The recent controversy surrounding Ric Edelman’s cease-and-desist letter to his former partner, David Bach, is another reminder of how difficult it can be to sustain wealth management partnerships despite their (sometimes) obvious advantages.  This week’s post explores the sources of these disputes and what you can do to avoid them.

No Family Feuds in this Business

Unlike most closely held businesses, RIAs are rarely owned by related parties.  One would think that this lack of corporate nepotism would alleviate some of the ownership tensions and succession planning issues that many family businesses struggle with, but that is hardly the case.  These businesses can be very valuable once they hit a certain scale, so there tends to be a lot to fight over when ownership disputes arise.

How Disputes Arise

The recent Edelman-Bach debacle is just a high profile example of what’s going on at RIAs across the country as an industry with aging ownership looks to transition to the next generation of leadership.  Edelman’s case may be more involved since it pertains to an alleged theft of trade secrets and two of the most recognized names in the advisory business, but it still shows how easily a mutually beneficial arrangement can devolve into a costly, litigious affair with no apparent winners.  A lot of our work at Mercer Capital revolves around resolving the valuation component of these disputes, so we see this acrimony firsthand.

This case shows how easily a mutually beneficial arrangement can devolve into a costly, litigious affair with no apparent winners.

Unfortunately for our clients, this trend is not showing any signs of rolling over.  A near decade of favorable market returns and wirehouse defections mean these businesses are more valuable than ever, and their numbers continue to increase.  These realities, combined with an aging ownership base, likely portend more shareholder disputes and business partnerships that may not work out in the end.  For an industry built on relationships, it seems ironic that so many RIA principals don’t get along, but perhaps this is more reflective of enterprising, type A personalities that often clash over firm direction and succession planning.  In our business, we call them business divorces, and they can be every bit as rancorous (or amicable) as their marital counterparts.

Ways to Avoid a Failed Partnership

Sometimes partnerships don’t work out, and fortunately, there are things you can do on the front end to mitigate the likelihood of a costly business divorce that can take years to fully resolve.  Here are a few preemptive maneuvers to consider as you’re evaluating a potential arrangement with another RIA principal or firm.

Do Your Diligence

This may seem obvious, but we often see business divorces that would have easily been avoided with an adequate amount of research on the counterparty.  This requires a much deeper dive than a cursory review of AUM history, client retention rates, fee structures, production levels, etc.  This process should involve several rounds of interviews with your prospective partner(s) and his or her staff, meetings with counsel over the anticipated deal terms, and even some correspondence with the partner’s major clients to understand his or her value-added proposition and likelihood of retention after the deal.  This may seem like a huge hassle and distraction from your current job, but no amount of investigation is as costly and time-consuming as a failed partnership.

Hire Advisors to Establish Pricing and Terms

Even those who are experienced in the world of RIA transactions benefit from some outside perspective on what an appropriate value is for the acquired firm and/or how to structure the partnership moving forward.  For larger transactions, it is common for both sides to hire representation (both legal and transaction-oriented), but it is not unusual for the two parties to jointly retain a single advisor for smaller deals to save costs.  In most transactions and partnership pairings, there can be a widely disparate view on pricing and/or terms, and often it’s up to the advisors to bridge the gap and move the deal forward if doing so is in the best interest of their client.

Negotiate a Buy-Sell Agreement While Your Incentives are Aligned

It’s also a good idea to have counsel draw up appropriate agreements (buy-sell, partnership, etc.) that govern not just the initial deal terms, but also the mechanism for future buy-outs and the dispute resolution protocol if one of the parties decides to part ways.  People don’t usually plan for what happens if things don’t work out, but doing so can save you a lot of hassle down the road.

Ask Yourself, “Can I Work With this Individual(s) on a Daily Basis?”

You’re usually not just pairing with a co-owner but a co-worker as well, which means you’ll likely be spending a lot of time together after the partnership.  Personality disputes are the leading causes of business divorces just as culture clashes are the primary contributors to failed acquisitions in our experience.  Somehow, this usually gets overlooked when a firm or individual is looking for a business partner even though it should be the first thing on their mind.  Business and partner combinations can look great on paper but quickly turn sour if the two parties simply don’t mesh.  We see it all the time, and the fall-out typically leaves both sides worse off than they were before the deal.

The best time to manage a dispute with a new partner is before it happens – or better yet – before he or she is your partner.

The list goes on, but these are the main things to think about before signing up a new partner or acquiring another firm.  We don’t know exactly how the Edelman-Bach dispute is going to play out, but it will likely be very costly and distracting for both of them.  Perhaps this discourse could have been avoided with a bit more diligence and contemplation.

We’re not saying that all RIA business combinations are doomed for failure.  Such partnerships can be (and often are) mutually beneficial arrangements for all parties involved.  We’re just reminding you that the best time to manage a dispute with a new partner is before it happens – or better yet – before he or she is your partner.