’t anything but positive.”
Catch and release
“Advisors become very nervous when venture capital and private equity firms are involved,” says Eric Schwartz, CEO of Cambridge. “They know they’re not interested in being in the business and are only thinking about getting 25% rates of return so
they can sell it and go on to the next project.”
Schwartz predicts consolidation will continue to be fostered by private equity firms who will buy these assets, hold on to them for five to seven years, and sell them.
Despite the interest from private equity firms, he’s still convinced that Cambridge can attract advisors and continue its rapid growth pattern of about 20% on an annualized basis on its own.
As a result, Schwartz says he doesn’t intend to get involved in a private equity deal anytime soon. “We can make decisions as a privately held company without debt that we couldn’t make if we had a venture capital partner expecting certain returns. Our goal is to be a survivor and I think many of the reps we have value our stability.”
Experience trumps cash
In addition, companies like Cambridge and Commonwealth tout the fact that they are filled with industry insiders and so can cater to advisors better than outsider private equity firms.
“It’s not an issue of resources,” says John Rooney, managing principal of Commonwealth. “It’s a question of what you do to cater to the niche and are you carving a value proposition in the broker-dealer landscape.”
He, too, speculates that private equity firms may score hefty profits and exit the industry as fast as they can.
“If you’re coming to a low-margin business can you grow it a little bit and find someone who will pay you a big multiple?” Rooney says. “Good luck with that. My value proposition is to be the high-end broker-dealer offering the best integrated set of services among broker dealers.”