Someday anthropologists will write the history of American society as viewed through the lens of the U.S. auto industry, and when they do, they’ll probably consider the cathartic moment in 2018 when Ford Motor Company announced that, except for the Mustang, they were no longer going to build cars. When my dad graduated from high school in 1957, the big three automakers sold their products based on the amount of horsepower and chrome they could bolt together. Trucks were strictly for work. Two generations later, as my older daughter heads into her senior year, $70 oil isn’t enough to deter Americans from wanting their own rolling living room with all-wheel drive. Ford’s capitulation to its own success with SUVs says as much about our country as it does about Ford. SUVs aren’t popular because they haul a lot of stuff; SUVs are popular because we have a lot of stuff to haul.
Last week we offered up some observations on Focus Financial’s S-1, and as we continue to study the filings, it occurred to me that they say as much about the current state of the RIA industry as to they do about Focus itself.
The RIA Industry Is Vast, and Growing
In its twelve-year history, Focus has completed 140 transactions, though they’ve barely made a dent in the industry. With annualized total revenue approaching $800 million, Focus can’t yet claim so much as a 2% U.S. market share in an industry that is projected to grow by nearly 50% over the next five years.
RIA industry growth is demand-driven. According to data cited in the S-1, the global high net worth population grew at a 7.2% annual rate from 2010 to 2016, and the wealth of that cohort is expected to grow at nearly a 6% clip over the next decade. The advisor community is growing to meet this demand, and the RIA channel increased its share of total advisors from 7% to nearly 12% over the past decade (over 20% if you include hybrid RIA-BD firms). Much of this growth is happening at the expense of wirehouse wealth management operations, which is why we’ll continue to hear more about broker protocol in the coming months and years – or at least until the wirehouse firms find a way to stabilize their market share within the broader investment management industry.
Focus has the benefit of scale in an industry with strong tailwinds, and with a public offering, they’ll have the currency to try their hand at organizing the space. Or at least that’s the idea.
The RIA Industry Is Stubbornly Diverse
As is often the case with fast-growing industries, the RIA community is highly fragmented. The Focus S-1 cites industry data that the 37,000 or so members of the RIA advisor community work for nearly 15,000 distinct RIAs. This would suggest the average RIA employs fewer than three advisors. While averages can be misleading, our research and experience also suggest that a substantial number of RIAs are small firms that are organized more as professional practices than institutionalized businesses.
Focus estimates that about 500 RIAs would qualify as direct partners (they’ve rolled up 55 so far) and 5,000 would be suitable for subsidiary level acquisition by partner firms. In a growing industry, we assume those numbers are trending up, even with the consolidation efforts underway.
The RIA industry doesn’t consist of that many firms by accident, however. A lot of advisors develop independent businesses because they like doing things their own way, and consequently, their firms are a product of the personalities of those founders.
Focus’s founder, Rudy Adolf, credits learning never to “turn a successful entrepreneur into an employee” from how his father organized the accounting firm he founded. The accounting industry is way ahead of wealth management in consolidation efforts, but accounting is a heavily regimented practice and is a profession not characterized by as much “personality” as the RIA community. Focus seems to recognize this in how they handle acquisitions, leaving partner firms to govern themselves while structuring financial motivations with prescriptive profit splits.
Consolidating the RIA Industry Is Available, but Not Easy
Focus was conceived 14 years ago and has been operating as a private equity platform for a dozen years. United Capital and Hightower have been at it for nearly as long, and the time involved in developing these consolidation efforts speaks to the difficulty of achieving scale in the wealth management industry.
The prospectus cites the lack of succession planning in the RIA community as an opportunity for Focus to provide exit capital and a path to retirement for RIA owners who don’t have another logical internal or external buyer. Succession planning is, in our perspective, a huge issue in an industry where some statistics suggest there are more practitioners in the latter stages of their careers (over 60) than in the building stages of their careers (under 40). We agree that this is a rich opportunity for Focus, but it’s also a challenge, as it suggests that succession planning isn’t really that much of a priority for many RIA owners who would rather retain the benefits of the status-quo than sell out to a third party.
Fortunately for Focus, this challenge is itself wrapped in an opportunity, because the aging of the RIA community mimics that of the global population, and most RIA clients materialize around the time they retire. The demand-side growth is all but certain. To be successful, though, Focus – or their partner firms – will have to out-recruit other industries to accumulate the talent necessary to service the demand. As we said in last week’s post, we think one of the most interesting challenges/opportunities for Focus is developing an operating platform to build what they’ve bought.